What is an exactly tracking contract under section 657 of the Corporation Tax Act 2009?

An exactly tracking contract is an embedded derivative within a debt instrument where the settlement amount equals the percentage change in value of specified underlying assets, or an index of those assets, applied to the original proceeds of issue of the host debt as determined under generally accepted accounting practice.

How is the relevant period defined for an exactly tracking contract under section 657?

The relevant period runs from the date the host debt came into existence to the date the corresponding creditor relationship ends. An alternative measurement period may be used if it covers almost all of the standard period and differs only for valuation purposes relating to establishing the value of the underlying assets.

Why does it matter whether an embedded derivative qualifies as an exactly tracking contract?

If an embedded derivative qualifies as an exactly tracking contract, chargeable gains and losses on the derivative element are calculated under the chargeable gains rules rather than the normal loan relationship income rules. This distinction affects how the taxable profit or loss on the derivative component is determined under United Kingdom corporation tax law.

How are the proceeds of issue determined for the purposes of the exactly tracking contract calculation?

The proceeds of issue are determined in accordance with generally accepted accounting practice, meaning UK GAAP or IFRS. They represent the amount recognised as proceeds received when the host debt was originally issued, and this figure forms the base to which the percentage change in the underlying asset value is applied to calculate the settlement amount.

Corporation Tax Act 2009 section 657

Meaning of "exactly tracking contract" in section 656

Section 657 defines what an "exactly tracking contract" is for the purposes of the chargeable gains rules for derivative contracts embedded in debt instruments.

An exactly tracking contract is one where the settlement amount equals the percentage change in value of the underlying assets (or an index of those assets) applied to the proceeds of issue of the related debt
The proceeds of issue are determined in accordance with generally accepted accounting practice (GAAP)
The relevant period runs from the date the debt came into existence to the date the corresponding creditor relationship ends
An alternative measurement period may be used if it covers almost all of the standard period and differs only for valuation purposes relating to the debt

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