Chapter 12: Disposals of futures and options involving guaranteed returns
Overview
2171.This Chapter rewrites the provisions in Schedule 5AA to ICTA on guaranteed returns on transactions in futures and options. It taxes as income profits and gains on a disposal of a future or option which, but for this Chapter, would be taxed as chargeable gains.
Section 555: Charge to tax under Chapter 12
2172.This section charges to tax profits and gains arising on a disposal of a future or option to which the Chapter applies. It is based on paragraph 1 of Schedule 5AA to ICTA.
2173.The section refers to “profits and gains”, as in the source legislation, since the profits arising may also be gains for the purposes of TCGA. There are provisions to ensure that a double charge under both this Chapter and TCGA does not arise. See new section 148A of TCGA (futures and options involving guaranteed returns) in paragraph 435 of Schedule 1 to this Act.
2174.The word “disposal” (see section 562 (when disposals of futures or options occur: general)) replaces “transaction to which this Schedule applies” since a gain can only arise on a disposal, although not all transactions are necessarily disposals.
2175.Subsection (1) refers to a disposal of a future or option rather than a disposal of futures or options as in paragraph 2(1) of Schedule 5AA to ICTA. A taxpayer is taxed on a disposal of a future or an option. A similar reference to a disposal of a future or option appears in sections 559 and 560 where the source legislation refers to a disposal of futures or options.
2176.Subsection (2) provides that profits which, but for this Chapter, would be capital profits, may be charged under this Chapter.
2177.Profits and gains from a trade, whether arising in the United Kingdom or abroad, are excluded and dealt with under Part 2 of this Act. See section 366(1) which gives the charge in Part 2 priority. That aside, the charge under this Chapter is on both UK and foreign profits and gains. See Change 101 in Annex 1.
Section 556: Income charged
2178.This section sets out the amount charged to tax on profits and gains that arise on the disposal of a future or option. It is based on paragraph 1 of Schedule 5AA to ICTA.
2179.Schedule 5AA to ICTA provides no precise computational rules for computing the profit or gain arising on the future or option chargeable to tax. It refers only to the profits being “realised”. This is rewritten by providing that the profits are the full amount of profits and gains arising when the disposal occurs. In most cases the quantum of profits will be the difference between the disposal proceeds and the acquisition cost of the future or option.
Section 557: Person liable
2180.This section states who is liable for any tax charged. It is based on paragraph 1 of Schedule 5AA to ICTA.
Section 558: Meaning of “future”, “option” etc.
2181.This section explains what is meant by future and option for the purposes of this Chapter. It is based on paragraphs 4 and 4A of Schedule 5AA to ICTA.
2182.Subsection (2) reproduces the definition of “traded option” in section 144(8) of TCGA rather than relying on a cross-reference to that Act, as paragraph 4(6) of Schedule 5AA does. But the section does not employ the term “traded option”. The distinction between a traded option and any other option is relevant only for paragraph 4(3) of Schedule 5AA to ICTA. Section 562 (when disposals of futures or options occur: general), which rewrites that paragraph, applies the substance of the definition without using the term.
2183.Subsection (3) has, for the sake of convenience, been introduced from TCGA.
Section 559: When disposals involve guaranteed returns
2184.This section explains for the purposes of this Chapter when a disposal involves guaranteed returns. It is based on paragraph 2 of Schedule 5AA to ICTA.
2185.Subsection (1) provides that where the conditions in subsections (2) to (4) are met a disposal will involve guaranteed returns. These conditions are that there must be at least one other related transaction, apart from the disposal giving rise to the charge, and that this, and the related transaction, are intended to produce a guaranteed return. (What is meant by “related transactions” is explained by section 566 (when transactions are related)). The guaranteed return should consist of the return from the disposal in question or a number of disposals of which the disposal in question is one.
