Publication
Global rules on foreign direct investment (FDI)
Cross-border acquisitions and investments increasingly trigger foreign direct investment (FDI) screening requirements.
United Kingdom | Publication | 8月 2020
The increasingly unpredictable economic landscape has created uncertainty and distress for businesses across a broad range of sectors and markets. Borrowers have been working to stabilize their businesses and ensure they have the liquidity to continue to trade through these difficult times. Lenders have been working to assist and support their borrowers by providing amendments and waivers under existing facilities as well as new money (where the circumstances permit).
We know from past experience that borrowers and lenders have a number of debt restructuring scenarios that they commonly consider: from partial waivers to debt-to-equity swaps; from conditional waivers to the sale of distressed debt. But especially in a cross-border context, specific local tax consequences can significantly impact the choice between one scenario and another.
Norton Rose Fulbright has performed research across selected jurisdictions (i.e. the US, Australia, Canada, South Africa, France, the UK, Germany, Luxembourg and the Netherlands) on various debt restructuring scenarios and the local tax impact on debtors and creditors. This research has provided us with insight into various pitfalls that might occur from international debt restructurings.
This note discusses three commonly used debt restructuring scenarios:
The goal is to flag key tax items across selected jurisdictions for each scenario, because we know from experience that, although certain international trends can be seen, any international debt restructuring requires careful consideration of the relevant local tax regimes.
The sale of distressed debt is a mechanism for a creditor to reduce their balance sheet exposure to debts which may currently be non-performing or have a significant risk of future default. In such circumstances, the debt would be sold at a discount to face value in view of the distressed financial circumstances of the debtor.
Certain private equity and other investment funds are known to have an appetite for the purchase of distressed debt on secondary markets (which may come in the form of an individual loan or a large portfolio) at a reduced price in order to realize a profit by either:
As well as sales to unconnected parties, it may also be that the parties want to arrange a disposal to a connected party. This may occur, for example, where a debtor wants to acquire a debt into a group to remove the controls placed on it by the third-party creditor.
The sale of distressed debt is achieved by way of assignment or novation, depending on the terms of the debt. Consent of the debtor to a sale may be required. Individual debt sales are usually carried out on standardized documents, whereas portfolio sales are more likely to be negotiated on a bespoke basis. Alternatively, the creditor may sub-participate its interest in the loan, in which case it remains the lender of record but transfers the credit risk of the debtor to the participant. This may not result in the distressed loan coming off its balance sheet.
The selling creditor will want to ensure that they are able to claim relief for any loss they have incurred with respect to the debt. A buyer will want to ensure that their base cost in the loan is the price paid; that they do not suffer any immediate tax charge and that there are no transfer taxes that arise as a result.
The debtor will want to ensure that there are no adverse tax charges arising for them in relation to the sale and that the sale does not adversely impact on the deductibility of interest payments going forward. It will also be important for the parties to consider the impact on the withholding tax treatment of interest payments and the allocation of risk under the loan documents. A change in lender may mean that interest can no longer be paid gross or new treaty applications are required.
Both parties will want to ensure there is no tax charge for the creditor.
Below we will summarize our key findings for the sale of distressed debt, where we distinguish between general international tax trends (i.e. how do the majority of the jurisdictions treat the sale of distressed debt) and specific tax issues (i.e. which jurisdictions take a different approach than others and therefore may need further consideration if a local tax payer is involved in the sale of distressed debt):
In circumstances where the buying creditor and debtor are related parties, the debtor may be subject to tax on the difference between the carrying value of the debt and the amount the incoming creditor paid for the acquisition.
The general rule which states that the debtor’s tax obligations will be unaffected on the sale of a debt will apply provided that the debtor is notified of the change in creditor.
If the sale is set up on beneficial terms for the incoming creditor, a taxable gain may be charged on any hidden capital contribution or distribution which that creditor receives.
Stringent anti-avoidance provisions are in place to ensure that a creditor cannot avoid Dutch tax liability from an upward valuation of a loan which has previously been written-down (where the parties are affiliates).
If a debt is sold to an incoming creditor that meets certain interest tests in the debtor for less than 80 percent of the principal amount of the loan, then a taxable credit may arise in the debtor.
A debt-to-equity swap, substitution or restructuring is a capital reorganization of a company in which a creditor (usually a bank, possibly together with other banks, bondholders or creditors) converts indebtedness owed to it by a company into one or more classes of that company’s share capital.
There is no preordained structure for a debt-to-equity swap. Much depends on the existing debt and capital profile of the company and the intended result. The main commercial issues to be settled between the company (effectively representing its shareholders) and its principal bank (and other creditors) are:
To a large degree, the negotiating position of the bank will depend on whether or not the reconstruction involves new money from other investors being injected by way of share capital. Institutional investors considering putting new money into the company will usually drive a harder bargain than the company itself.
The creditor will be interested in:
From a debtor perspective, the key aspects are:
Below we will summarize our key findings for debt-to-equity swaps, where we distinguish between general international tax trends (i.e. how do the majority of the jurisdictions treat a debt-to-equity swap) and specific tax issues (i.e. what jurisdictions take a different approach than others and therefore may need further consideration if a local tax payer is involved in a debt-to-equity swap):
When a German debtor is relieved from its debt (including as a result of a debt-to-equity swap), the cancellation of the debt will trigger a taxable gain to the extent the debt was depreciated by the creditor. This is the reason that straight-forward debt-to-equity swaps are very rare in Germany.
