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.
This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq
Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.
The original publication date for this article was 11/10/11.