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When a company is in financial distress, it needs to act quickly and one factor in determining which restructuring route to pursue may be the relevant tax treatment of the deal. By extending the cases where tax relief is available, the government hopes to promote a greater range of options. Lara Okukenu, senior tax manager at Deloitte, explains the changes put forward.
When an unconnected debt is released—ie the creditor waives the debtor’s obligation to repay—amounts credited in the debtor’s accounts in respect of the release will normally be taxable as loan relationship credits.
This requirement to tax the release credit does not apply where:
Despite this, however, until the draft Finance Bill 2015, no such relief was afforded for companies in financial distress for whom a debt/equity swap or formal insolvency processes were not appropriate. The government has sought to address this by introducing new provisions removing the need to bring into account loan relationship credits arising on a release of debt, where it is reasonable to assume that—but for the release—there would be a material risk that within the 12 months following the company would be unable to pay its debts.
The terms ‘reasonable to assume’ and ‘material risk’ should, when taken together, mean there must be a realistic likelihood of the company going into insolvency within 12 months of the date of the release if remedial action is not taken.
This is intended to hypothesise a position that would have happened but for the debt release. It is not intended to imply that the company’s directors are currently in breach of their company law obligations by continuing to trade.
There is no prescriptive list of evidence that must be provided to benefit from the tax relief, however draft HMRC guidance does provide a list of the sort of circumstances one may look to, including:
Given the subjective nature of this exemption, one would advise contemporaneous evidence is maintained. In many cases, the facts will be quite clear in practice.
It is intended that the changes should be effective for any releases of a debtor relationship of a company on or after 1 January 2015.
However, as noted above, in applying the exemption it must be reasonable to assume that but for the release, there would be a material risk that within the 12 months following the release, the company would be unable to pay its debts.
The new general exemption is intended to facilitate corporate rescue without requiring a formal process or the uncertainties and restrictions associated with debt/equity swaps. Hopefully, this will reduce the need for advance HMRC clearance which is currently viewed by companies (and their lenders) as a critical component of corporate restructurings.
The acid test will be whether it is feasible for companies and their advisors to conclude that as at the time of the release, the conditions are satisfied. In many cases, the facts will be clear. However, in boundary cases companies will need to assess whether clearance could be sought or, indeed, if they may need to revert to more familiar methods such as debt/equity swaps.
The proposed law changes are also intended to cover ‘modifications’ or ‘replacements’ of debts, sometimes referred to as ‘amend and extend’ exercises.
The terms ‘modifications’ or ‘replacements’ refer to the accountancy treatment whereby the debtor company realises a profit as a result of contractual terms having been changed.
In such a case, where it is reasonable to assume that but for the modification or replacement, there would be a material risk that within the 12 months following, the company would be unable to pay its debts, then again, no credit should be brought into account for tax purposes.
Equally however, any debit recognised on the reversal of an exempt credit will also be prevented from being brought into account. This prohibition does not apply to a release of debt on the basis that the debt no longer exists.
Interviewed by Julian Sayarer.
The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.
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First published on LexisPSL Restructuring and Insolvency
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