Accountants for US and UK: ASAs and Convertible Notes

For a UK-resident American angel, an advance subscription agreement (ASA) or convertible loan note (CLN) is taxed twice under two frameworks that disagree on what the instrument even is. HMRC may treat a compliant ASA as an EIS-eligible share subscription; the IRS may treat it as a prepaid forward, equity or debt. The classification drives every return you file.

That gap is why angels who write pre-round cheques into UK companies need Accountants for US and UK who prepare both sides of the file together, rather than a UK adviser who stops at EIS and a US preparer who has never seen an ASA. At Jungle Tax we prepare the returns and information forms that follow these instruments from signature, through conversion at the priced round, to exit or failure. This guide sets out how each instrument is treated in each country, where the two systems collide, and what must be on your US and UK returns in each year.

It sits between two of our existing guides. If you already hold priced ordinary shares with EIS or SEIS relief, read EIS and SEIS shares: US tax reporting for American investors. If you invest in US companies and are chasing QSBS, read our guide for UK-resident angels in US startups. This guide covers the period before the priced round, and the moment the instrument turns into shares.

What is the difference between an ASA and a convertible loan note?

Both instruments let a startup take money now and defer the valuation debate to the next priced round. Commercially they look alike: a discount to the round price (often 10% to 30%), sometimes a valuation cap, and automatic conversion when a qualifying round closes. Legally and for tax purposes they are different animals.

• Advance subscription agreement. The investor pays a subscription amount up front in exchange for the company's promise to issue shares later. There is no debt, no interest and, if drafted for EIS or SEIS, no right to get the cash back. The investor is, in substance, a shareholder-in-waiting.
• Convertible loan note. The investor lends money. The note usually accrues interest (frequently rolled up rather than paid), has a maturity date, and converts into shares at a discount on a qualifying round. If no round happens, the investor may be entitled to repayment or conversion at a default valuation. The investor is a creditor until conversion.

The UK draws a hard line between the two because of EIS and SEIS. The US draws its line using general debt-equity principles, which do not map neatly onto the UK labels. The result is that an instrument can be equity to HMRC and something else entirely to the IRS.

UK treatment: when does an ASA qualify for EIS or SEIS?

EIS and SEIS relief attaches to shares issued for cash and fully paid up at issue. An ASA is not itself a share, so HMRC's position is that relief is available only once the shares are actually issued, and only if the ASA was drafted so that the money was genuinely at risk as a subscription rather than a loan. HMRC's Venture Capital Schemes Manual at VCM12025 sets out the conditions. HMRC does not consider an ASA suitable for the schemes unless the agreement:

• does not permit the subscription money to be refunded in any circumstances;
• cannot be varied, cancelled or assigned;
• bears no interest; and
• has a longstop date by which the shares must be issued, which HMRC expects to be no more than six months after the agreement is signed.

Several practical consequences follow for the investor's UK return:

• Relief runs from the share issue date, not the payment date. The income tax relief is claimed for the tax year in which the shares are issued (with the usual carry-back option), and the three-year qualifying period starts then. Your compliance certificate (EIS3 or SEIS3) will follow issue, not signature.
• Refund or interest provisions are fatal. An ASA with a cash refund on insolvency, a redemption right if no round occurs, or a coupon is likely to be treated by HMRC as a loan in substance, and shares issued on conversion of a loan do not qualify.
• Longstop drift is a real risk. Where a round slips and the parties extend the longstop by side letter, the agreement has been varied. Treat any extension as a potential loss of relief and review it before signing.
• Advance assurance should precede the ASA. HMRC's guidance indicates that a company seeking advance assurance should apply before the ASA is entered into.

Convertible loan notes and EIS

A CLN is debt. Shares issued on conversion are issued in satisfaction of a loan rather than for new cash, so as a general rule they do not qualify for EIS or SEIS. Some founders describe a CLN as "EIS-compatible"; in practice that usually means the round shares bought with fresh cash qualify, while the converted shares do not. For an American investor, the loss of EIS matters less than it might appear, because UK relief does not reduce US tax. It does, however, change how much UK tax is available to credit on the US return.

How is CLN interest taxed in the UK?

