UK Tax Traps on Restructuring

8/3/2019 UK Tax Traps on Restructuring

1/5

International

Corporate Rescue

This article was first published in Issue 3, Volume 7 of International Corporate Rescue and is reprinted with permission of

Chase Cambria Publishing Ltd - www.chasecambria.com


2/5

154

ARTICLE

UK Tax Traps on Restructuring

Brenda Coleman, Tax Par tner, Weil Gotshal & Manges, London, UK

As anticipated, the current economic climate has

resulted in a signicant number of restructurings of

groups in nancial difculties. They cover a range of

different situations. There may be consensual trans-

actions where the debtor is trying to restructure its

balance sheet by obtaining new nance in return for

the lender acquiring an equity stake or a release ofdebt in return for equity or share warrants (which

may take place within or outside the framework of a

statutory procedure such as a scheme of arrangement

or a corporate voluntary arrangement (CVA)) or a debt

buy back. The complexity of these procedures has been

compounded by the complex capital structures, includ-

ing those seen in the leveraged buy-outs, of the last ten

years.

This article is focusing on some of the UK tax issues

typically encountered in these situations. Each case

will inevitably be unique and no nite list of tax issues

can be presented at the outset. Whilst this article looks

at tax issues of UK groups and UK lenders, debtors andcreditors in other jurisdictions will be faced with simi-

lar issues but may need to nd different solutions which

have the desired tax consequence under local law.

There are particular features of restructurings that

may be more likely to give rise to tax consequences that

should be identied early on in the transaction.

Is there a release of debt?

Where a debtor company is released from an obligation

to pay a debt, an accounting prot would normallyarise. As a result for a UK corporation tax payer, the re-

lease of an obligation under a debtor loan relationship

would normally give rise to a taxable credit. However,

there are exceptions and it is important deals should be

structured to fall within these exceptions.

The three main exceptions which may apply are

where debt is exchanged for equity, the debtor and

creditor are connected or where the release is in the

course of an insolvency procedure.

However, the exceptions need to be carefully re-

viewed. The exception for debt to equity swaps requires

that the debtor account for the debt on an amortised

cost basis and also that the shares issued in considera-

tion for the release of the debt are shares in the debtor

company. This can give rise to a requirement to reor-

ganize the debt in the debtor group prior to the debt for

equity swap if, for example, the creditor requires shares

in the top company or to avoid a degrouping if shares

are issued in lower tier subsidiaries. For example, the

debt may need to be novated up to the top company

before the shares are issued. (The novation should notresult in a credit or debit arising as the transaction

should be treated as taking place for a consideration

equal to the notional carrying value of the liability so

that no prot will arise). Alternatively the debt for eq-

uity swap can take place in the debtor company and the

shares subsequently exchanged for shares in the top

company (but consideration must be given to whether

any additional stamp duty charge arises on this route).

The shares which are issued must be ordinary shares,

i.e. they must be shares other than shares which give

the holder a right to a dividend at a xed rate but no

other right to share in the prots of the issuer. The pro-

vision to lenders of a more contingent right to equitymay therefore be difcult. For example, it would be dif-

cult to issue warrants as consideration for the release

of a debt and bring the transaction within the excep-

tion for debt to equity swaps.

The debt to equity swap exception can apply ir-

respective of the value of the shares issued. Therefore

even issuing a very small number of shares in respect

of the release would appear to fall within the exemp-

tion. HMRC do however refer to the application of the

transfer pricing rules in the HMRC manual in connec-

tion with debt to equity swaps. However it is not clear

how this is in point although it may be more relevantfor the remaining debt if the lender now has an equity

interest.

It is also important to address whether the equity

is being issued in respect of accrued interest, as this

can result in a UK withholding tax liability arising in

the absence of any exemption or Double Tax Treaty

applying. This can be avoided when shares are issued

in consideration of the release of the debt rather than

in satisfaction of the debt so that no interest is paid

(although this could have consequences for certain

interest which accrues to connected parties where in-

terest is not deductible until paid).