2186.Subsection (5) explains the phrase used in the first condition “two or more related transactions designed to produce a guaranteed return”. A “main purpose test” is applied to the two or more related transactions. Considering them together, it must be reasonable to assume that their main purpose or one of their main purposes is to produce that guaranteed return.
2187.Subsection (6) then explains what factors may be considered in making a “reasonable assumption”. These are the same factors as in section 566 (when transactions are related).
Section 560: Production of guaranteed returns
2188.This section explains, for the purposes of this Chapter, what is meant by producing a guaranteed return from a disposal of a future or option. It is based on paragraph 3 of Schedule 5AA to ICTA.
2189.Subsection (1) gives the basic rule for ascertaining whether a guaranteed return is produced from a disposal of a future or option. A risk of fluctuations in the underlying subject matter (defined at subsection (6)) of the future or option must be eliminated or reduced so that the return on the disposal meets the two conditions in subsections (3) and (4).
2190.Subsection (2) supplements the rule in subsection (1) where there is more than one disposal.
2191.Subsections (3) and (4) provide two conditions that must be met for the basic rule to apply. Broadly, the return on the investment must be predictable and have more similarity to interest than to the risk expected on a future or option.
2192.Subsection (5) extends the circumstances in which risks are treated as eliminated or reduced. A main reason for the choice must be the expectation that the value of an asset of that nature will be liable to only minimum fluctuation.
Section 561: The return from one or more disposals
2193.In order to ascertain whether there is a guaranteed return for the purposes of this Chapter, section 559 (when disposals involve guaranteed returns) requires a consideration of “the return from one or more disposals”. This section explains what is meant by “the return from one or more disposals”. It is based on paragraph 5 of Schedule 5AA to ICTA.
2194.Subsection (1) contains the basic rule. The charge under section 555 (charge to tax under Chapter 12) is on a profit or gain from an individual disposal. But, in deciding whether there is a guaranteed return, more than one disposal in the scheme or arrangement can be taken into account and the overall result of that disposal or those disposals considered, that is to say the profits or gains less losses on those disposals or on all but an insignificant part of them.
2195.Subsection (2) provides that profits or gains or losses are to be treated as made by the same person, notwithstanding that they are realised by different persons, if they are made by persons who are associated with each other.
2196.Subsections (3) to (6) explain when persons are associated with each other. (This is quite unconnected with the associated person test in section 227 of ICTA.) All disposals must be part of the same scheme or arrangements (defined in subsection (7)) and all must share in the net return of all the profits and losses incurred on those disposals in a sharing arrangement agreed for that scheme or arrangements.
2197.The references in paragraph 5(3) of Schedule 5AA to ICTA to “associated companies” have not been reproduced. See Change 102 in Annex 1.
Section 562: When disposal of futures or options occur: general
2198.Tax is charged under this Chapter on the profits and gains arising from a disposal of a future or option. This section explains when there is a disposal. It is based on paragraph 4 of Schedule 5AA to ICTA.
2199.Subsection (1) refers to the relevant sections of TCGA which decide whether and when a disposal occurs. Section 143(5) and (6) of TCGA treat as disposals futures contracts which are closed out by entering into another contract or which are settled by payment. Section 144 of TCGA treats as disposals grants and abandonments of options (but not the exercise of an option). Section 144A of TCGA provides that the exercise of an option which is settled by cash is treated as a disposal both in respect of the grantor of the option and the grantee. These last two sections also provide rules as to when a future or option in these circumstances has been disposed of.
2200.The assumptions that apply in interpreting subsection (1) are set out in subsections (2) to (4).
2201.Subsection (2) requires, for the removal of doubt, that all futures are to be considered as assets in applying the TCGA sections. (Options are already listed as chargeable assets in section 21(1) of TCGA.)
2202.Subsection (3) requires section 143(5) and (6) of TCGA to be read without the words “in the course of dealing in commodity or financial futures” since the range of futures transactions covered by this Chapter extends beyond commodity and financial futures as defined in section 143 of TCGA.
