Company debt rules to be changed to help corporate rescues, says HMRC

Out-Law News | 15 Apr 2014 | 11:55 am | 5 min. read

The modernisation of the 'loan relationship' rules for taxing companies on debts will include a new rule to provide tax relief in more cases of corporate rescue, according to a technical note issued by HM Revenue & Customs (HMRC).

The technical note says that government intends to develop a new exemption, alongside the current debt release exemptions, applying to a wider range of corporate rescues. The new provision would apply to "consensual debt restructuring aimed at early remedial action to avert financial distress". It will take account of cases where lenders cannot, for commercial reasons, take equity in the debtor company.

According to the note, the government is also considering whether the exemption could also cover the accounting revaluation of liabilities which can sometimes arise as part of ‘amend and extend’ restructuring of debt. 'Amend and extend’ arrangements are those where the conditions of a loan may be relaxed, perhaps by extending the term, in order to avoid a default. 

The current rules for the taxation of corporate debt or loan relationships were introduced in 1996 and involve the profits being taxed and expenses allowed, broadly in accordance with the accounting treatment of the debts.  Without specific exemptions, releases of debt, even if pursuant to a corporate rescue, would give rise to a potential tax liability for the debtor company.

Another key proposal mentioned in the technical note is the introduction of a new regime-wide anti-avoidance rule. The note says that the government regards this as "an important element in achieving improved anti-avoidance protection" and in "reducing the need for new and complex anti-avoidance rules to deal with new attempts at avoidance in future".  

The rule will operate where there are arrangements which are aimed primarily at obtaining a tax advantage in terms of taxable amounts under the loan relationships and derivative contracts regime, according to HMRC. It will result in adjustments to negate the tax advantage sought. The note says that the new rule should permit the repeal of "some existing anti-avoidance rules". HMRC will consult on the detailed wording of the rule.

Tax expert Heather Self from Pinsent Masons, the law firm behind, said "HMRC has listened and responded to concerns about tax relief in 'corporate rescue' cases, and has shown welcome flexibility in their revised proposal.   However, there remains a lot of uncertainty around the scope of the proposed new anti-avoidance rules:  it is disappointing, and slightly surprising, that HMRC continues to see the need for additional detailed anti-avoidance rules, now that the general anti-avoidance rule (GAAR) is in place."

Changes to the 'unallowable purpose' rule will continue to be considered by the government but on a conditional basis so that they may not necessary go ahead, the technical note says. The unallowable purpose rule prevents a company from getting a deduction in respect of debits incurred in relation to a loan where the purposes for which the company entered into the loan include a purpose "which is not amongst the business or commercial purposes of the company".

The government says that "some stakeholders take the view that at least some of the changes are unnecessary" but the government "continues to consider that some changes, at least, have the potential to improve the clarity of the application of the rule". The changes include changes to clarify the definition of a ‘related transaction’, the treatment of set-off of credits on derivative contracts where debits are restricted due to an unallowable purpose and the treatment of contingent tax advantages.

The government confirms that it intends to go ahead with changes to take amounts recognised in profit or loss as the starting point for calculating taxable amounts on loan relationships and derivative contracts. Currently the rules take into account amounts recognised for accounting purposes wherever they appear in the accounts. This includes amounts in reserves, equity or ‘other comprehensive income’ (OCI), and amounts recognised direct to equity.

The note says that items initially recognised in OCI are generally at some later point ‘recycled’ into profit or loss, so the main impact of this change will be in timing. It says that rules will "take appropriate account of non-recycled items and the possibility of deliberate manipulation of accounting rules for tax avoidance purposes". HMRC says that as a result of the change amounts recognised direct to equity would not typically be brought into account for tax. It states that changes may be needed to address "the possibility of additional volatility in life insurance companies" as a result of the ‘decoupling’ of movements on assets from movements on linked liabilities to policyholders, which may not be recognised in profit or loss.

"The tax regime for corporate debt has always been closely aligned with the accounting treatment, but with some difficult areas around the question of whether amounts 'fairly represent' a profit or loss.  The new proposals show that HMRC is taking a pragmatic approach, following the accounts except where an anti-avoidance rule applies." said Heather Self.  

It is expected that the changes will generally have effect for accounting periods commencing on or after 1 January 2016, although the note says that some anti-avoidance measures may apply earlier.

In the consultation the government announced that it proposed to change or abolish the 'late paid interest rule'.  This rule prevents companies from getting tax relief in the period in which it accrues for interest paid in respect of loans from connected companies in certain territories where the interest is paid more than a year after the period in which it accrues. In these circumstances tax relief is only available when the interest is actually paid.

The technical note says that some respondents to the consultation had expressed concern about the change or abolition of this rule because it is used by insurance companies in particular, as a way to maximise the availability of loss relief. The technical note says that the government is continuing to consider this proposal "while in the meantime remaining of the view that an anti-avoidance rule is not an appropriate vehicle for tax planning".

Changes to clarify how the corporate debt and derivative contract rules work for partnerships with corporate members have proved "more difficult than expected to finalise" and will be included in the Finance Bill 2015, rather than the 2014 bill, as was originally planned.

In the 2013 Budget, the government announced a consultation on a package of proposals to modernise the corporation tax rules governing the taxation of corporate debt and derivative contracts. The government responded to the consultation in December 2013 and the technical note provides an update on "the Government’s developing thinking". The rules include some highly complex features and the government has received "frequent adverse comment on the complexity of the current rules".

The note confirms that some changes, such as a proposal to combine the loan relationships and derivative contracts rules into a single part of the legislation, will not go ahead. A fundamental change to the 'group continuity' rules will also be abandoned.

Although there is no formal consultation period for this document, HMRC has said that they would welcome further comment.  "We need to wait for more detail on the draft proposals, before forming a view on whether the detailed legislation achieves the stated policy objectives." said Heather Self.