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The application of corporate debt rules to restructuring of debt
Zeeshan Khilji explores how the corporate debt rules can be relied upon in certain debt structuring scenarios, allowing companies to structure their debts tax efficiently
Unsurprisingly, many companies have struggled to meet their loan repayment obligations in the aftermath of the economic downturn caused by the Coronavirus pandemic. As such, a significant number of companies need to take action to restructure their debts in order to enable them to manage their cash flow.
Before any debt structuring is undertaken, the tax implications of such restructuring should always be considered.
Basic tax treatment
A formal release of a loan is a method of eliminating debt. A release of debt would typically result in a P&L debit (i.e. expense) and credit (i.e. income) for the lender and borrower companies respectively. In the absence of specific tax legislation, credits arising from a formal release would be taxable for the borrower, and debits will be tax-deductible for the lender. However, there are certain exceptions to the rules as set out below.
It is important to note that for the loan to fall within these categories, it must fall within the ‘loan relationship’ rules. Without going into the technical details of what constitutes ‘loan relationship’, some common types of debt which fall within this definition include bank loans, overdrafts and debentures.
A special exemption is available where a release is credited to the borrower’s profit and loss account, where this takes place:
Connected company rules
The legislation also provides for a tax neutral treatment, such that any credit would be non-taxable, and any debit non-deductible, providing certain conditions are met and the creditor and debtor companies are ‘connected’ under the loan relationship rules. Companies are connected for these purposes if one company controls the other, or both are under the common control of a third company.
As mentioned earlier, it is important that the loan falls within the definition of ‘loan relationship’ in the first place. If in the first instance, this is not the case, a potential solution may be available under the extended definition of a loan relationship, which allows a debt that has not arisen from the actual lending of money to be deemed a loan relationship by the issue of a debt instrument, such as a promissory note.
Debt for equity swaps
Although a business may be struggling, the lender may take the view that the borrower is still capable of producing returns in future, when trading conditions eventually improve. As such, an alternative method for eliminating debt would be to cancel the debt in exchange for an issue of new shares in the borrower. Using new shares to replace debt will lead to savings in interest payments and give a business a much better chance of returning to profit.
In such cases, the general rule is that where debt is swapped for equity in an unconnected borrower, the borrower is not taxed on the release.
It is important that specific tax advice is sought in relation to the above exemptions. At ETC Tax, we have specialist experience in assisting companies with debt restructuring and can advise on ensuring that specific steps are followed, such that any debt elimination does not give rise to unexpected tax charges.
If you would like specialist tax advice, please do not hesitate to get in touch.