Introduction Background Note
23.A stock lending arrangement involves the transfer of securities from a “lender” to a “borrower”, under an agreement that provides for equivalent securities (identical in nature and number to those transferred) to be returned to the lender at a prescribed date. Although described as a “loan”, the transactions involve the transfer of full title to the securities.
24.Because of the temporary nature of the change of ownership, the TCGA includes special rules to ignore the transfer from lender to borrower and the return of the equivalent securities from borrower to lender.
25.However, it is possible that during the currency of a stock lending arrangement, it may become apparent that the equivalent securities will not be returned to the lender. In that case, to recognise that there has been a permanent transfer of the securities, the lender is deemed to have disposed of the securities at the time it becomes apparent that they will not be returned, and the borrower is deemed to acquire them at that time. The consideration for this deemed disposal and acquisition is the market value of the securities at that time. (This is not specifically stated in the legislation as it currently stands, but changes made by this Schedule will make it explicit.)
26.There is one particular circumstance where the rule that the lender is deemed to have disposed of the loaned securities can give an unwanted result. This is where the failure to return the securities results from the borrower’s becoming insolvent, and the arrangements include the lodging of collateral or the offering of indemnities by a third party to protect the borrower.
27.In such a case it is possible, by utilising the collateral or calling on the indemnity, to provide the lender with replacement securities exactly as would be the case if the borrower had returned securities under the agreement. Where this occurs, the rule that treats the lender as disposing of loaned securities could result in a chargeable gain arising to a lender, with an associated liability to tax, even though the lender’s situation is the same as if the securities had been returned under the stock lending arrangements.
28.This section and Schedule prevent that outcome, treating the provision of replacement securities by use of collateral or indemnity as though they had been replaced under the agreement.
29.It should be noted that the Schedule refers only to “collateral”, while this background note talks of both “collateral” and “indemnity”. The definition of “collateral” in the section is framed to include indemnity, and the term is used below to describe both collateral and indemnity.
30.The Schedule also covers the situation where collateral is sufficient to replace only some of the borrowed securities, or where the lender chooses not to use available collateral to replace as many of the loaned securities as possible. In such circumstances the lender has effectively disposed of the securities that were not replaced by the collateral.
31.In the case where the lender chooses not to replace as many of the loaned securities as possible, the lender will retain some of the collateral. In that case, the lender is treated as having disposed of the number of loaned securities that were not replaced, and the consideration for that disposal is effectively the value of the collateral that was retained by the lender rather than being used to acquire replacement securities.
32.Where the value of the collateral was insufficient to replace all the loaned securities, under a standard stock lending agreement the borrower would owe the lender an amount equal to the value of the securities that could not be replaced.
33.Where the borrower has become insolvent, it is likely to be some time before it becomes clear whether the lender will receive anything in respect of this debt owed by the borrower. The section therefore provides for immediate relief to the lender by prescribing that, where the whole of the available collateral is used to acquire replacement securities, the lender is treated as receiving no consideration for the deemed disposal resulting from the inadequacy of the collateral. This should result in a loss being treated as arising to the lender on the deemed disposal, and the lender can deduct this loss from chargeable gains arising to him.
34.If, at a later date, the lender does receive any payment in respect of the debt, the whole amount received is treated as a chargeable gain arising at the time of receipt. The broad effect of this arrangement is that the lender’s net gain or loss reflects his actual gain or loss on the securities that were not returned (taking account of the amount actually received in respect of the debt owing by the borrower), but at the time of the insolvency of the borrower the lender can claim a loss of the whole of his allowable expenditure on the securities in question, reflecting that there is no immediate receipt and that it may be some time (if ever) before the lender receives anything in respect of the debt.
35.Section 83 and Schedule 37 complement this section and Schedule, giving relief from charges to stamp duty or stamp duty reserve tax in circumstances where a party to a stock lending arrangement becomes insolvent.