How does section 585 of the Corporation Tax Act 2009 treat embedded derivatives in loan relationships?

Section 585 requires that where accounting standards separate a loan relationship into a host loan and embedded derivatives, each embedded derivative is treated as a separate relevant contract for corporation tax purposes. The host loan continues under the loan relationships rules in Part 5 of the Act.

How are embedded derivatives classified under section 585?

Each embedded derivative deemed to be a separate relevant contract is classified as an option, a future, or a contract for differences. The classification depends on the character the embedded derivative would have if it existed as a standalone contract, determining how it is taxed under the derivative contracts rules in Part 7.

Can a company elect to apply the splitting treatment under section 585 even if accounting standards do not require it?

Yes. Section 416 of the Corporation Tax Act 2009 allows a company to elect for the splitting treatment to apply to certain loan relationships that would not automatically be separated under the accounting practice the company uses, enabling the embedded derivative rules of section 585 to apply voluntarily.

What happens to the host loan element after an embedded derivative is separated under section 585?

The remaining rights and liabilities forming the host loan element, after the embedded derivatives have been stripped out, continue to be dealt with under the loan relationships rules in Part 5 of the Corporation Tax Act 2009, specifically under section 415, and are taxed accordingly as a straightforward debt instrument.

Corporation Tax Act 2009 section 585

Loan relationships with embedded derivatives

Section 585 explains how embedded derivatives within a company's loan relationships are treated as separate derivative contracts for corporation tax purposes.

Where accounting standards require a loan relationship to be split into a host loan and one or more embedded derivatives, each embedded derivative is treated as a separate relevant contract for tax purposes
Each such relevant contract is classified as an option, a future, or a contract for differences, based on the nature of the rights and liabilities of that embedded derivative
An embedded derivative can be a derivative financial instrument or an equity instrument as recognised under generally accepted accounting practice
Companies may also elect to apply this splitting treatment to certain loan relationships that would not otherwise be separated under their chosen accounting practice

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