On 14 October 2009 the Government announced a major change to the way in which company buy-backs of debt will be taxed. The change may be relevant to any corporate debt buy-back where debt is being purchased at less than face value, including the exercise of a post-enforcement call option in a securitisation.
The global financial crisis has resulted in many loans trading at below par value. This presents borrowers with an opportunity to purchase their own debt and, therefore, extinguish the debt at a reduced cost.
The tax treatment of loans issued by a company follows the company’s accounting treatment. If a company buys back its own debt it will extinguish that debt and the accounts will show a profit as the purchase price will be less than the book value of the debt. This accounting profit will be subject to UK corporation tax in the company’s hands.
The change announced by the government is targeted at a perceived loophole in the legislation which arose from a provision designed to provide an exemption from the charge in the case of corporate rescues of companies in financial difficulties. It was possible to set up a new company within the borrower group and use that new company to buy-back group debt at a price less than face value. This would not have resulted in a tax charge because the debt would not be extinguished when purchased by a person other than the issuer. If the purchasing company was resident in the UK for tax purposes it would be subject to UK corporation tax on the difference between the amount paid for the loan and the eventual repayment amount. However, as the debtor and creditor would be connected ,it was often possible for the debt to be written down and repaid at cost without any tax charge arising. Also, if the purchasing company was not resident in the UK a UK tax charge could generally be avoided.
With effect from 14 October 2009, the Government press release states that "only those debt buy-backs that are undertaken as part of genuine corporate rescues will benefit from buy-back profits not being subject to tax".
The proposed changes are to introduce three conditions so that in order to avoid the tax charge:
- there must have been a change in ownership of the debtor in the period of 12 months before the buy-back;
- the buy-back must have been intrinsic to the change of ownership; and
- before the change of ownership, the debtor must have been suffering severe financial difficulties.