The end of 2009 brought with it significant changes to the UK tax treatment of corporate debt in the form of the “worldwide debt cap” and proposed changes to the treatment of debt buy-backs. This article provides a brief summary of these developments and their relevance.
Worldwide Debt Cap (WDC)
The WDC applies for accounting periods beginning on or after 1 January 2010 to restrict the UK tax deductions available in respect of intra-group financing costs (most obviously interest) in certain circumstances by reference to the external financing costs of the relevant “worldwide group” (defined by reference to the broad IAS definition of “group”). The WDC potentially penalises cash-rich groups when compared with their leveraged counterparts, and it applies in addition to existing UK rules on deductibility.
The rules are detailed and will involve a large compliance burden as they require the position of a whole group to be analysed when considering deductibility in the UK. To the Treasury’s credit, there is a “gateway test” to the application of the WDC (broadly, the WDC will not apply where UK net debt does not exceed 75 percent of worldwide gross debt) designed to ease the burden here, but work will obviously be required simply to determine whether that test is satisfied. Also, the rules are still subject to change. For instance, concerns were raised that corporate fund vehicles would potentially form “supergroups” for WDC purposes that straddle otherwise unrelated companies/groups (meaning the external financing position of one would impact on the UK deductibility position of another). The Treasury has therefore proposed changes to the relevant provisions in an effort to deal with this issue. These (and other) changes are expected to be legislated in a Finance Bill early in the next Parliament, but will generally apply from the same date as the WDC generally.
The acquisition of impaired debt at a discount by a company connected with a UK debtor company can trigger a UK tax charge for the debtor, subject to an exception where the purchaser and debtor were not connected within the three year period beginning four years before the acquisition. The Treasury believes this exception has been abused (for instance, by groups establishing new SPVs to acquire group debt at a discount, and then subsequently releasing that debt without a tax charge arising) and so plans to replace it with three new exceptions which are less easily abused. These essentially apply to arm’s length acquisitions that:
- occur in relation to a genuine corporate insolvency (the “corporate rescue exception”);
- are made in exchange for certain debt securities (the “debt-for-debt exception”); or
- are made in exchange for certain shares (the “debt-for-equity exception”).
These new exceptions are drafted restrictively (for instance, the corporate rescue exception requires a change of control, a circumstance a struggling debtor will often wish to avoid) and it will not always be easy to determine whether they apply in practice. Also, even where one of the first two exceptions does apply, a subsequent release of the debt in question may now give rise to a UK tax charge where it previously may not have. This significantly narrows the flexibility available to corporate debtors/ debtor groups in respect of their impaired debts. The relevant provisions are in draft form and are likely to be enacted in the Finance Act 2010, but will apply for some transactions dating back as far as October 2009.