The COVID-19 crisis is likely to result in many UK businesses seeking to raise new debt funding, renegotiate existing facilities and/or reduce the amount of borrowing. It is also likely to give rise to issues around foreign exchange, hedging and impairment. All of these issues are likely to give rise to important tax implications, which will need to be considered. This article seeks to highlight some of these potential tax implications for UK corporates.
Raising New Debt Funding
- Companies accessing funding under one of the new Government-backed COVID-19 facilities will need to confirm how the implicit Government subsidy element will be accounted for (given this will be the starting point for corporation tax (CT));
- Companies drawing down new related party funding will need to consider those facilities as potential market comparators for transfer pricing purposes;
- Companies affected by COVID-19 may increasingly be asked for parental guarantees to support third-party lending. This may have transfer pricing implications; and
- The crisis may result in greater use of loans with ‘equity kickers’ (e.g. ‘convertible’ loan notes or loans with ‘warrants’). Depending on how the transaction is structured, this can give rise to various UK tax issues (e.g. interest being treated as a non-deductible distribution or the borrower being de-grouped from its parent). In addition, where an issuer of a convertible note bifurcates the loan in its accounts, special CT rules can apply to the embedded derivative or equity instrument.
Renegotiating Existing Funding
- Where terms of existing loans are renegotiated in the borrower’s favour, this may result in an upfront P&L credit for the borrower. One potential bear trap is that although there is a specific CT exemption for credits resulting from a ‘substantial modification’ of a loan in a ‘corporate rescue’ scenario, this exemption does not currently apply to credits arising from ‘non-substantial modifications’ (which can now arise under IFRS 9); and
- Care will need to be taken to ensure any costs of renegotiating existing facilities are tax deductible for the borrower (e.g. ensuring that any such costs are incurred by, or recharged to, the borrower).
Reduction of Debt Liabilities
- Once the immediate crisis has abated, many borrowers may need to seek to reduce their overall debt levels via a consensual or non-consensual restructuring;
- Care will need to be taken to ensure any P&L credit recognised by the borrower as a result of any such compromise qualifies for exemption from CT; and
- When assessing the tax consequences of reducing the amount of borrowing, an assessment must be made of whether there is a mismatch in the tax treatment between the borrower and lender because this could result in the borrower being required to recognise a taxable profit.
Foreign Exchange, Hedging, Impairment & CIR
- Careful analysis will be needed:
- To determine whether any foreign exchange gains or losses triggered by COVID-19 are taxable or exempt; and
- To ensure any new foreign exchange risk arising from any COVID-19 inspired restructuring of operations or funding is properly hedged for tax;
- If the crisis results in termination or ineffectiveness in a company’s hedge accounting, this may give rise to unexpected tax liabilities (subject to any Disregard Regulations election, where applicable);
- Companies recognising additional impairment losses on financial assets will need to confirm if these are tax-deductible. (They normally will be, except where the counterparty is a connected company.) IFRS 9 is a relatively new accounting standard and companies may recognise a different accounting treatment than might previously have been expected; and
- Given the CIR rules now cap tax relief for finance costs by reference to (a percentage of) a group’s tax-EBITDA, the CIR impact of any changes in the group’s debt and/or EBITDA profile as a result of the crisis will need to be factored into any re-modelling of effective tax rate calculations.