Interest on a CLN is savings income for a UK-resident individual and is generally taxed when received or credited, not as it accrues. Three points catch investors out:

• Rolled-up interest settled in shares. Where accrued interest is converted into shares rather than paid in cash, HMRC may treat the value of the shares issued for the interest as interest received at that point, taxable as savings income in that year.
• Deduction of tax at source. A UK company paying yearly interest to an individual is generally required to deduct basic-rate income tax at source. Where tax has been deducted, you claim credit for it on your Self Assessment return, and it is a creditable foreign tax on the US side.
• Chargeable gains on the note. A convertible note is often not a qualifying corporate bond, which affects whether a gain or loss on the note itself is within capital gains tax and how conversion is treated. Conversion is commonly treated as a reorganisation, with the shares inheriting the note's base cost. Confirm the classification from the note terms before assuming either outcome.

US treatment: is an ASA equity, a prepaid forward or debt?

The Internal Revenue Code has no category called "advance subscription agreement". The IRS will classify it by substance, using the same analysis US practitioners apply to the American SAFE. There are three candidate characterisations.

1. Current equity

If the investor bears full equity risk, has no creditor rights, and ranks with shareholders on a liquidation, there is a respectable argument that the ASA is stock (or equivalent to stock) from the day it is signed. On that view the holding period starts at signature, and for US purposes you already own an equity interest in a foreign corporation, with the PFIC and Form 5471 questions that follow.

2. Prepaid forward contract

The more common view for an EIS-style ASA is that it is a variable prepaid forward contract to acquire a variable number of shares. Open-transaction treatment means no taxable event on payment and no taxable event on delivery of the shares. Your basis in the shares equals the amount paid; your holding period in the shares generally begins when they are issued. If you ultimately sell within twelve months of issue, that distinction is the difference between short-term and long-term capital gain.

3. Debt

An ASA that refunds the money if no round happens, pays interest, or ranks ahead of shareholders starts to look like debt. Those are precisely the features HMRC's conditions exclude, so an EIS-compliant ASA is unlikely to be debt for US purposes. A non-EIS ASA drafted with investor protections is a different matter and needs to be read clause by clause.

There is no ruling that settles the point, so the position taken must be consistent across years and documented in the file. What matters for your return is that the characterisation chosen in the year of investment is carried through to the year of conversion and the year of sale.

US treatment of convertible loan notes: OID, conversion and basis

A genuine CLN will almost always be treated as debt for US purposes until it converts. That has four consequences.

• Interest is taxed as it accrues. Where interest is rolled up and payable only at maturity or conversion, the note generally carries original issue discount. A cash-basis US individual must include OID in income each year on a constant-yield basis, even though nothing is received. The UK, by contrast, taxes the interest when it is paid or settled in shares.
• The conversion feature is usually ignored for OID. A right to convert into the issuer's own stock does not ordinarily turn the note into a contingent payment debt instrument, so the OID calculation is normally based on the stated interest alone.
• Conversion is generally a non-event. Converting a note into shares of the same issuer is usually tax-free under the reorganisation or conversion-privilege rules. Your basis in the shares carries over from the note, including OID you have already included in income, and the holding period of shares attributable to principal generally tacks on to the note's holding period.
• Unincluded accrued interest is the exception. Shares received in respect of accrued interest that has not already been taxed are generally treated as interest income at conversion, with a fresh basis and a new holding period.

Sterling adds a currency layer

A UK note is denominated in pounds. For a US taxpayer, OID is calculated in sterling and translated to dollars, and repayment of principal can generate foreign currency gain or loss under the section 988 rules, which is ordinary rather than capital. On conversion the dollar basis carries into the shares. None of this appears on UK paperwork, so it must be reconstructed from the note and exchange rates.

The timing mismatch and foreign tax credits

Because the US taxes CLN interest as it accrues and the UK taxes it when paid or converted, the UK tax usually arrives years after the US income. Foreign tax credits in the passive category can be carried back one year and forward ten, so the credit can generally be matched, but only if the returns in the intervening years were prepared with the carryover schedule maintained. Where accrued interest is never paid because the company fails, you may have paid US tax on income never received, and the recovery route runs through the loss rules discussed below.

