ERSM40090 | Convertible Securities

s440 & s441 Part 7 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA)

Computing the taxable amount: examples

Example 1: securities acquired on or after 1 September 2003

100 Convertible shares were acquired by A Smith on 1 December 2003 and were converted into 100 Ordinary shares on 31 March 2004. On acquisition, Smith paid 50p for each share which at that time were worth £1 on a non convertible basis and £1.25 on a convertible basis.

There was no consideration given for the right to convert the securities as the non-convertible market value on acquisition exceeded the price paid by Smith (see ERSM40070).

To calculate the tax charge on acquisition; reduce the non-convertible market value by the amount paid for the shares, so:

Taxable amount on acquisition = (100 x £1) less (100 x .50p) = £50.

Smith paid £25 to convert the securities on 31 March 2004 when the Ordinary shares acquired were worth £3 each and the original Convertible shares were worth £2 each (on a non-convertible basis). There were no other expenses incurred by Smith for the conversion and no

To calculate the tax charge on conversion; apply the formula

CMVCS – (CMVERS + CC)

CMVCS: Market value of newly converted securities = 100 x £3 = £300

CMVERS: Market value (non convertible basis) of original securities when converted

= 100 x £2 = £200

CC: Consideration given to convert the securities = £25

Taxable amount on conversion = 300 – (200 + 25) = £75

Example 2: securities acquired before 1 September 2003

Claire Brown paid tax on convertible loan stock acquired from her employer on 1September 2002. This included a charge on the value of ‘right to convert’. She received £100 convertible loan stock @ 10% with a right to convert into shares in three years’ time. A payment of £10 is required to convert. The total market value on acquisition was £120, on which she paid tax. The value of the right to convert was agreed at £20. After three years the stock, ignoring the right to convert, is now worth £200 (because interest rates have declined), and the shares into which the stock is converted are worth £300.

From the consideration received (cash on sale, or market value of new securities onconversion) will be deducted

• the current value of the old security ignoring the right to convert,

• anything paid for conversion, and

• part of the old convertible security’s value (paid for or charged to tax) that related to the acquisition of the right to convert.

This will allowed as a deduction in the s 440(1) ITEPA formula, per subsection (3). The computation will be, using acronyms in s440 and s441 ITEPA.

CMVCS – (CMVERS + CC) – CE

where:

• CMVCS is Current Market Value of Converted Securities,

• CMVERS is Current Market Value of Employment Related Securities,

• CC is Consideration for Conversion, and

• CE is Consideration for Entitlement to convert plus expenses.

Thus:

Taxable amount on conversion = 300 – (200 + 10) – 20 = £70