Tax should not prevent your restructuring

Last updated 11 June 2020

The last few months have been focused on cash flow and keeping businesses afloat, but now the focus is shifting to the future.  As companies emerge from the “lockdown” many are now assessing their future operating and financing models.  For some,  this may involve significant restructuring of routes to market, supply chains and business lines. For many, it will also involve ensuring that their leverage is right-sized to take account of a more difficult trading outlook to ensure that they can continue to trade beyond the next 12 months and into the future.

As a general rule, HMRC do not want companies to fail and end up insolvent.  Even where companies are not profitable and hence do not incur corporation tax, they can generate significant tax revenues through employing staff and charging VAT etc. Therefore, HMRC have always sought to ensure that a corporation tax charge does not prevent companies from restructuring and ‘right-sizing’ debt levels to avoid an insolvency event.

The potential issue

When a lender waives/releases a company’s obligation to repay all or a proportion of its debt or significantly amends the terms of the debt this can give rise to an accounting credit. Without specific exemptions, this accounting credit would be chargeable to corporation tax. Certain exemptions are, however, available for companies in potential financial distress where there is an actual insolvency or a real prospect that they will be unable to repay their debts.

Actual Insolvency

Where a company is released from all or part of its liabilities where either:

• The company is subject to a statutory insolvency arrangement; or
• One of the ‘insolvency conditions’ are met

then the accounting credit will be exempt for tax purposes.

The ‘insolvency conditions’ include insolvent liquidation, insolvent administration, insolvent receivership, provisional liquidation (including Northern Ireland Insolvency Orders), and equivalent rules outside the UK.

Material risk of insolvency – the corporate rescue exemption

It is common for parties to work together to try an prevent an actual insolvency through a debt for equity swap (see below), however, there can be regulatory or commercial restrictions which mean this isn’t possible in all cases.

Where a debt for equity swap is not possible further exemptions from a tax charge can apply where there is a material risk the company would be unable to meet its debts at some time in the next 12 months. These exemptions include full or partial releases of debt, as well as ‘amend and extend’ cases where there is a substantial modification or replacement of debts.

Debt for equity swaps

It is relatively common for banks / other lenders to agree to a restructuring of debt as a last resort to help alleviate a company’s financial distress in order to help secure some return to the lenders. Often the parties will enter into a debt-for-equity swap under which lender will release the debt in exchange for an equity interest in the borrower, and generally these can take place with no tax charge.

For the avoidance of doubt, the debt for equity swap rules do not require an insolvency or financial distress (as with the corporate rescue exemption) and are potentially applicable in all circumstances.

Other features in debt restructurings

It is worth noting that debt restructurings will often have a number of complex features and specialist advice should be sought. Examples of other considerations include:

• Transfer or novation of debt to companies in the same group;
• Split of debts into tranches and the seniority changed;
• derivative contracts hedging the debt may be closed out or altered

Our specialists are available to assist, please get in touch.