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Proposed amendment to legislation on hybrid capital instruments

Proposed amendment to legislation on hybrid capital

A proposed amendment to the definition of ‘hybrid capital instrument’.

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Director, Financial Services Tax

KPMG in the UK


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An issue has been identified with the ‘hybrid capital instruments’ rules which, from 1 January 2019, are relied upon by many banks and insurers to give corporation tax relief for the coupon payments on regulatory capital securities. This could have resulted in many instruments with standard takeover or change of control provisions being inadvertently excluded from the rules and hence tax relief being lost. HMRC have therefore published revised guidance on the rules, confirming that it is intended to retrospectively amend the legislation later this year to address the issue and ensure the rules operate as planned.

Prior to 1 January 2019, the taxation of regulatory capital instruments issued by banks and insurers was governed by a specific regime. This was designed to ensure that, in particular, the coupon payment on relevant instruments continued to attract tax relief as a deductible interest cost, notwithstanding the fact that the instruments themselves had a number of equity like features.

Finance Act 2019 replaced this regime with new rules for the taxation of ‘hybrid capital instruments’. These new rules, which took effect from 1 January 2019, are not explicitly restricted to regulatory capital, but nonetheless play a similar role to the old regime in ensuring tax relief is available for coupon payments on certain regulatory capital instruments.

The definition of ‘hybrid capital instrument’ includes specific conditions limiting the circumstances where an instrument may allow for conversion into share capital. In particular, qualifying instruments can only be converted into ordinary share capital of:

  • The debtor; or
  • The debtor’s quoted parent company (which includes a requirement that the debtor is a 75 percent subsidiary and that the parent’s shares are listed on a recognised stock exchange).

It has been identified that various instruments intended to fall within the scope of the legislation include standard takeover or change of control provisions. These typically permit the acquirer (in a takeover or change of control) to agree with the instrument’s issuer that on a subsequent conversion the notes will convert into the acquirer’s shares rather than the shares of the pre-existing parent.

Concerns have been raised that the inclusion of this kind of provision may technically disqualify instruments from the ‘hybrid capital instrument’ regime if they could apply in cases where the acquirer may not qualify as a ‘quoted parent company’ (regardless of whether any takeover actually occurs). This might be the case, for example, if the provisions could apply where the acquirer obtains a controlling interest below the 75 percent threshold referred to above, or is an unquoted company.

To address these concerns the Government intends to amend the definition of ‘hybrid capital instrument’ to ensure that a takeover or change of control provision will not exclude instruments that only allow for conversion in qualifying cases and that are, in essence, debt. This amendment will apply retrospectively, so as to preserve coupon deductibility for affected instruments from the commencement of the ‘hybrid capital instruments’ regime on 1 January 2019.

This issue had the potential to create a significant unexpected tax cost for many banks and insurers. Confirmation that the Government intends to act to resolve the problem will therefore be warmly welcomed by the financial sector, although the precise form of the solution (and in particular the nature of the requirement for an instrument to in essence be debt) will not be known until draft regulations are published for consultation in due course.

Of less comfort for affected businesses is the fact that the timeline for making any changes remains uncertain, with HMRC simply stating that final regulations will be laid before the House of Commons by 31 December 2019. This means that businesses are likely to still need to grapple with the question of how the problem, and its planned solution, should be appropriately reflected in interim financial statements.

HMRC’s technical note on the ‘hybrid capital instruments’ rules can be found here, and includes a discussion of the proposed amendment at paragraph 2.4. A further revision of the note, addressing various questions raised on other aspects of the new rules since they first were announced at Budget 2018, is expected later this year.

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