2203.Subsection (4), by requiring references to a financial option in section 144 of TCGA to exclude only listed options, extends the provisions of that section to cover options that would otherwise be excluded under the definition in subsection 144(8) of TCGA. (Section 144 of TCGA provides for the grant and abandonment of options to be treated as disposals and for premiums to be included in the computation of the gain or loss.) These listed options are referred to as “traded options” in paragraph 4 of Schedule 5AA to ICTA. The context demands that the listing should be at the time of disposal and this has been added for clarification.
2204.Subsection (5) provides a cross-reference to sections 563 (timing of certain grants of options where related disposals occur later) and 564 (deemed disposal where futures run to delivery or options are exercised).
2205.Section 563 provides timing rules for deemed disposals where futures run to delivery or option contracts are exercised. Section 564 provides that futures running to delivery and options exercised are treated as disposals for the purposes of this Chapter if they would not otherwise be.
2206.This section does not rewrite paragraph 4(1) of Schedule 5AA to ICTA. That subparagraph explains that a disposal is a disposal of futures or options if it is the disposal of one or more futures or one or more options or both combined. Because a taxpayer is charged on a disposal of a future or option and more than one future or option may already be taken into account in ascertaining whether there is a guaranteed return (see section 561), it is considered that this sub-paragraph adds nothing but simply serves to confuse.
Section 563: Timing of certain grants of options where related disposals occur later
2207.This section provides that certain grants of options are to be treated as having taken place after other transactions. The purpose is to allow loss relief arising on the grant of an option to be set against a later profit. The section is based on paragraph 4 of Schedule 5AA to ICTA.
2208.Subsection (1) sets out the general rule. There are three conditions that must be satisfied for the rule to apply.
2209.Subsections (2) to (4) set out these three conditions. There must be a number of related transactions designed to produce a guaranteed return of which one is the grant of an option. At least one of the other transactions should be entered into after the grant and should be a disposal that is not a grant of an option.
2210.Subsection (5) then provides that the grant of the option is deemed to take place at the same time as the next one of the transactions referred to in subsection (4) takes place. As a result, a loss on the grant of an option will coincide with any profit arising on the later transaction. Because losses under Schedule 5AA to ICTA are allowable against Schedule D Case VI profits they may be carried forward against other Schedule D Case VI profits arising in a later year or set off against other Schedule D Case VI profits of the same year, but not carried back. Since the Schedule D Case VI set-off rule is rewritten, this section allows that later profit to be reduced by a loss which, but for this section, could arise in a later year than that profit.
2211.Subsection (6) consequently requires that the two timing rules in sections 144(2) and 144A(2) of TCGA, should they apply, take precedence over the timing rule in this section. But in most cases the two rules will give the same result. (Sections 144(2) and 144A(2) of TCGA treat grants of options and transactions by the grantor to fulfil his obligations as a single transaction.) The purpose of this is to allow the sum received on the grant to fall within the same capital gains computation as arises when the option is exercised, etc. Where it applies for this Chapter, the timing rules in these two sections of TCGA will generally achieve the same results as this section. But the rules in sections 144(2) and 144A(2) of TCGA will not always apply because certain transactions within this Chapter fall outside them.
Section 564: Deemed disposal where futures run to delivery or options are exercised
2212.This section provides that futures which are allowed to run to delivery and option contracts which are exercised will be treated as disposals for the purposes of this Chapter if they would not otherwise be disposals under this Chapter. Paragraph 94 of Schedule 2 to this Act ensures that these transactions are not disposals if they took place before 6 February 1998. This section is based on paragraph 4A of Schedule 5AA to ICTA.
2213.Subsections (2) and (3) provide the conditions that must apply for there to be a deemed disposal. There must be two or more related transactions (section 566 explains what is meant by a related transaction). One of these must be the creation or acquisition of a future or option and the other the running to delivery of that future or exercise of that option but which is not already a disposal for the purposes of this Chapter.
