Readers' forum: Interesting bonds

A client has been offered the opportunity to subscribe for loan stock in a company. The terms of the bond include the payment of 5% interest in the form of additional loan stock redeemable at par at the end of the loan period. For example a holder of £10 000 nominal stock would receive another £500 nominal at the end of the first year and another £525 nominal at the end of the second year (5% of £10 500). The stock will not be a readily realisable asset and will be redeemed by the company after five years (all being well). The stock would also be repayable in the event of the company being taken over.

Can Taxation readers advise on how this interest is taxed in the hands of the recipient? In cash terms it looks like a deeply discounted security (interest taxed on redemption or...