Tax treatment of convertible notes

A convertible note is a financial instrument, typically issued by a bank or corporate institution.  An investor generally receives interest on the face value of the note, from the issue date to the maturity date.  It is possible that investors receive income other than interest from holding convertible notes, for example, dividends.  On the maturity date, the note may be converted into equity in the entity, usually ordinary shares. Alternatively, the convertible note may be redeemed by the issuer and the face value of the note returned to the investor.

Generally, convertible notes are treated as being on revenue account for income tax purposes.  That is, any gains or losses realised upon their disposal, conversion or maturity will be on revenue account.

However, where an investor converts the note and receives ordinary shares (or other such securities), these shares or securities will be on capital account and subject to the capital gains tax (CGT regime).  As such, any gains realised may be able to be reduced by the CGT discount where the relevant conditions are met.  Available capital losses may also be used to offset any capital gains.

In some circumstances, convertible notes may be treated as CGT assets from the date of issue.  The tax treatment in these circumstances is explained in the CGT section.

The date that a convertible note is issued will determine whether an investor has a taxing point at the time of conversion to ordinary shares. The issue date of the convertible note should not be confused with the date that the investor acquired the convertible note (where the investor did not acquire the convertible note through the original issue).

Any gain (or loss) derived (or incurred) on conversion is included in the investor’s assessable income as ‘other income’ (or as a deductible loss).  The cost base of any ordinary shares received upon conversion will include the cost base of the convertible note, any amount paid on conversion and any amount previously recognised as assessable income upon conversion.  The acquisition date of the ordinary shares for CGT purposes will be the date of conversion.  The acquisition date is important as this is the date that is relevant for determining an investor’s entitlement to any CGT discount.

Any gain (or loss) derived (or incurred) on conversion is disregarded for tax purposes.  The cost base of any ordinary shares received upon conversion will include the cost base of the convertible note and any amount paid upon the conversion.  The acquisition date of any ordinary shares acquired will be the date of the conversion.  The acquisition date is important as this is the date that is relevant for determining an investor’s entitlement to any CGT discount.

Depending on the terms of the note, an investor may have a choice between receiving the face value of the note in cash or receiving a certain number of ordinary shares in the issuing company.  Note that depending on the terms of the note, the conversion to ordinary shares may be mandatory.  These details will be explained in the product disclosure statement.

Where an investor receives the same amount of money as was paid to acquire the notes, the sale proceeds will equal the cost base, and there will be no assessable income for an investor to report.

Where, on the other hand, an investor purchased the notes on the ASX it is more than likely that the notes were purchased at a price other than their face value.  In this situation, the investor will need to compare the sale proceeds to the cost base to determine if they have made a gain or loss that will impact their assessable income.

We will report in accordance with the following:

income received while holding a convertible note will be disclosed as interest or dividends (depending on the distribution on the notes) in the Tax Report – Detailed

  • if a convertible note is sold, the assessable gain or deductible loss will be disclosed in the Other Income section in the Tax Report – Detailed.
  • if a convertible note has been converted, the issue date of the note is taken into consideration:
    • if issued prior to 15 May 2002, any gain or loss on conversion will be disclosed in the Other Income section in the Tax Report – Detailed
    • if issued after 14 May 2002, any gain or loss arising on conversion is ignored for tax purposes and will not be disclosed on the Tax Report – Detailed.