Citation, commencement and effect

1. This Order may be cited as the Finance Act 2002, Schedule 26 (Parts 2 and 9) (Amendment No.3) Order 2005, shall come into force on 31st December 2005 and shall have effect in respect of accounting periods ending on or after that date.

2. Schedule 26 to the Finance Act 2002 (derivative contracts) is amended as follows.

Amendment of Part 2 of Schedule 26

3. Part 2 is amended as follows.

4. In paragraph 2(5) (derivative contracts and relevant contracts)( 2 ) after “sub-paragraph (4)” insert “(an “embedded derivative contract”)”.

5. —(1) Amend paragraph 4 (contracts excluded by virtue of their underlying subject matter) ( 3 ) as follows.

(2) In sub-paragraph (2)(b)(i) for the words from “other than shares” onwards substitute insert “other than shares excluded by sub-paragraph (2ZA); or”.

(3) In sub-paragraph (2)(b)(ii) at the end add “other than a scheme to which paragraph 4 of Schedule 10 to the Finance Act 1996 applies”.

(4) After sub-paragraph (2) insert—

“ (2ZA) The shares excluded by this sub-paragraph are—

(a) shares in relation to which section 91A or 91B of the Finance Act 1996 ( 4 ) has effect;

(b) shares in an open-ended investment company to which paragraph 4 of Schedule 10 to the Finance Act 1996 ( 5 ) applies. ” .

(5) In sub-paragraph (2B)(b)—

(a) after “the contract and” insert “—(i)”; and

(b) after “unit trust scheme,” insert—

“ or

(ii) any share capital of the company, ” .

(6) In sub-paragraph (2D)(a)(ii) after “an asset” insert “or liability”.

6. —(1) Amend paragraph 12 (definition of terms relating to derivative contracts) as follows.

(2) In sub-paragraph (1)( 6 )—

(a) after paragraph (b) insert—

“ (bza) a contract of long-term insurance (see sub-paragraph (16)); ”

(b) in paragraph (cc)—

(i) before “hedging” insert “a”; and

(ii) after “an asset” insert “or a liability”; and

(3) In sub-paragraph (14)—

(a) in the words before paragraph (a) after “an asset” insert “or a liability”;

(b) in paragraph (b) after “asset”, in both places, insert “or liability”; and

(c) after paragraph (b) add—

“ For the purposes of this sub-paragraph the liabilities of a company include its own share capital. ” .

(4) In sub-paragraph (16), for “has” substitute “and “contract of long-term insurance” have”.

Amendment of Part 9 of Schedule 26

7. Part 9 (miscellaneous) is amended as follows.

8. —(1) Amend paragraph 45C (derivative contracts relating to land or certain tangible movable property) ( 7 ) as follows.

(2) For paragraph (1)(d) substitute—

“ (d) sub-paragraph (1A) does not apply. ” .

(3) After sub-paragraph (1) insert—

“ (1A) This sub-paragraph applies if—

(a) paragraph 45F applies to the derivative contract, or would apply to it but for sub-paragraph (2)(f) of that paragraph, or

(b) paragraph 45K applies to derivative contract, or would apply to it but for sub-paragraph (2)(e) of that paragraph. ” .

9. —(1) Amend paragraph 45H (treatment of net gains and losses on terminal exercise of option) as follows.

(2) In sub-paragraph (1)(b), for “exercised to any extent” substitute “to any extent exercised or otherwise disposed of”.

(3) In sub-paragraph (2)(b) for paragraphs (i) and (ii) substitute—

“ (i) as a result of the exercise of rights mentioned in sub-paragraph (1)(b); and

(ii) in circumstances where a disposal is deemed not to occur by virtue of section 127 of the Taxation of Chargeable Gains Act 1992 ( 8 ) . ” .

10. In paragraph 45HA(4)( 9 ) (treatment of credits and debits on terminal exercise of option) in the definitions of G and L for “paragraph 14(2)” substitute “paragraph 14(3)”.

11. In paragraph 45J(8) (issuers of securities with embedded derivatives)( 10 ) in paragraph (a) of the definition of F, after “paid” insert “by the debtor”.