2214.Under subsection (4) a disposal is deemed to have taken place the moment before the future runs to delivery or the option is exercised and that disposal is deemed to be a disposal provided for in a scheme or arrangements.
2215.Both parties to the future or option are affected by the deemed disposal.
2216.Under subsection (5) the person whose rights and entitlements have a value immediately before the option is deemed to dispose of that right or those rights for their market value. Thus the same disposal proceeds are deemed to arise as if the person had disposed of the contract to another and a profit or gain had arisen in those circumstances.
2217.Under subsections (6) and (7) any other party to the future or option is deemed to have received nothing on the disposal but to have incurred costs equal to the amount the person would have been expected to pay in an arm’s length transaction for the release of the person’s obligations under the contract.
2218.Subsection (8) requires that section 144(2) and (3) of TCGA should be disregarded in applying subsections (1) to (3). This is because under these two subsections of section 144 of TCGA (applicable as a result of section 562 (when disposals of futures or options occur: general)) the grant and exercise of an option are treated as a single transaction (to enable the premium to be set against the disposal proceeds). But, in order for this section to apply, subsections (1) to (3) require two related transactions, the creation of the future or option and its running to completion or being exercised, so those two transactions must not be taken to be a single transaction.
Section 565: Interpretation of section 564
2219.This section provides explanations necessary to understand the previous section. It is based on paragraph 4A of Schedule 5AA to ICTA.
2220.Subsection (3) defines “party” in relation to the future or option in terms of rights, entitlements, obligations and liabilities, ensuring that both “grantors” and “grantees” of both futures and options fall within the definition.
Section 566: When transactions are related
2221.This section provides an explanation of what is meant by related transactions. The rules given in this section are necessary for the definition of what constitutes a guaranteed return in section 559, for the timing of disposals in section 563 and for applying the provisions on deemed disposals in section 564. This section is based on paragraph 6 of Schedule 5AA to ICTA.
Section 567: Losses
2222.This section gives some rules on losses, when they arise and how they are relievable. It is based on paragraph 1 of Schedule 5AA to ICTA.
2223.Subsection (4) gives a link to three sections which have been inserted into TCGA by paragraph 435 of Schedule 1 to this Act. They rewrite paragraph 4A(5) to (9) of Schedule 5AA to ICTA. The rules in these two new sections prevent gains which have been charged under this Chapter from being taxed again under TCGA and losses relieved under this Chapter from being relieved again under that Act. Because these rules are properly relevant to the capital gains regime they are rewritten as consequential amendments to TCGA.
Section 568: Special rule for certain income of trustees
2224.This section provides, with some exceptions, that profits or gains arising to trustees under this Chapter are chargeable to tax at the rate applicable to trusts in section 686 of ICTA. It is based on paragraph 7 of Schedule 5AA to ICTA.
2225.The reference in subsection (4) to a superannuation fund to which section 615(3) of ICTA applies has effect for the tax year 2006-07 onwards only. There is a transitional rule in paragraph 95 of Schedule 2 to this Act which gives the rules for 2005-06. Changes to the rules on superannuation funds in FA 2004 only apply from 2006-07.
2226.Subsection (6) qualifies the meaning of “trustees” for the purposes of this section. Paragraph 7(3) of Schedule 5AA to ICTA simply refers to section 686 of ICTA but the definition in that section is rewritten in full here.
Section 569: Anti-avoidance: transfer of assets abroad
2227.Sections 739 and 740 of ICTA provide rules to counter the avoidance of income tax by the transfer of assets abroad. They apply where income is payable to a person resident or domiciled outside the United Kingdom but which a person domiciled or resident within the United Kingdom has the power to enjoy. This section enables sections 739 and 740 of ICTA to apply to profits arising under this Chapter by ensuring that the profits or gains are treated as income payable to a person resident or domiciled outside the United Kingdom. It is based on paragraph 8 of Schedule 5AA to ICTA.
