Corporation Tax Act 2009 section 654

Payment instead of disposal on exercise of deemed option

Section 654 deals with how a chargeable gain or allowable loss is calculated when an embedded derivative option is exercised but settled in cash rather than by issuing or transferring shares.

• Where a convertible debt instrument contains an embedded option to issue or transfer shares, but the option is settled by a cash payment instead, special rules apply to determine any chargeable gain or allowable loss.
• The calculation compares the tax-adjusted carrying value of the option (CV) at the time the company became party to the debtor relationship with the amount paid to settle the obligation (X), reduced by the fair value of the host loan contract at the date the option is exercised.
• If CV exceeds X, a chargeable gain equal to the difference arises; if X exceeds CV, an allowable loss equal to the difference arises.
• This provision ensures that cash-settled exercises of embedded options are brought within the chargeable gains regime, even though no shares actually change hands.