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Restructuring company debt – some key tax points


To stay afloat many companies will need to address their level of indebtedness. In an ideal world they would secure a measure of debt forgiveness from their creditors. An alternative would be to convert a proportion of their debt into equity. In either case, tax considerations will be key.

Debt forgiveness

Usually, when a corporate debt is written off, the debtor must credit the debt to his profit and loss account. This credit would then be subject to tax. In certain situations, tax law makes an exception and the debt can be written off without triggering a tax charge for the debtor. This is true in the following scenarios:

1. The debt release is part of a statutory insolvency arrangement

A ‘statutory insolvency arrangement’ is where, in accordance with a legal procedure, a debtor company is released from all or part of its liabilities under an agreement with its creditors allowing the company to continue trading and avoid liquidation. It can be a voluntary arrangement, a compromise arrangement or an equivalent arrangement under foreign law. The new ‘restructuring plan’ recently introduced in the Corporate Insolvency and Governance Act 2020 should also qualify.

2. The debt release is required for a corporate rescue

A corporate rescue situation is where it is reasonable to assume that, but for a release of a debt, there would be a material risk that within 12 months the company would be unable to pay its debts. The test for the exemption to apply is not as stringent as that for insolvency where there must be ‘no reasonable prospect’ that the company will be able to avoid insolvency.

3. The debt release is between connected companies

Where the lender and borrower are connected (i.e. where one controls the other or both are under the control of the same party) funding loans can be released on a tax-free basis. The connected lender will not obtain any relief for the amount written-off. To be legally effective, the debt must be released under a formal deed.

Debt for equity

Another way to avoid a debt release tax charge on the debtor is for the creditor and debtor to enter into a debt for equity swap. The creditor uses his unpaid debt as subscription money for an issue of new ordinary shares (or share options) in the debtor company.

Further detail on the commercial aspects and company law requirements for converting debt to equity can be found here.

From a tax perspective, a key consideration will be whether the debt for equity swap will give the lender a controlling interest in the borrower company. If this happens it can cause the borrower to leave its existing corporate group.

  • A de-grouping could affect the borrower’s ability to surrender losses to fellow group companies.
  • It could also trigger charges in respect of historic asset transfers, for example, a capital gains tax charge, an intangibles charge or a stamp duty land tax clawback.
  • Finally, the carry forward of unused trading losses can be denied where, within a period of five years, there is both a change of control and a major change in the nature or conduct of the borrower company’s trade.

The following points are also important to note:

  • A condition of the tax exemption for the borrower is that the 'amortised cost' basis of accounting for the debt is used in the period in which the debt is released. This is usually the case.
  • A lender will normally be able to claim relief on the amount of debt forgiven as part of the swap to the extent the amount released exceeds any impairment loss already claimed and provided the lender is not connected to the borrower.
  • The terms of the debt for equity swap agreement should reflect that the entire release is comprised in the swap (although a restructured debt should still qualify).
  • HMRC will expect to see that the creditor has taken a genuine economic interest in the company and not simply acquired worthless shares in order to save a tax charge on the debtor.
  • HMRC may refuse tax relief in cases where, soon after the debt-for-equity swap, the lender sells its newly acquired shares to the existing shareholders who never intended for their equity holdings to be diluted.
  • Where the debt is exchanged for an option or warrant to subscribe for shares at a future date, it must be likely that the option or warrant will be exercised.

In light of all of the above, companies should tread cautiously as they take on more debt. If the revenues required to service the debt do not materialise, they may find themselves having to restructure it. This must be planned and executed with due consideration to avoid unnecessary tax charges for lender and borrower alike.

This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.

© Farrer & Co LLP, July 2020

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