Convertible interests

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This information may not apply to the current year. Check the content carefully to ensure it is applicable to your circumstances.

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Convertible notes

A convertible note (which is one type of convertible interest) is another type of investment you can make in a company or unit trust. A convertible note earns interest on the amount you pay to acquire the note until the note's expiry date. On expiry of the note, you can either ask for the return of the money paid or convert that amount to acquire new shares or units.

Convertible notes you acquired after 10 May 1989 will generally not be subject to CGT if you sold or disposed of them before they were converted into shares. Instead, you include any gain you make on your tax return as ordinary income and any loss you make is included as a deduction.

For more information, see You and your shares 2005–06.

If you have sold or disposed of a convertible note that you acquired before 11 May 1989, phone the Business Infoline on 13 28 66. When you phone, make sure you know the date you acquired the convertible note as this may affect the tax treatment.

Conversion of notes to shares

The tax treatment that applies when your convertible notes are converted to shares depends on when you acquired the convertible notes, the type of convertible note, when the conversion occurred and when the convertible note was issued.

Shares acquired by the conversion of a convertible note on or after 20 September 1985 will be subject to CGT when they are sold or disposed of as the shares are taken to be acquired when the conversion happens.

You may have acquired the convertible note on or after 20 September 1985 and, as a traditional security or qualifying security, you have already included the gain you made on the conversion of the note on your tax return as income (or as a deduction if you made a loss).The way you calculate the cost base of the shares varies depending on whether the notes converted to shares before 1 July 2001 or on or after that date. Table 1: Treatment of convertible notes acquired after 10 May 1989 provides a summary.

Convertible notes issued after 14 May 2002

If you have convertible notes that are traditional securities and were issued by a company after 14 May 2002:

• any gains you make when these notes are converted or exchanged for ordinary shares in a company will not be ordinary income at the time of conversion or exchange, and any losses you make will not be deductible
• instead, any gains or losses you make on the later sale or disposal of the shares (incorporating any gain or loss that would have been made on the conversion or exchange of the notes) will be:
  
  • subject to CGT if you are an ordinary investor, or
  • ordinary income (or deductible, in the case of a loss) if you are in the business of trading in shares and other securities.
   

Note 1: A traditional security is one that is not issued at a discount of more than 1.5%, does not bear deferred interest and is not capital indexed. It may be, for example, a bond, a deposit with a financial institution, or a secured or unsecured loan.

Note 2: A qualifying security is one that has a deferred income element - that is, it is issued under terms such that the investor's return on investment (other than periodic) will be greater than 1.5% per annum.

If you are an individual who is an ordinary investor, this change means you will be able to get the benefit of the CGT discount if you own the shares for more than 12 months. The table above sets out how you calculate the cost base.

Conversion of notes to units

Convertible notes - converted before 1 July 2001

If the convertible note is a traditional security, the first element of the cost base and reduced cost base of the units is their market value at the time of conversion. You disregard any capital gain or capital loss made on their conversion to units in the unit trust.

If the convertible note is not a traditional security and was issued by the unit trust after 28 January 1988, the first element of the cost base and reduced cost base of the units includes both the cost of the convertible note and any further amount payable on the conversion. You disregard any capital gain or capital loss made on their conversion to units in the unit trust.

Convertible notes - converted after 1 July 2001

If the convertible note is a traditional security the first element of the cost base and reduced cost base of the units includes:

• the cost base of the convertible note, plus
• any amount paid on conversion, plus
• any amount included in your assessable income on conversion.

You disregard any capital gain or capital loss made on their conversion to units in the unit trust.

Similarly, if the convertible note is not a traditional security and was issued by the unit trust after 28 January 1988, the first element of the cost base and reduced cost base of the units includes:

• the cost base of the convertible note, plus
• any amount paid on conversion, plus
• any amount included in your assessable income on conversion.

You disregard any capital gain or capital loss made on their conversion to units in the unit trust.