Tax efficient debt restructuring

As property values continue to fall many real estate and construction businesses are facing weakening cash flows and uncertain futures even where their underlying business remains fundamentally sound in the medium to long term. 

With the number of stressed and distressed loans on their books continuing to rise lenders are becoming increasingly anxious about the ability of borrowers to keep servicing debt borrowed during more buoyant times.

With new funding difficult and expensive to obtain many companies are considering the different ways by which they can restructure their existing debt obligations, in conjunction with lenders, to keep within lending covenants.  In some distressed cases, as an alternative to formal insolvency procedures such as administration or even liquidation, banks and other lending institutions may agree to cancel debt in exchange for an issue of new share capital in the borrower.  Capitalising debt has the advantage of reducing the borrower's financing costs and significantly improving its prospects of weathering the downturn.

The tax legislation provides for corporate rescue situations where funding debt is capitalised by way of a debt equity swap.  It is usually possible to structure such transactions so that the borrower is not subject to tax on the amount of any debt forgiven, whilst the lender is entitled to impairment relief based on the amount of the debt cancelled provided there was no previous connection between the lender and the borrower.  However, transactions of this nature can often have wider taxation implications which need to be fully considered.

BDO's advice

It is important to consider both the structuring of the debt equity swap as well as the amount of share capital held by the lender as a result of the debt capitalisation.  In some cases this can result in adverse tax implications, for example, if the equity held by the lender is sufficient to inadvertently remove the borrower from its existing tax group. 
 
Where de-grouping occurs, the borrower can be prohibited from surrendering its tax losses to other related companies and where assets have previously been transferred intra-group this could trigger capital gains de-grouping charges and/or a claw back of stamp duty land tax.  Additionally, any tax losses of the borrower could be placed in jeopardy where there is a change in ownership of the borrower as a result of the transaction, with the consequence that their future use could be denied where, for example, there is or has been a major change in the nature or conduct of the borrower's business.
 
We can provide advice and assistance to clients wishing to restructure both external and intra-group debt tax efficiently and help them to better withstand the worst effects of the recession.

For more information please contact:
richard.bertini@bdo.co.uk