12. —(1) Amend paragraph 45L (derivative not embedded in a loan relationship)( 11 ) as follows.

(2) In sub-paragraph (1)—

(a) for “Where” substitute “This paragraph applies where”;

(b) in paragraph (a) for “a relevant contract” substitute “an embedded derivative contract”; and

(c) omit the words following paragraph (c).

(3) For sub-paragraph (2) substitute—

“ (1A) In this paragraph “the original contract” means the contract mentioned in paragraph 2(3) to which the company is party and as a result of which the company falls to be treated by virtue of paragraph 2(4) as a party to the derivative contract.

(1B) Where this paragraph applies—

(a) paragraph 14(2) and (3) (trading and non-trading credits and debits) do not apply in relation to the derivative contract, but

(b) sub-paragraph (1C) or (2) applies in relation to the original contract, according to whether or not that contract is a derivative contract.

(1C) If the original contract is a derivative contract, profits and losses are to be computed for the purposes of this Schedule as if that contract—

(a) were not one where the rights and liabilities are treated as divided as mentioned in paragraph 2(3), and

(b) were not one in relation to which a fair value basis of accounting is used.

(2) If the original contract is not a derivative contract, profits and losses are to be brought into account for the purposes of the Corporation Tax Acts in relation to that contract as if that contract—

(a) were not one where the rights and liabilities are treated as divided as mentioned in paragraph 2(3), and

(b) were not one in relation to which a fair value basis of accounting is used.

This sub-paragraph has effect notwithstanding paragraph 1(2). ” .

(4) At the end of sub-paragraph (2A)( 12 ) add—

“ unless—

(a) the contract is a contract of long-term insurance, or

(b) the underlying subject matter of the embedded derivative contract is, or includes, commodities.

Paragraph 45LA contains further provisions about elections under this sub-paragraph. ” .

13. After paragraph 45L insert—

“ Elections under paragraph 45L(2A): further provisions

45LA. —(1) In this paragraph “a disapplication election” means an election under paragraph 45L(2A).

(2) Where—

(a) a company makes a disapplication election in relation to its contracts, and

(b) another company, which is a member of the same group as the company making the election, is a party to a contract to which the election applies,

the other company shall be treated, in relation to that contract, as if it had also made a disapplication election.

(3) Where—

(a) a company (“the electing company”) makes a disapplication election in relation to its contracts,

(b) another company (“the transferee”) becomes party to a contract, to which paragraph 2(3) applies, in place of the electing company (whether before or after the disapplication election is made), and

(c) the transferee is a member of the same group of companies as the electing company at the time of the transfer,

the transferee shall be treated, in relation to the contract referred to in paragraph (b), as if it had also made a disapplication election.

(4) Where—

(a) a company (“A”) is treated under paragraph 2(4) as party to a relevant contract to which paragraph 45L(1) applies,

(b) another company (“B”), becomes a party to that contract in place of A,

(c) A and B are members of the same group of companies when B becomes a party to the contract, and

(d) paragraph 45L(1) does not apply to B’s other relevant contracts by reason of a disapplication election (whenever made),

sub-paragraph (5) applies, unless A, subsequent to B’s becoming party to the contract, makes a disapplication election.

(5) Where this sub-paragraph applies B shall be treated, in relation to the contract referred to in sub-paragraph (4)(b), as if paragraph 45L(1) applied to it.

(6) In this paragraph references to companies being members of the same group of companies shall be construed in accordance with section 170 of the Taxation of Chargeable Gains Act 1992 ( 13 ) . ” .

14. In paragraph 45M(1)(a) (treatment of host contract as a loan relationship)( 14 ) for “relevant contract” substitute “embedded derivative contract”.

Consequential amendment

15. In paragraph 54(1) (interpretation)( 15 ) at the appropriate points in the alphabetical list insert the following definitions—

“ “embedded derivative contract” shall be construed in accordance with paragraph 2(5); ” ;

“ “open-ended investment company” has the meaning given by section 468A(2) of the Taxes Act 1988 ( 16 ) ; ” .