HM Revenue & Customs (HMRC) recently revised its guidance (again) on section 322(4) of the Corporation Tax Act (CTA) 2009. This provides relief to a UK corporate debtor against a tax charge on the release of a debt obligation where such debt is released "in consideration of shares", or in consideration of an entitlement to receive shares which form part of the ordinary share capital of the debtor.
HMRC's guidance on this topic was last revised in July 2010 and at that time HMRC included the statement that, in its view, a release is not in consideration of shares "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".
The source of this suggested "no interest in being a shareholder" test was far from clear, as it is not based on the legislative framework for the relief from the charge to tax in relation to debt for equity swaps. In issuing this guidance last year we believe HMRC was seeking to discourage mischief around pre-ordained arrangements for the creditor receiving the shares to then sell them onto a connected party of the debtor (e.g. its existing parent company).
The new revisions to HMRC's guidance on this topic, issued without fanfare in October, seem to suggest HMRC is moving away from the wide stance set out in its July 2010 guidance. In our view this is rightly so, as there may be a number of sound commercial reasons why a creditor wishes to dispose of the shares it receives as part of a debt for equity swap (e.g. for regulatory capital reasons or to ensure that the debtor does not come under the control of the creditor).
The new guidance states that "[t]here is no requirement for the shares issued by the debtor company to be held for any particular length of time" and replaces the "no interest in being a shareholder" test with one which states "[w]hether or not a debt is released 'in consideration of shares' will depend on whether on a realistic view of the transaction, [section 322(4) CTA 2009], construed purposively, can be said to apply to it".
HMRC still does not like the pre-ordained situation where a lender is issued with shares in consideration of waiving a debt and then on-sells those shares to a connected third party. It argues in the revised guidance that in this situation the consideration the lender receives, on a realistic view of the transaction as a whole, is the cash it gets in return for the sale of the shares. This consequently makes the release of the debt entirely gratuitous (and therefore taxable in the debtor company).
The HMRC's revised guidance does helpfully include a list of features that may arise in debt restructuring situations which it believes will not in themselves cast doubt on the availability of the exemption. These include: (i) arrangements for a party to exit a joint venture, or for a party to become the controlling shareholder of a joint venture company; (ii) allowing the shares issued in exchange for the debt to have different rights to other shares issued by the debtor company; and (iii) where the shares are sold on to a third party, this being on deferred terms so that the lender benefits from a future increase in its value. It's a move that appears aimed at freeing up more time for HMRC's officers by reducing the volume of clearance applications the organisation receives on this topic.
In revising this guidance HMRC may not have made its position much clearer over what will and will not amount to a debt for equity swap to qualify for this tax exemption, but it has at least clarified a number of commercial features that will not impact on the status of the swap. In practice, this will mean fewer debt restructurings will create headaches around whether the debt for equity swap will have adverse tax consequences for the debtor company.
All of this means that creditors looking at potential restructurings should consider again including debt for equity swaps as part of their restructuring armory.