US vs UK treatment at a glance

Issue	UK (HMRC)	US (IRS)
EIS-compliant ASA at signature	No share yet; no relief until shares issue	Likely prepaid forward (no tax event) or arguably current equity
ASA share issue	EIS/SEIS relief from issue date if conditions met	Generally no tax event; basis equals amount paid
Holding period	EIS three-year period runs from share issue	Usually from share issue (prepaid forward view); from signature if equity
CLN interest	Savings income when paid or settled; tax may be deducted at source	OID included annually as it accrues, even if unpaid
CLN conversion	Commonly a reorganisation; shares take note's base cost; converted shares generally not EIS-eligible	Generally tax-free; carryover basis and tacked holding period for principal
Currency	Not relevant (sterling)	Section 988 gain or loss on principal; OID translated to dollars
Company status risk	None specific	PFIC or CFC status of the UK company
Information reporting	EIS3/SEIS3 claim on Self Assessment	Form 8938; Form 8621 if PFIC; Form 5471 if 10%+

Is a UK startup a PFIC after the ASA or note converts?

This is the question almost no UK-side adviser asks, and it is the one with the heaviest consequences. A foreign corporation is a passive foreign investment company for a year if 75% or more of its gross income is passive, or 50% or more of its assets (by average value) produce or are held to produce passive income. Cash is a passive asset. Interest on cash is passive income.

A pre-revenue UK startup that has just closed a round is, on paper, a textbook PFIC risk: a bank balance, interest on that balance, and little or no trading income. Whether it actually fails the tests turns on detail:

• Income test. If the company has any meaningful trading revenue, passive interest may fall well under 75%. If it has none, even a small amount of interest can make 100% of gross income passive.
• Asset test. For a company that is not a controlled foreign corporation, assets are measured by value. A priced round at a high valuation often implies substantial goodwill and intangible value, which is generally treated as an active asset. The priced round that converts your ASA may therefore also help evidence that the company is not a PFIC.
• Start-up exception. A company is not treated as a PFIC for its first taxable year with gross income if it is not a PFIC in either of the following two years. It is a narrow, backward-looking exception and cannot be relied on in advance.

Why the pre-conversion period matters for PFIC

The PFIC rules treat options to acquire PFIC stock as PFIC stock for certain purposes, and the holding period of shares acquired by exercising an option can include the option period. An ASA or convertible note that is analysed as an option-like right to shares may therefore carry PFIC exposure into the shares from the start. Crucially, a qualified electing fund (QEF) election cannot be made in respect of an option. If the company is a PFIC in any year in your holding period without a timely QEF election, the default excess distribution regime applies on sale, with gains taxed at the highest ordinary rate and an interest charge.

Form 8621 and the QEF statement problem

A QEF election requires the company to provide a PFIC Annual Information Statement. Early-stage UK companies rarely know what that is, and fewer still will prepare one. In practice:

• ask for the statement as a side-letter commitment at the ASA or note stage, before you have handed over the money and lost your leverage;
• if the company is plausibly not a PFIC, document the analysis each year using the management accounts and the round valuation, and keep it with your return;
• if the company is a PFIC and no statement is available, consider whether a protective statement or a later purging election is appropriate, which is a technical exercise best done before the year of sale.

Form 8621 is filed with your Form 1040 for each PFIC in which you hold shares, subject to a de minimis exception for small holdings where no election is made and no excess distribution occurs. See the IRS page for Form 8621. For the wider mechanics, our guide on the PFIC trap for Americans in the UK explains the three regimes in detail.

Which US information returns apply: Form 8938, Form 5471 and FBAR

Form 8938

An ASA, a convertible note and the shares issued on conversion are all specified foreign financial assets: they are financial instruments or interests issued by a foreign person and held outside a financial account. They count toward the Form 8938 thresholds, which for US taxpayers living abroad are higher than for residents (for a single filer abroad, broadly $200,000 at year end or $300,000 at any time; doubled for married couples filing jointly). An angel with several UK positions plus UK pensions and investment accounts will often exceed them. The value to report is fair market value, which for a pre-round instrument is usually its cost unless there is evidence of a different value. See the IRS page for Form 8938.

FBAR

Directly held shares, notes and ASAs are not financial accounts, so they are generally not reported on the FBAR. The UK bank account from which you paid the subscription is, and it counts toward the $10,000 aggregate threshold. Investors frequently over-report the instruments and under-report the accounts.

