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The rules on how groups of companies are taxed when they buy back their issued debt at a discount to the amount borrowed are to be changed, the financial secretary to the Treasury, Stephen Timms, has announced.
Under the existing legislation, where a debtor company pays less to redeem its debt liability than the amount borrowed, it is taxed on the difference between the two amounts.
As an anti-avoidance measure, the same rules apply where a company connected to the debtor: for example, a fellow group member instead buys the debt from the creditor.
However, in order to help genuine company rescues, there is an exception to this rule in certain circumstances:
- where the creditor company is arm’s length to the purchaser; and
- where the purchasing company was not connected to the debtor at any time during the three-year period ending 12 months before the purchase.
In the current financial conditions many banks and businesses have issued debt that is trading at a discount to the amount borrowed and, for good commercial reasons, are seeking to buy it back from the market.
Some are taking advantage of the rules set up to help company rescues to avoid being taxed on the profit they make when their debt is cancelled for less than the amount they borrowed. Firms do this by setting up a new company to buy the debt.
The Government therefore intends to change the rules to ensure that only those debt buy-backs that are undertaken as part of genuine corporate rescues will benefit from the buyback profits not being subject to tax. This will apply any debt buy-backs that take place from 14 October 2009.
In essence, the conditions requiring the purchasing company not to be connected with the debtor during a prescribed period will be replaced by the following three conditions:
- There must have been a change in ownership of the debtor in the period of 12 months before the debt purchase;
- The debt purchase must have been intrinsic to the change of ownership; and
- Before the change of ownership, the debtor must have been suffering severe financial problems.
Where these conditions are met, any future cancellation of the debt by the new creditor will result in the debtor being taxed on the previously untaxed discount.
Law firm Herbert Smith LLP said: ‘While the changes should not impact on transactions which have already completed, there do not at present appear to be grandfathering provisions. This means that buy backs offers which have been made but not completed may be captured by the new rules.'
Similarly, restructuring transactions which contemplate debt buy backs at future dates, or in response to external triggers should also be reviewed.