An alternative exemption is where the debtor and

creditor are connected. This would typically be relied


3/5

UK Tax Traps on Restructuring

International Corporate Rescue, Volume 7, Issue 3

2010 Chase Cambria Publishing

155

on for intra-group debt which is waived (for example,

intra-group debt which arises on a novation of debt to

a parent company or otherwise). One point to watch

here is that the debt must represent a loan relationship

for these rules to apply. Intra-group debt can also be

capitalized by subscribing for shares with the purchase

price being off-set against any debt. A group may want

to ensure such arrangements are structured as far as

possible to give them a base cost for any shares issued

equal to the value of any debt which is being given up

in return.

The most straightforward way of avoiding a tax

charge on release of debt is for debt to be released as

part of a statutory insolvency arrangement such as a

CVA or scheme of arrangement or circumstances cor-

responding to these in other territories which would,

for example, include chapter 11 proceedings. In these

circumstances the loan relationship rules provide that

no tax credit arises in respect of the release.It should be noted that other jurisdictions may have

less generous rules than the UK. In certain jurisdictions

where there is no exemption for debt to equity swaps, it

may be possible to provide for debt to be repurchased

by an afliated company and then waived when con-

nected. However this will not be effective where there

are rules equivalent to the UK rules which would result

in a tax liability on any prot on a buy back by an afli-

ate at less than the par value of the debt.

Has the creditor become connected with thedebtor?

The creditor position should also be kept in mind on a

debt for equity swap. A creditor will be concerned to

get relief for the bad debt. The general rule is that an

impairment loss should be available for a UK creditor

provided the creditor does not control the borrower,

ignoring any connection arising on the debt for equity

swap or where the debtor is an insolvent process. One

point to watch out for is where the debt for equity swap

takes place in the top company but the creditor retains

debt in a lower tier company. On a subsequent waiver

of the lower tier debt, bad debt relief will not be avail-

able if the creditor controls the top company by virtue

of the earlier debt for equity swap.

Is there new debt?

Where new nance has been made available, the

transfer pricing rules will need to addressed. It is also

important to look at any rescheduling of debt to see

whether the changes are so fundamental that there

has been a rescission of the existing agreement and the

implementation of a new contract. This might amountto a new provision for transfer pricing purposes. Where

transfer pricing is relevant, it is necessary to consider

the question of whether the new loan would have been

entered into at arms length and if so on what terms.

There are rules with attribute the rights and powers

of each person who acts together in relation to the

nancing arrangements, to each other person who so

acts, which can bring third party lenders within the

scope of the rules. However, HMRCs guidance indi-

cates that where the lenders view of risks/reward in

relation to the lending is unlikely to be affected by any

interest it may have in the equity, it should be treated as

a transaction at arms length.

The transfer pricing analysis may be difcult where

there is a credit bid and the lenders provide nance to a

new vehicle by way of contributing the debt in the ex-

isting company or where the new funds are effectively

round tripped to pay back the original loan. It may be

less clear that such a loan is on arms length terms

looked at in isolation. However, in these situations it

is considered that HMRC should look at the entirety ofthe arrangement to determine whether they have been

entered into at arms length although it is not clear that

this is the approach they do take.

As with any new debt, account needs to be taken as

to whether interest can be paid without withholding for

UK tax and whether there are any other provisions that

might deny relief for that interest and whether there

are sufcient prots against which the resultant losses

can be surrendered or whether a push down should be

implemented to make better use of the deductions.

Is there a disposal of assets?

Many restructurings involve a disposal of assets often

in the context of an enforcement of a security or a pre-

pack. Shares are typically sold to a Newco owned by

the banks or other creditors. If signicant debt remains

in the target, shares may have a low value and tax on

disposal or stamp duty issues may not be signicant.