The UK has prescriptive rules which govern the circumstances in which debt-to-equity swaps will give rise to relief for the creditor and avoid a taxable credit for the debtor. For example, the release must be in consideration for ordinary share capital which rules out use of fixed rate preference shares. Care must be taken to ensure that the relevant conditions are met.
A debt-to-equity swap is generally a tax neutral event for debtors, where both the release of the debt and issuance of shares are accounted for at nominal value rather than market value.
A debt waiver, debt cancellation or debt forgiveness is a transaction in which a creditor (usually a shareholder but also third-party creditors such as banks, bondholders or suppliers) voluntarily relinquishes its right (in whole or in part) to payment under a debt instrument. The waiver serves the purpose of relieving the debtor from a financial obligation; it is a common element in restructuring scenarios, including UK Schemes of Arrangement and US “Chapter 11” procedures (and is expected to form a part of WHOA schemes). The debt waiver is often part of a package of relief used in an effort to ensure the survival and prospects of the debtor.
There is no set structure for a debt waiver. In principle, it may be implemented by a simple and short waiver declaration.
As an alternative to a waiver, the terms of the debt may be amended so any repayment is contingent on certain conditions being satisfied. However, agreeing the conditions for payment may be a complex task as the agreement needs to anticipate under which circumstances the company is required to pay the debt.
As a part of restructuring negotiations, creditors may require some form of reward if the restructuring proves successful. These benefits can take a number of forms, including increased pricing, a cash sweep, exit fees and/or equity-like debt instruments. For this purpose, the debt can be (partially) waived, amended and/or swapped for a new instrument at the time of the restructuring. Payment of the debt could be conditional on the financial situation of the debtor improving such that its debt capacity allows for a (partial) servicing of the debt.
In Germany, creditors can agree to a waiver of debt on the basis that such debt will be reinstated if certain conditions are satisfied, e.g. if and to the extent the debtor recovers financially.
Similar to the modification of debt, the agreement on the terms of the reinstatement of the debt can be rather complex. From a tax and accounting perspective, such transaction is treated as a full waiver and the creation of new debt once the reinstatement takes place. Other jurisdictions outside Germany do not treat a waiver with a conditional reinstatement as a waiver of debt, but rather as an amendment to the payment terms of the instrument.
The main commercial issues to be settled between the company and its creditors are:
To a large degree, the negotiating position will depend on the granularity of the creditor group. The more the company needs to rely on the buy-in of only a few creditors, the more bargaining power they will have when it comes to the terms of the reinstatement.
The creditor will be interested in:
From a debtor perspective, the key aspects are:
Below we will summarize our key findings for debt waivers and modifications, where we distinguish between general international tax trends (i.e. how do the majority of the jurisdictions treat a waiver and reinstatement of debt) and specific tax issues (i.e. what jurisdictions take a different approach than others and therefore may need further consideration if a local tax payer is involved in a debt waiver or modification):
The waiver of shareholder debt may be treated as a (hidden) contribution in kind, if and to the extent the debt is valuable. The conditional debt waiver is also used as a loss-refresher to carry a loss beyond a change-of-control which would typically cause a forfeiture of tax losses.
A conditional debt waiver is accepted as a waiver and potential reinstatement if, at the time of the waiver, it is unlikely that the debtor becomes solvent again. Given that many restructuring/ insolvency regimes work on the assumption of a successful turnaround, the conditional waiver may often not be recognized.
Where a loan is amended so that repayment is made to be contingent or conditional then care will need to be had that this does not cause the loan to be treated as equity.
The current economic environment may create the need for multinationals to reconsider their debt positions. At the same time, distressed debt and other investment funds (such as private equity investors) are actively looking for investment opportunities. But especially in a cross-border context, each debt restructuring scenario is impacted by specific local tax consequences.
In this note we have summarized some general trends and specific tax issues that could arise from a sale and purchase of a distressed debt, debt-to-equity swaps and debt waivers. One of the key take-aways from our international research is that although certain international trends can be seen, any international debt restructuring requires careful consideration of the applicable local tax regimes.
At Norton Rose Fulbright, we have extensive experience in helping clients navigate the complex debt restructuring issues, including the aforementioned tax issues. Please speak to your usual Norton Rose Fulbright contact if you would like to discuss any of the issues raised in this briefing in further detail. Based throughout Europe, the United States, Canada, Latin America, Asia, Australia, Africa and the Middle East, our bankruptcy lawyers handle some of the most complex and sensitive domestic and cross-border assignments across the globe. The strength of our global bankruptcy, financial restructuring and insolvency practice lies in our multidisciplinary experience and international reach. We have represented major interests in some of the world’s most high-profile bankruptcy and workout cases, including the US Trustee of Lehman Brothers Inc., JPMorgan Chase, Bank of America, Citibank, the Commonwealth Bank of Australia, the Royal Bank of Canada, NextEra Energy, Japan Airlines, Nortel Networks and Export Import Bank of China. Please visit our website from more information or speak to your usual Norton Rose Fulbright contact if you would like to discuss any of the issues raised in this briefing in further detail. |
Publication
Cross-border acquisitions and investments increasingly trigger foreign direct investment (FDI) screening requirements.
Publication
Artificial intelligence (AI) raises many intellectual property (IP) issues.
Publication
Our Asia Competition Law facts sheets provide insights into the main competition law regimes across Asia, reflecting the experience and reach of our Asia competition team in an ever changing and increasingly complex competition law environment.
Subscribe and stay up to date with the latest legal news, information and events . . .
© Norton Rose Fulbright LLP 2023