CFM82180 | Old rules: convertibles pre 2005: nature of the security: option to purchase shares

Entitlement to acquire shares

This guidance applies to periods of account beginning before 1 January 2005

A convertible security will clearly show as part of its terms, or as a consequence of rights attached to the security, that the holder has an option to acquire shares. This may either be at the end of the term of the loan or when certain conditions are met.

Example 1

LB Ltd issues a security for £10,000 with a face value of £10,000, to KD Ltd. The terms show that

• at the end of 1 year, the holder can choose to convert the security into LB Ltd shares

• the shares will be issued on a 1 for 1 basis, that is, £1 nominal loan stock will be converted into £1 nominal of shares issued by LB Ltd.

This security would have satisfied the conditions in FA96/S92(1)(b).

If KD Ltd decides not to opt to convert, and continues to hold the security, it would have ceased to satisfy the conditions of S92(1)(b) and would then be dealt with as a normal loan relationship.

Example 2

LB Ltd issues a security for £10,000 with a face value of £10,000, to KD Ltd. The terms show that

• at the end of 1 year, the holder can choose to exchange the security for shares in TG Ltd

• the shares will be exchanged on a 1 for 1 basis, that is, £1 nominal loan stock will be exchanged for £1 nominal of shares in TG Ltd.

LB Ltd may already own TG Ltd shares, or may have to buy them in order to fulfil the terms of the security.

This security would have satisfied the conditions in S92(1)(b).

If KD Ltd decided not to opt to convert, and continued to hold the security, it would have ceased to satisfy the conditions of S92(1)(b) and would then be dealt with as a normal loan relationship.