Form 5471

Form 5471 applies only if you own, directly, indirectly or constructively, 10% or more of the company by vote or value, or if the company is a controlled foreign corporation and you are a US shareholder. A typical angel cheque is far below 10%. The traps are family attribution (a spouse or parent who also invests), acquisitions that cross 10% on conversion when the discount and cap produce more shares than expected, and companies that become controlled by US persons after a US-led round. Where 10% is crossed, the form is due for the year of acquisition, and penalties for failure start at $10,000 per form per year. See the IRS page for Form 5471.

What happens if the startup fails before or after conversion?

Many pre-round investments end in failure, and the timing of failure relative to conversion changes the treatment on both sides of the Atlantic:

• ASA, company fails before shares are issued. No EIS shares were issued, so there is no EIS relief to withdraw but also no EIS loss relief against income. The UK capital loss position depends on the rights under the agreement. On the US side the loss is generally capital, and its year depends on when the right became worthless.
• CLN, company fails before conversion. You hold worthless debt. For US purposes a note issued in registered form is typically a security, giving a capital loss in the year it becomes wholly worthless; otherwise it may be a nonbusiness bad debt, which is a short-term capital loss. Previously included OID increases your basis and therefore your loss.
• After conversion. You hold shares, and the ordinary rules apply: a negligible value claim in the UK, and a worthless securities deduction in the US, subject to any PFIC overlay.

The UK negligible value claim is elective and can be backdated; the US worthless securities deduction is fixed to the year of worthlessness. We have covered this divergence in depth in our guide to negligible value claims and worthless UK shares on the US return, so we do not repeat it here.

A worked example: one angel, two instruments

Consider a US citizen resident in London who, in June 2025, signs a £100,000 EIS-compliant ASA with a UK software company and, in the same year, subscribes £50,000 for a convertible note in a second company carrying 8% rolled-up interest. The ASA converts in November 2025 when the first company closes its seed round; the note converts in 2027.

• UK, 2025/26. The investor claims EIS relief on the shares issued in November 2025 once the EIS3 arrives. No UK tax arises on the note's accruing interest until it is settled.
• US, 2025. The ASA is reported as a prepaid forward that settled in November: no income, basis equal to the dollar cost at payment, holding period from November. The note generates OID for the part of 2025 it was outstanding, translated to dollars. Both positions go on Form 8938 if thresholds are met. A PFIC analysis is prepared for each company.
• US, 2026. A full year of OID on the note, with no cash. No UK tax yet, so a US liability arises unless other credits cover it.
• 2027 conversion. The UK taxes the rolled-up interest settled in shares as savings income. On the US side the conversion is tax-free for amounts already included as OID; the UK tax on the interest becomes a passive-category credit, carried back or forward to match the earlier US inclusions.

The EIS relief on the first company reduces UK tax, which reduces the foreign tax available to credit on the US return. Well-planned, the two returns are coherent. Prepared by two unconnected advisers, they usually are not.

Already invested and not reported? Catching up

Many angels discover these rules only when the company is sold or an adviser asks for their Form 8621 history. Missing OID, unfiled Forms 8938 or 8621, and unreported UK accounts can generally be corrected. Where the failure was non-wilful, the Streamlined Foreign Offshore Procedures allow three years of amended or late returns and six years of FBARs with no penalty for eligible taxpayers resident abroad. Our IRS streamlined filing team prepares these filings, and our high-net-worth service handles the ongoing cross-border compliance once the catch-up is complete.

Documents to keep for each instrument

• the signed ASA or note instrument, including any side letters and longstop extensions;
• bank evidence of payment date and sterling amount, with the dollar exchange rate used;
• the company's advance assurance letter and the EIS3 or SEIS3 certificate;
• the conversion notice, share certificate, and cap table extract showing shares issued for principal and for interest;
• annual management accounts or balance sheets sufficient to support the PFIC analysis;
• any PFIC Annual Information Statement the company agrees to provide.

Speak to accountants who prepare both returns

Pre-round instruments are where UK venture relief and US anti-deferral rules meet, and where a single drafting choice can decide whether you receive 30% EIS relief, an OID bill on income you have not received, or a PFIC charge on your eventual exit. We prepare the US and UK returns, the Form 8938, 8621 and 5471 filings, and any catch-up disclosures for American angels investing in UK companies. To arrange a confidential review of your ASA and note portfolio before your next filing deadline, contact our cross-border team.