Legislation for the ‘hybrid capital instruments’ regime has been published.
The ‘hybrid capital instruments’ regime, like the ‘regulated capital securities’ provisions it replaces, is intended to ensure that certain debt instruments continue to be treated as such for tax purposes (in particular continuing to attract relief for interest payments) notwithstanding the inclusion of some equity-like features. This is especially important to regulated businesses operating in the financial sector, which will often issue this kind of debt in order to satisfy regulatory requirements and could face a materially higher cost of funding if it was re-characterised as equity for tax purposes. Whilst the detailed technical note published by HMRC on Budget Day means that there are few surprises in the Finance Bill legislation implementing the new regime, the significance of the proposed rules means that these will nonetheless be studied carefully by both regulated businesses and others issuing debt with contingent interest payments.
For most businesses the initial focus will be on the precise scope of the new regime, both in relation to instruments within the existing rules for regulatory capital, and also in respect of planned issuances of new instruments which may not have benefitted from these. For banks, this will include debt issued in order to satisfy the new minimum requirement for own funds and eligible liabilities (MREL) taking effect from 1 January 2019 – the same date that the ‘hybrid capital instruments’ regime should begin to apply.
Unlike the existing regime, however, the scope of these new rules is not explicitly tied to regulatory definitions and instead requires a consideration of the particular features of the instrument concerned. Whilst this reduces the risk of the new rules being regarded as illegal State Aid to the financial sector, a legislative balancing act is required to formulate the gateway into the regime in a way which captures only those instruments which the Government intends to benefit from the reliefs offered. It is reflective of the difficulty of this, that the draft legislation gives the Treasury power to retrospectively amend the scope of the regime up to 31 December 2019. Notwithstanding this potential for change, regulated businesses – and especially those facing a 1 January 2019 deadline – are likely to want to undertake an exercise now to determine which of their existing and planned issuances would be covered by the proposals as currently drafted.
In this context it should be noted that the new rules will not apply automatically to instruments covered by the existing regime. Even where these instruments do meet the definition of ‘hybrid capital instrument’, it will be necessary to formally elect into the new regime on an instrument-by-instrument basis in the same way as for new issuances. Although the draft legislation gives an extended deadline of 30 September 2019 to complete this process, that will still require many companies to undertake this as a separate exercise to the annual compliance cycle.
As detailed in KPMG’s summary of HMRC’s technical note, the direct consequences of falling within the new regime are fewer than under its predecessor. For example, there is no longer a blanket exemption from the obligation to deduct withholding tax on interest payments. This reflects a view that in many cases the consequences of falling within the regime were already provided for to the extent necessary by other statutory provisions.
There does, however, appear to be a willingness to mitigate the impacts of the change in approach. A stamp taxes exemption has been retained and limited grandfathering preserves the withholding tax exemption and deemed accounting treatment of instruments within the existing rules until 31 December 2023, and this will need to be taken into account in considering whether the change in regime causes any tax break clauses to be triggered.Even more limited grandfathering preserves the exemption under the current regime for credits arising from the triggering of a ‘bail in’ of regulatory capital issued by insurers until 30 June 2019.
This reflects concerns that this may not be straightforwardly replicated by any other existing statutory exemption, with the proposed early expiry date being consistent with the expectation that if the concerns here are found to be valid then it is likely that this would be replaced with a new exemption.