Commentary on Sections Overview Chapter 2: Contracts to which this Part applies Section 592: Embedded derivatives treated as meeting condition in section 591 etc
1591.This section extends the ability to satisfy one of the conditions in section 591 to certain embedded derivatives within the meaning of section 584. It is based on paragraphs 2B(3), 45M and 54(1) of Schedule 26 to FA 2002.
1592.If this section applies, the underlying subject matter of the embedded derivative may satisfy the definition of “excluded property” in section 589(2). The embedded derivative may thereby not be a derivative contract for the purposes of this Part.
1593.The section applies only if the “hybrid derivative” (within the meaning of section 584) is a relevant contract within section 579(1)(b). That is one that is not treated as a derivative by accounting standards because of the size of the initial outlay (for example, a prepaid equity forward) but is treated as a financial asset or liability. Also, the “host contract” (subsection (5)) must be treated for accounting purposes as (or as part of) a financial asset.
1594.The embedded derivative must itself satisfy section 579(1)(a) (a relevant contract that is treated for accounting purposes as a derivative). And its underlying subject matter must be wholly shares in a company or rights of a unit holder in a unit trust scheme. Subsection (4) indicates that section 590 applies if appropriate to determine whether the “wholly” test in paragraph (c) of subsection (1) is met.
1595.If the section applies, the embedded derivative is treated as satisfying one of the conditions in section 591, and therefore meets one element of the meaning of “excluded property” in section 589(2). In the source legislation the embedded derivative is treated as meeting condition A in section 591 because this rule is expected to be relevant primarily (although not exclusively) to insurance companies (and condition A specifically applies to such companies). But it is sufficient to deem the embedded derivative to meet any one of the conditions in section 591 for the purposes of section 589(2).
1596.The section does two more things. First, it treats the embedded derivative (which in all likelihood is not now a derivative contract, because of section 589) as a “chargeable asset” for the purposes of this Part and TCGA. See the definition of that term in section 703.
1597.Second, the host contract is treated as a “creditor relationship” of the company for the purposes of the Corporation Tax Acts. That primarily affects the operation of Parts 5 and 6 (loan relationships). But it also affects those sections in this Part that operate by reference to a creditor relationship (for example, section 631(4)). See the definition of “creditor relationship” in section 704.