However, if debt is left behind and the target or other

asset is sold on a debt-free basis, there may potentially

be a gain on the disposal of the assets (including shares)

and stamp duty or SDLT on land transaction payable

on the purchase price. The substantial shareholding

exemption will typically be available on a sale of more

than ten per cent of the shares in a trading group pro-

vided the transferor continues to operate a trade. In

the context of a pre-pack this requirement may not be

satised if the transferor has no other assets although

it is generally considered the exemption will be avail-

able where the transferor is liquidated immediately

after the sale although this is not entirely clear. Other

issues which should be considered in the usual way

are possible exit charges where a company is sold out

of a group, any reporting requirements where shares

are transferred out of a non-UK tax resident subsidiarycontrolled by a UK group and whether the losses will

continue to be available to a purchasing vehicle. If land


4/5

Brenda Coleman

International Corporate Rescue , Volume 7, Issue 3

2010 Chase Cambria Publishing

156

is being sold, SDLT at four per cent, may be signicant,

although reliefs may be available where land is sold in

return for the assumption of debt.

Has the company been put into a process?There are tax consequences which may arise as a result

of the company being put into a process. It is important

to evaluate these before this process is started. For ex-

ample, the availability of losses may be impaired. The

entry into administration triggers a new corporation

tax accounting period, so the range of losses which

can be used may be reduced. For example, there may

be carried forward losses that can not be sheltered be-

cause carried forward losses from an earlier accounting

period cannot be group relieved. However, the appoint-

ment of an administrative receiver does not end an

accounting period.It may also be relevant that a company in liquidation

will lose the benecial ownership of its assets. However,

this does not prevent it using pre-liquidation losses

against its income. It will not be treated as disposing

of it assets and a capital gains tax grouping will not

be broken. However, it may prevent stamp duty group

relief being claimed or surrendering losses around a

group. The ranking of tax may also change in a proc-

ess. If there is a sale outside of an administration, tax

would be an unsecured claim where as in an adminis-

tration procedure corporation tax on a gain would rank

as an expense of the administration and may prejudice

creditors. It may also be relevant to consider whether

the appointment of any UK insolvency practitioner to

non-UK company may make it a UK tax resident. How-

ever, this can normally be avoided by ensuring that the

UK administrator takes decisions offshore consistent

with the company continuing to be centrally man-

aged and controlled outside the UK. It is also necessary

to consider whether as part of the process there is an

intention for the COMI (the centre of main interests)

to be migrated to the UK in order to bring the action to

the UK courts. Consideration must be given to the effect

this has on the residence of the company and whether

it will result in the company being subject to UK tax byvirtue of being resident for UK tax purposes in the UK.

Have you created a trust?

Procedures may result in assets being held on trust for

creditors. This can occur where there is a scheme of

arrangement or CVA. A normal CVA will generally be

a bare trust but it is important to review the drafting

to ensure that entitlements may be dened in advanceso that it is clear that a bare trust exists. Where a dis-

cretionary trust exists, unexpected income tax, capital

gains tax and even inheritance tax charges can result.

Distribution trusts can also give rise to difculties in re-

lation to any interest which is accumulating in the trust

which may need to be paid out subject to withholding.

Has the debtor or an associated company

bought back its own debt?

An effective way of reducing a companies leveragemay also be to buy back debt which is trading at a dis-

count in the secondary debt markets. A careful review

of the documents will be required in order to determine

whether the transaction is permissible. The Loan Mar-

ket Association recommended documentation has been

amended to introduce specic controls on buy-backs.

Tax rules relating to the buy back of a debt have re-

cently been amended. In normal situations the debtor

would be taxed on a prot on the buy back. If an afliate

of the debtor buys it back a tax charge will normally be

imposed on the debtor by deeming the debt to have been

released. There was an exception to this rule that was

introduced to allow corporate rescues which allowed

afliated companies that had been in existence for less

than 12 months to buy back debt at a discount without

triggering a tax liability. The rules were changed re-

cently and restrict this exemption to cases where there

is a change in ownership of the debtor and, before the

change of ownership, the debtor was suffering from

severe nancial problems. The detailed legislation effect-

ing these changes will be introduced in the Finance Bill

2010 although they have immediate effect.

