Corporate debt restructuring

Corporate debt restructuring can be complex with companies often encountering common pitfalls, such as overlooking tax implications and failing to engage in thorough planning.

In a time where many businesses are facing uncertainty on meeting loan covenants and payment terms, companies are under increasing pressure to secure new funding and restructure their existing debt.

It’s essential to understand the history of any corporate debt and whether the debt and related transactions are considered to fall within the loan relationships legislation or not. This article explores common debt structuring options involving loan relationships and typical pitfalls in these areas.

What is a loan relationship?

A loan relationship arises where a company has been party to a transaction involving the lending of money. It’s possible for money debts to occur within companies where they do not arise from the lending of money, so aren’t considered to be a loan relationship.

The loan relationship legislation applies to companies and partnerships with corporate members; the legislation does not apply to individuals.

Release of debt

Debt restructuring usually involves the whole or partial release of debt. A write-off (as opposed to a formal release) of a loan would not have the same effect. A lender might write-off the loan from their perspective because it’s no longer considered recoverable, but the borrower would not be in a position to write-off the loan as it would remain a liability of the company until it’s released of the obligation to repay it by the lender.

The legal documentation must be clear when debt is being released. To achieve this, loans are formally released via a deed. We’d always recommend any documentation relating to the release of debt is reviewed by a tax specialist to ensure the documentation carries out its intended purpose from a tax perspective.

The release of debt for no consideration between two companies is likely to give rise to a taxable credit for the borrower and a deduction available for the lender. There are however several exemptions where the credit will not be subject to corporation tax, and therefore no deduction available for the lender.

Release of debt between connected companies

Where there is a release of debt between connected companies and certain conditions are met, there is an exemption which may mean that any credit arising is not subject to corporation tax. For these purposes, two companies are connected if one has control over the other, or if both companies are under common control.

Often, connected companies may hold balances outstanding on intercompany loan accounts or debts arising from the sale or goods or services between the group, which would not be a loan relationship. Where the release of debt is not a true loan and where the release is not formally documented, the credit may be taxable for the borrower.

Care should be taken where impaired debt is acquired from a connected party, or where debt is impaired and both debtor and lender become connected. There are provisions in place to overturn the exemption available for connected companies where this is the case.

A point that is often overlooked is the tax position of the shareholder where debt is released between two companies with a common shareholder. The release of debt is usually a distribution to the shareholder, which may be less of a problem where the shareholder is a corporate entity or where the debt is irrecoverable. However, if the shareholder is an individual, a dry tax charge could arise.

Debt for equity swaps

Where debt is released in consideration for shares forming part of the ordinary share capital of the borrower (or an entitlement to such shares), any credit arising from the release may be exempt from corporation tax.

It’s possible for HMRC to question whether there has been a release of debt in exchange for share consideration, and this will depend on whether a ‘realistic view’ of the transaction can be said to apply.

HMRC accept that most debt for equity swaps will occur in distressed company situations and will therefore accept that, typically, the share capital issued by the borrower will be worth less than the amount of debt released.

HMRC have said that they will therefore not argue that the exemption doesn’t apply just because of the wide disparity between the debt released and the market value of the equity issued in exchange for the debt.

Close collaboration between the tax advisers and the lawyers will be important.

Corporate rescue exemption

Before the release of debt, where it’s reasonable to assume that without this there would be a material risk that within the next 12 months a company would be unable to pay its debts, any credit arising on the release may not be taxable, under what is known as the corporate rescue exemption.

HMRC have specific guidance on what they consider to be a ‘material risk’ which can include examples of evidence such as breaches of financial covenants, negotiations with third-party creditors over restructuring of debt, adverse trading conditions, insolvent balance sheets and other examples supporting a distressed company position.

The corporate rescue exemption is subjective and is not determined by one single factor. It’s therefore important to consider all facts and ensure any position is supported by evidence.

How can we help?

The loan relationship rules are complex, and this article outlines the main provisions. We can assist you with identifying where tax issues could arise from restructuring debt and what steps can be taken to ensure exemptions are available.

This article is based on HMRC guidance and legislation at 25 September 2024.