Tax relief for impairmentsin the credit crunch

David Southern

The crisis

• Willingness to lend

• Value of collateral

• Circularity

• German banking crisis of 1931

• No credit

• Restructuring

Tax consequences

• Creditors – relief for write-downs

• Debtors – restructuring

• Equity related losses

• Debt related losses

Six principles

• Every transaction is debt or equity

• Substance v form

• Loan notes

• QCB v non-QCB

• Bells and whistles

• Assigned according to payments rights and obligations

Some dilemmas

• Scylla v Charybdis

• Accounts consolidation

• Symmetry

• Asymmetry

• Earlier recognition of losses

Tax deferral

• Revaluation of investments

• CDOs

• Trading

• Non-trading

Restructurings

• Novations

• Tax event

• Up-front recognition

• ‘related transactions’

• Charges and expenses

• Recharacterisation

Third parties

• Substitute debtor

• Transfer of assets

• Guarantee called

• Guarantor becomes loan creditor

• Group substitution rules

Connected parties

• Transfer pricing rules

• Connected party rules

• Work in quite different ways

• Treated as equity loss

• Restricted rules on connection

Transfer pricing

• ‘Provision’

• More extensive than connected party rules

• Corresponding adjustments

• If both UK resident

Bifurcation

• Assumption of conversion

• Redemption is share price falls

• Investor suffers income loss

• Treated as capital loss for tax

Debt-equity swaps

• Scheme of arrangement

• In satisfaction of a debt

• In consideration of a release

• No credit in debtor

• Deemed releases

• Change in control of debtor

Debt waivers

• Gives rise to tax charge

• Subject to five exceptions

• Statutory insolvency arrangement

• Connection

• Past connection/insolvent creditor

• No connection prior to insolvent debtor

• Debt swapped for ordinary shares

Insolvency arrangements

• Liquidation

• Administration

• Administrative receivership

• Fixed charge receiver

• Pre-liquidation tax – unsecured claims

• Post-liquidation tax is an expense

• ERIP

Conclusion

• Monetising tax losses

• Greater marginal impact than additional profits

• Recouping losses suffered elsewhere in the organisation

• Importance of tax function