Debt Buybacks: HMRC to introduce anti-avoidance measures

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16 October 2009

HMRC announced on 15 October 2009 that anti-avoidance legislation will be included in the next Financial Bill, but which will have retrospective effect from 15 October 2009, and which affects debt buybacks.

This will have a direct impact on the situation where a company which owes money to an arm's length lender (e.g. a bank) wants to write off or write down that debt, as does the bank.

Current Position

The general position is that unless the parties are connected, or there is some sort of insolvency arrangement, or there is a debt/equity swap etc, the write off or write down of the debt will generate a taxable credit in the borrower, and a tax deduction in the lender.

Previously, in order to maintain the taxable deduction for the lender yet avoid the taxable credit for the borrower, the borrower company could set up a subsidiary company which would buy the debt in from the lender for £1. Since this was an arm's length transaction, the lender would get its tax write down.

The subsidiary company would then release its parent from its debt, and because that happened between connected parties, there was no taxable credit in the original borrower (but no corresponding write down in the subsidiary company (i.e. the new lender)).

Anti-avoidance legislation was introduced a few years ago which impacted on this scenario, but the above provisions still applied provided that the acquisition of the debt from the lender was at arm's length and the subsidiary company was not connected to the parent at any time during a 3 year period ending 12 months before the debt buy in. Therefore, if a new company was established which bought on arm's length terms, this was fine.

It is this situation that will now be fundamentally changed.

HMRC Proposals

There are two proposals. The first is that instead of the criterion that the purchasing company must not have been connected to its parent at any time during the 3 year period ending 12 months before the buy in, there are three new conditions which must be met.

These are:

(a) there must have been a change in ownership of the debtor (i.e parent company) in the period of 12 months before the debt purchase (by subsidiary company);

(b) the debt purchase must have been intrinsic to the change of ownership; and

(c) before the change of ownership the debtor must have been suffering severe financial problems.

If these criteria are not met, then the anti-avoidance provisions will apply, and there is in effect a tax hit on the subsidiary company when it acquires the debt.

This of itself will severely curtail the strategy. However there is a second provision which will also make such arrangements unattractive.

This second provision bites if the debt is bought in by the subsidiary company (the group having met the conditions mentioned above), but then the debt is released. As mentioned above, in normal circumstances, this will be treated as tax neutral (i.e. no tax hit on the original borrower but no tax deduction in the subsidiary company creditor). However, this second provision suggests (it is not very clear from the press release) that in these circumstances it will not be tax neutral and the parent company, being released from the debt, will be taxed on the amount released. In other words it will be treated as if it were released by an arm's length lender. In these circumstances, there is no suggestion that the subsidiary company will get a tax deductable write down (i.e. there is no symmetry).

It is important to note, however, that the other ways of ensuring that there is asymmetry when debt is written off (for example debt equity swaps etc) are still available.

If you require further information or assistance with the subject matter of this email, please contact Richard Leeming, Cara Sykes or your usual Burges Salmon contact.

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