The uncertainty continues. Over the past few years, the published guidance from HMRC has given rise to doubts as to the tax treatment of debt-for-equity swaps. Whether the current legislation has supported HMRC’s position is debatable but it now appears that HMRC would like to have the legislation amended to more closely reflect its views.
On 6 June 2013, HMRC launched a consultation on “Modernising the taxation of corporate debt and derivative contracts”. The stated purpose of the consultation is to gather views about proposed changes to the structure of the regime and to the detailed rules currently contained in Parts 5, 6 and 7 of the Corporation Tax Act 2009 (CTA).
Under the current legislation, where a loan relationship is released by an unconnected party, the debtor company is taxed on the amount so released. However, where the debt is released in consideration for the issue of ordinary share capital in the debtor company, the debtor company is not required to bring into account a taxable loan relationship credit. The consultation proposes to restrict such beneficial tax treatment to corporate rescue situations.
If implemented, this would require debt-for-equity transactions explicitly to be made on arms’ length terms and/or for it to be reasonable to suppose that, but for the debt-for-equity transaction, the insolvent borrower would otherwise, within one year, have entered administration or liquidation, or had an administrative receiver appointed to its assets.
The proposed scope of the corporate rescue exemption could have an impact in certain cases and restrict the ability to effect debt-for-equity swaps at an early stage, where it is apparent that a company is over-leveraged but before it is in real financial distress. We would therefore query whether this is the appropriate test and would have the potential to discourage good financial hygiene.
Given the consultation document hints at an irritation at the large number of clearance applications that they have received from practitioners on the current law, it is it is ironic that this proposal will potentially increase rather than remove any uncertainty.
CMS is considering its response to the HMRC proposal. The consultation period closes on 29 August 2013.
A link to the full consultation document can be found here.