Many of the traps that arise on restructurings can

therefore be removed by careful planning. As always,

it is important to get tax advice at an early stage of therestructuring!


5/5

International Corporate Rescue

International Corporate Rescue addresses the most relevant issues in the topical area o insolvency

and corporate rescue law and practice. The journal encompasses within its scope banking and

fnancial services, company and insolvency law rom an international perspective. It is broad

enough to cover industry perspectives, yet specialized enough to provide in-depth analysis topractitioners acing these issues on a day-to-day basis. The coverage and analysis published in the

journal is truly international and reaches the key jurisdictions where there is corporate rescue

activity within core regions o North and South America, UK, Europe Austral Asia and Asia.

Alongside its regular eatures Editorial, The US Corner, Economists Outlook and Case Review

section each issue o International CorporateRescue brings superbly authoritative articles on the

most pertinent international business issues written by the leading experts in the feld.

International Corporate Rescue has been relied on by practitioners and lawyers throughout the

world and is designed to help:

Better understanding o the practical implications o insolvency and business ailure and

the risk o operating in certain markets.

Keeping the reader up to date with relevant developments in international business and

trade, legislation, regulation and litigation.

Identiy and assess potential problems and avoid costly mistakes.

Editor-in-Chie: Mark Fennessy, Orrick, Herrington & Sutclie (Europe) LLP, London

Scott Atkins, Henry Davies York, Sydney; John Armour, Oxord University, Oxord; Stephen Ball,

Bryan Cove, London; Samantha Bewick, KPMG, London; Geo Carton-Kelly, Baker Tilly, London;

Sandie Corbett, Walkers, British Virgin Islands; Stephen Cork, Smith & Williamson, London;

Ronald DeKoven, 3-4 South Square, London; Simon Davies, The Blackstone Group, London; David

Dhanoo, Qatar Financial Centre Regulatory Authority, Qatar; Hon. Robert D. Drain, United States

Bankruptcy Court, Southern District o New York; Nigel Feetham, Hassans, Gibraltar; Stephen

Harris, Ernst & Young, London; Christopher Jarvinen, Hahn & Hessen LLP, New York; Matthew

Kersey, Russell McVeagh, Auckland; Joachim Koolmann, J.P. Morgan, London; Ben Larkin, Berwin

Leighton Paisner, London; Alain Le Berre, London; Guy Locke, Walkers, Cayman Islands; Proessor

John Lowry, UCL, London; Lee Manning, Deloitte, London; David Marks Q.C., 3-4 South Square,

London; Ian McDonald, Mayer Brown International LLP, London; Riz Mokal, 3-4 South Square,London; Lyndon Norley, Greenberg Traurig Maher LLP, London; Rodrigo Olivares-Caminal, United

Nations Conerence or Trade and Development, Geneva; Christian Pilkington, White & Case LLP,

London; Susan Prevezer Q.C., Quinn Emanuel Urquhart Oliver & Hedges LLP, London; Sandy

Purcell, Houlihan Lokey Howard & Zukin, London; Dr Arad Reisberg, UCL, London; Peter Saville,

Zolo Cooper, London; Daniel Schwarzmann, PricewaterhouseCoopers, London; Sandy Shandro,

3-4 South Square, London; Richard Snowden Q.C., Erskine Chambers, London; Dr Shinjiro Takagi,

Nomura, Japan; Lloyd Tamlyn, 3-4 South Square, London; Stephen Taylor, Alix Partners, London;

William Trower Q.C., 3-4 South Square, London; Mahesh Uttamchandani, The World Bank,

Washington, DC; Robert van Galen, NautaDutilh, Amsterdam; Miguel Virgs, Ura & Menndez,

Madrid; Dr Haizheng Zhang, Beijing Foreign Studies University, Beijing.

For more information aboutInternational Corporate Rescue, please visit www.chasecambria.com

UK Tax Traps on Restructuring

Documents

Transcript of UK Tax Traps on Restructuring