CFM37770 - Loan relationships: 鈥榟ybrid鈥� securities with embedded derivatives: expenses of issuing security

Expenses of issuing a security

Where the accounting treatment of a compound instrument requires bifurcation (for example, in the case of a convertible bond), the costs of issuing the security may for accounting purposes be apportioned between the 鈥榟ost contract鈥� and equity component (CFM37660).

For tax purposes, however, the effect of CTA09/S415(1) is to treat 鈥榬ights and liabilities under a loan relationship鈥� as divided between a notional loan relationship and a relevant contract. That effect does not extend to expenses which are incurred in issuing the security, but which do not form part of the company鈥檚 liabilities under the terms of the security itself.

Thus when considering the allowability of expenses, it is necessary to apply CTA09/S307(4) to the debtor loan relationship as a whole. It will not matter whether the security is bifurcated in the company鈥檚 accounts, or accounted for as a single instrument.

In particular, incidental expenses relating to the issue of shares to satisfy liabilities under a convertible security (such as legal costs) will be allowable provided they are directly incurred for the purpose of raising finance through the issue of securities. For example, where it is necessary for a company meeting to agree an increase in a company鈥檚 authorised share capital before it issues a convertible security, the expenses of calling the meeting will not be allowable (as a loan relationships debit) where that is only one of a number of items of business being transacted.

Expenditure is allowable on the basis shown in the accounts: where some debits are attributed to the host contract and some to the equity element (or embedded derivative) for accounting purposes, they must be 鈥榯aken together鈥� in accordance with CTA09/S307(3).

The same principles apply to holders of hybrid securities. However, where shares are acquired under a convertible or exchangeable security, any subsequent expenditure on selling the shares (including any costs of swapping mandatorily exchangeable preference shares for ordinary shares) will form part of the capital gains computation on the share disposal.