What a difference a year makes. Last July, HMRC published their view that the preferential corporation tax treatment of a debt for equity swap could be denied where the creditor immediately sells on the acquired shares. An unexpected update in the HMRC manuals late last week, however, shows that this stance is softening.
Where a UK resident company is released from third party debt, it is generally subject to a taxable loan relationship credit equal to the amount of the release, even where the debt released is effectively worthless. However, there are statutory exceptions to this general position; one of which prevents a taxable credit from arising if the release is in consideration of shares forming part of the ordinary share capital of the debtor company. It therefore became common practice for a distressed borrower to issue a lender with some form of deferred shares in consideration of the release of part of the outstanding debt.
Last July, HMRC announced that if, “on the facts, the creditor has no interest in being a shareholder in the debtor company and is releasing the debt gratuitously, with shares being issued merely to obtain a tax advantage for the debtor company” then the taxable credit in the debtor company would still arise. HMRC considered that where a lender was issued shares which it was already contractually bound to sell, then this would indicate that the lender had ‘no interest in being a shareholder’.
Whether or not the legislation justified HMRC’s stance has always been up for debate, but this published view placed sufficient doubt as to the tax treatment that the banks became unwilling to capitalise debt and then immediately dispose of the new equity, e.g. for regulatory reasons, that the advice was to seek clearance from HMRC or find another way of restructuring.
In revised guidance issued late last week, however, HMRC’s stance appears to have softened substantially. They now acknowledge that under the statutory exemption “there is no requirement for the shares issued by the debtor company to be held for any particular length of time. Indeed, regulatory capital requirements may lead a bank to sell on the shares received as part of a debt/equity swap.”
While the revised guidance doesn’t expressly state as much, this suggests that banks should be able to swap into equity and sell on the latter without disadvantaging the debtor company. This is consistent with the approach that HMRC appear to have been taking very recently in response to clearance applications.
It appears from the revised guidance that the nuisance that HMRC is trying to prevent is where a debt is capitalised and the resulting shareholding is sold to an existing shareholder. The manuals go on to state “On the other hand there may, for example, be arrangements (contractual or other) in place for the lender to divest itself immediately of the shares to a company connected with the borrower for nominal consideration. If so, the consideration the lender receives may be the cash it gets, not the shares”.
It remains to be seen whether this revised guidance gives banks sufficient comfort to be able to enter into debt for equity swaps and then immediately sell on the resulting equity without obtaining specific approval from HMRC. It is, however, a welcome sign that HMRC’s published view is no longer at odds with its internal practices.