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Autumn Budget 2018: Hybrid capital instruments

Hybrid capital instruments

A fundamental rewrite of the tax rules governing regulatory capital, extending access to the regime beyond the regulated financial sector.


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Debt instruments issued to satisfy regulatory capital requirements usually contain a number of equity like features (for example, discretionary coupons or no fixed redemption date) which can make them difficult to classify as debt or equity for tax purposes. The UK’s historic policy has been to treat these instruments as debt and the specific tax regime giving effect to this has been seen as providing important certainty to the financial sector. The decision to rewrite that regime in response to two key industry concerns is therefore a welcome reaffirmation of the Government’s overall policy in this area, even if some details of the new regime may be viewed less positively.

The first concern which the rewrite addresses (albeit not explicitly acknowledged in the announcement) is that by providing benefits to regulated businesses only, the existing regime could fall foul of European State Aid requirements – thought to be a key driver of the abolition of similar Dutch rules earlier this year. The new regime responds to this by ceasing to be explicitly restricted to instruments issued to satisfy regulatory capital requirements. Although in practice it is still likely to be regulated financial services businesses which principally make use of the new rules, this broadening will be welcomed by some other industries – utilities having in particular requested this move for a number of years.

The second industry concern driving the rewrite is the impending rules on the minimum requirement for own funds and eligible liabilities (MREL), which take effect for the banking sector from 1 January 2019 and are not covered by the existing regime. Again the Government has sought to address this in the way it has defined the scope of instruments falling within the new regime.

To fall within the regime an instrument must be a loan relationship on which the debtor is allowed to defer or cancel interest payments. This is subject to an election into the regime and the instrument containing “no other significant equity features” – broadly intended to exclude equity-like features not included to comply with regulatory requirements.

The effects of falling within the regime are similar to those offered by the existing rules:

  • Coupons are treated as interest rather than distributions (other than for uncommercial securities) even if accounted for as distributions;
  • Instruments are treated as ‘normal commercial loans’ (preventing inadvertent de-grouping of issuers); and
  • Transfers are exempt from all stamp duties.

As with the existing regime a targeted anti-avoidance rule (TAAR) is intended to limit improper use of the regime, but despite this the broadened scope has inevitably resulted in a reduction of the benefits available.

These notably include the repeal of a blanket exemption from withholding tax (subject to a five year transitional period) and of the explicit exemption for credits arising on a ‘bail in’ event.

In many cases groups will instead be able to rely on the quoted Eurobond exemption from withholding tax, but previous threats across the political spectrum to repeal this exemption may make such reliance short-lived.

HMRC’s guidance suggest that other existing statutory exemptions may also limit an impact from the removal of the rules dealing with bail in events. These only apply to instruments accounted for on an amortised cost basis. However, and unlike the existing rules, the new regime does not appear to mandate amortised cost accounting in all cases. This may raise questions about the effectiveness of this aspect of the new rules in relation to some categories of regulatory capital instrument – for example, Tier 2 debt.

Paul Freeman

+44 (0)20 7694 3121

Mark Semple

+44 (0)20 7311 1850

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