Experts call for long-term certainty as part of Government review of corporate debt tax regime

Heather Self of Pinsent Masons, the law firm behind Out-Law.com, said that the tax rules had "sometimes struggled to keep up with" commercial developments. The publication of draft proposals for consultation follows the Chancellor's Budget announcement of a review of the rules governing the taxation of corporate debt and derivative contracts.

"We welcome this review, but want to ensure that the benefits of potential change outweigh the costs," said Self. "It is good to see that this consultation is not being rushed, with most of the possible structural changes being deferred until 2015."

She said that some aspects of the consultation would be of particular interest to the nuclear energy industry, given the long timescale of projects and need to ensure that funds are available for decommissioning liabilities. For example, the consultation is seeking input on how tax relief in respect of increases in the value of index-linked gilts, which can be used to hedge later costs, could be better targeted.

"Investors in new nuclear build will want to ensure that there is certainty about the treatment of corporate debt instruments, particularly given the need to fund decommissioning liabilities over very long timescales," she said.

"Recent cases before the tax tribunals have highlighted the range of avoidance schemes involving financial instruments which have been prevalent in recent years. Whether radical change is still necessary, given the introduction of the general anti-abuse rule (GAAR), is a moot point," she said.

Any changes to the tax regime as a result of the consultation will be introduced over two years, with the most significant structural changes scheduled for 2015, the Government said. Measures to be introduced in 2014 will focus on areas where there is a current risk of tax leakage, according to the consultation.

The changes are intended to make the regime simpler and clearer, and to make tax avoidance measures more robust. The Government also proposes repealing those parts of the legislation that are rarely used in practice. The tax regime for loan relationships was originally introduced in 1996, with rules for derivative contracts following in 2002. In its consultation, the Government said that updates to the regime since then had been "piecemeal", arising from changes in commercial practices and accounting standards and in response to attempts to avoid tax.

The consultation proposes clarifying the role to be played by a company's financial statements in identifying and calculating the amount chargeable to tax. Amongst other changes, the Government is proposing basing the loan relationship and derivative contract regimes on a company's accounting profit and loss, rather than recognising amounts appearing anywhere in the accounts as is currently the case. This would bring these regimes into line with the normal approach used to calculate profits for accounting purposes.

As a general rule, the consultation proposes that the updated regime "rationalise and set out clearly the exceptional cases" where tax treatment should depart from the normal treatment of company accounts. In particular, it seeks views on the appropriate tax treatment of connected party debt and transfers of debt around a group. Although the consultation presents various options for change, the general approach is to question the extent to which special rules are necessary. Compound or 'hybrid' instruments, such as debt which is convertible to equity or instruments which include an embedded derivative, should also be treated as under the accounting regime, with each component taxed as if it was a separate instrument.

The consultation also proposes substantial changes to the way in which foreign exchange (forex) and hedging relationships are taxed. The proposals would generally only see forex movements in respect of loans and derivatives held for trading or property business purposes being taxed or qualifying for tax reliefs. Other forex movements would only be considered in prescribed circumstances, particularly in the context of hedging relationships.

Changes to the taxation of loan relationships and derivative contracts held by partnerships are also considered, in conjunction with the more wide-ranging review of partnership taxation published last month. The proposals would see instruments taxed in the same way that they would have been had each corporate partner held the appropriate proportion of the instruments directly. Any changes made would be included in next year's Finance Bill, so that they would come into force at the same time the other proposed changes to the partnerships regime.

Tax experts at Pinsent Masons sounded a note of caution about some of the proposals, particularly changes to the tax treatment of restructuring of debt. One proposal would see an exemption from tax currently available where a debt is released in exchange for shares issued by the debtor limited only to those releases made in a 'corporate rescue', where the debtor is at risk of insolvency.

"It will be vital that Government concerns over particular historic tax schemes do not lead to wholesale change to aspects of the regime," said Pinsent Masons's Tom Cartwright. "In particular the restructuring of debt is a complex area and the commercial management of debt by large corporates must not be rendered impractical by any of the proposals."

"Given the Government's objective to reduce the corporate tax rate in the UK to 20%, the outcome of this consultation could add significantly more complexity to the UK tax system if the new systems faces as many problems as the old one," said Ray McCann of Pinsent Masons. "If this was the case, the changes could cause considerable uncertainty to a range of businesses at a time when many may see the need to use complex loan instruments for tax planning reasons as less important."

The consultation also seeks views on combining the separate regimes for loan relationships and derivative contracts into a single code, in order to reduce the length of the legislation and eliminate unintended discrepancies between the two regimes. While the Government has not made a firm proposal, it has asked companies for their views on the extent to which the benefits of a combined regime would justify the "inevitable" transitional disruption.