Debt instruments are amended for a range of commercial reasons. It may be to replace references to LIBOR, to change bond restrictive covenants under a consent solicitation process or as part of an 'amend and extend' exercise for bank debt. The changes will rarely be tax-driven but it is important both for the debtor and for creditors that the potential tax issues are not overlooked.
Exactly what the tax issues are for a particular amendment will depend on a wide range of factors. The jurisdictions concerned, the nature of the amendments, the types of debtor and creditor and the date of the original debt instrument are likely to be significant, for example. However, broadly, the issues can be divided into three questions:
1. Will the amendment be a taxable event? Will creditors be treated as having disposed of their original asset for tax purposes? If so, they may recognise a taxable gain (or allowable loss) as a result. A similar point may arise for the debtor if it is required to derecognise its liability under the old debt and recognise a new liability in respect of the amended instrument. For jurisdictions which impose stamp or transfer taxes on issues of debt instruments, this also needs to be considered. Does the original debt instrument remain albeit on new terms or is it to be treated as having been cancelled and replaced by a fresh issue?
2. Will the ongoing tax treatment of the debt instrument be altered? First, will the amended terms themselves result in a different tax treatment? For example, could the debt become viewed as being equity-like for tax purposes because the rate of interest now exceeds a reasonable commercial return or because its term has been extended? Where the borrower has entered into a derivative or other instrument for hedging purposes, this also needs to be taken into account in evaluating the tax effects of the amended borrowing as a whole.
Second, where tax rules have changed since the original debt instrument was entered into, it may benefit from grandfathering protection allowing it to continue to be taxed under the prior rules. FATCA grandfathering for pre-1 July 2014 obligations and pre-1 January 2016 equity accounted instruments under the UK's loan relationship rules are just two examples. This grandfathering protection may be lost if the instrument is materially modified (or treated as cancelled and reissued) after the rules changed.
3. How will any payments to creditors be treated? Not all amendments will involve the debtor making payments to the creditors but where such payments are made the analysis as to their tax treatment for both payer and payee can be complicated. In many cases, it will depend on exactly what the creditors are being paid for doing. The same point arises in the context of VAT: are payments for agreeing to the amendment consideration for a supply for VAT purposes and, if so, is that supply exempt or standard rated?