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bigduckontax
bigduckontax, Accountant
Category: Tax
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Experience:  FCCA FCMA CGMA ACIS
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I have an investment that was structured as a zero coupon

Customer Question

Hi.
I have an investment that was structured as a zero coupon bond. I paid an issue price of 20%.
However, the bond is linked to the performance of a highly risky credit Index (i.e. a performance index). i.e. there is an embedded derivative in the bond.
At maturity, I will get 100% (PAR) if the index performed fully, or less if the index does not perform fully.
Now, given that there is an embedded derivative / performance is linked to an index, I want to understand the tax treatment for this when it matures:
1. I know that typically zero coupon bonds are subject to income tax (instead of CGT) based on the difference between maturity amount and initial purchase price.
2. However, given this is such a risky investment (i.e. I bought at 20%, and the performance is index linked), can the profits/gains be subject to CGT?
thanks!
Submitted: 1 year ago.
Category: Tax
Expert:  bigduckontax replied 1 year ago.
Hello, I am Keith, one of the experts on Just Answer, and pleased to be able to help you with your question. Zero coupon bonds are, as you are aware, generally taxed as follows. The rate of return on such stocks is subject to tax income which arises on maturity. If disposal is made prior to the bond's maturity there may be an element of taxable gain which would be subject to CGT. The element of risk does not come into the taxation equation at all I am so sorry to have to rain on your parade.
Customer: replied 1 year ago.

Hi. I understand, but if there are embedded derivatives/or performance linkage, sure that should get bifurcated?

For example, I am aware in the structured products world that if you buy a note linked to the equity markets, and such note is capital guaranteed, then you get charged CGT on the performance?

Is it not the same here?

Expert:  bigduckontax replied 1 year ago.
Not unless you cash in prior to maturity as I explained. Otherwise it is all classified as income.
Customer: replied 1 year ago.

Ahh - I missed that part.

How do I determine the part subject to CGT if I cash in early (which I can certainly do)?

And do I need to cash in very early? For example, what If I sell 1 day before maturity?

Expert:  bigduckontax replied 1 year ago.
I suggest that HMRC would view that with deep suspicion and in any event the closer to maturity the exercise the lesser of the more reduced will be the element of capital gain inherent in the transaction.
Customer: replied 1 year ago.

Understood, but that was just theoretical. Can you advise how the CGT vs income portion is assessed if sold early? e.,g. I could even sell 1 or 2 years prior to maturity, but need to understand the treatment?

Expert:  bigduckontax replied 1 year ago.
It would be proportionate based on the time remaining so if you sold aright at the start 100% would be a capital gain. if half way through 50% and at the end nil, all gains beings assessed in this case as income.
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Expert:  bigduckontax replied 1 year ago.
Thank you for your support.

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