JULY 2016 - Corporate Rescue Exemption
As a legacy of the financial crash a number of companies in distress are still carrying debt which they may not have the ability to pay but have been unable to agree a release or restructure with the lender. Legislation has recently been introduced which may debt restructuring more attractive and practical for companies.
Historically, the general rule for debt release by a lender to an unconnected borrower is that the accounting credit arising is taxable in the borrower For example, if a company owes £100 but agrees with the lender to pay only £80, the difference of £20 is a taxable credit on the borrower. Exemptions from the taxable credit were only available in exceptional circumstances, when a company is part of an insolvency arrangement or the debt has been restructured via a debt for equity scheme.
The debt for equity scheme is not always feasible for lenders as they may be precluded from holding shares in borrowers or it isn’t commercially attractive.
The 2015 summer Finance Act introduced legislation aimed at companies in significant financial distress which will potentially allow them to restructure debt with unconnected creditors without recognising a taxable credit and undergoing a debt for equity swap or being part of an insolvency arrangement.
The legislation has been introduced to allow companies to restructure and potentially reduce their debt without incurring a potentially unaffordable taxable liability which may lead to risks of insolvency.
From 1 January 2015 companies entering into debt restructuring with unconnected parties, such as banks, are not required to recognise a taxable credit if:
- the restructuring is treated for accounting purposes, under FRS 102 or IFRS 9, as substantial modification of the terms of the loan relationship; and
- immediately before the modification it is reasonable to assume that, without restructuring, there would be a material risk that at some time within the next twelve months the company will be unable to pay its debts.
A restructuring may include the rescheduling of capital payments or amended interest rates.
The legislation states that a company is considered unable to pay its debts if:
- it is unable to pay its debts as they fall due; or
- the value of the company’s assets is less than its liabilities, taking into account contingent assets and liabilities.
It should be possible for companies to confirm if they meet the criteria of the second test but the first test is more subjective. HMRC guidance defines material risk of being unable to pay its debts as a significant risk of insolvency that is real concern to directors. The guidance suggests that no one factor will lead to a company meeting the criteria. Factors which will lead to the criteria being met include:
- breaches of financial covenants
- enforcement actions taken by creditors
- failure of a material customer or supplier
- management accounts showing cash flow shortfalls
Temporary cash flow difficulties will not be sufficient for the exemption to apply.
How can French Duncan help?
We are able to help in the analysis of the company’s current and forecasted financial position in order to identify whether there is a material risk of the company being unable to pay its debts.
We can then lend our considerable expertise to the interpretation of what this could mean from a tax perspective and whether proactive planning can lead to a more favourable outcome. This can include reviewing previous debt restructurings (ie debt for equity swaps) given the retrospective nature of the legislation. As companies have up to two years after the balance sheet date to resubmit a corporation tax return we can submit amended returns to ensure that transactions meeting the above criteria are not taxable income.
This will no doubt involve liaising with lawyers and lenders to ensure that any contract for debt release is structured in the most tax efficient manner.
In cases where there is doubt over whether the qualifying criteria will be met we can submit a clearance application to HMRC in order to gain assurance regarding the tax treatment of any credit arising from a restructure.
For more information or to discuss, please click here.