How to restructure debt effectively

 ”Phil, we hear the term debt restructuring and refinancing bandied around, but what do those terms actually mean? What are the different types and what are the key differences? 

 There’s two sort of key types of debt restructuring. There’s corporate debt restructuring, where we might move some of the debt from different entities within a group, and there could be reasons for doing that. And there’s debt restructuring, from looking at the different types of debt product that you may have within organisations. So, for example, moving from a property loan to a term loan secured on cash flows of business. 

 So, can you give me an example of where a group has chosen to refinance and has chosen to spread the debt across a few different products and the reasons for that? 

It’s not uncommon for businesses to raise money and they probably haven’t thought about why they’re raising it and the purpose of what they’re going to use it for. As a consequence, the use of the funds and how they’re being raised, there can be a bit of a disconnect between the two. 

 A good example might be where a business raises some money for an acquisition, but it may use working capital facilities, so an overdraft or some sort of confidential invoice discounting facility, to fund that acquisition. So, on one side of things, you’ve got a facility very short term in nature, and yet the purpose of the funding is used for something that’s very long-term in nature being acquisition of a business. 

 That typically is okay. However, where you may get some short-term challenges in the business or there may be some training challenges, then you can have a situation whereby those facilities are no longer appropriate for the situation in which they’re being used. I would always say try and use the right funds for the use, try and match it to the use of what you’re going to be using the money to be paying for. 

 The second scenario explained is the restructuring of debt within a corporate group. What might that look like? What are the sort of drivers for doing that? 

 Okay, thinking about a corporate debt restructure, and it may be that an organisation may want to exit part of their business or demerge parts of their business. So allocating debt across different parts of the business before some sort of demerger event would be right, and therefore trying to match up again the debt with that part of the organisation would be the right thing to do. 

 A good example could be a farming business which also packs produce to be sold to retailers. That farming business may have a combination of debt that may be land related and it may have some debt that might be related to working capital, so invoice discounting. The business may decide to split the farming and the retail supply business into two different parts.  

In which case reorganising the debts such that some of the debt’s attributed to the farming property, and some of it’s attributed to the trading business being supplied into supermarkets, would be the right thing to do before the businesses are demerged into separate organisations. 

 Okay, so we’ve got a client that may be looking to reorganise its debt across different businesses. One of the things that’s obviously very important is considering the tax implications of that. So, what about that, what do you see in corporate debt restructuring? 

 The sort of scenario you described where debt is being restructured in anticipation of a transaction is very common and something we deal with a lot. If we think about a purely domestic group to begin with, quite often we see loans being waived, so that’s absolutely fine and the tax legislation allows for a tax neutral treatment generally. But obviously the devil is always in the detail when it comes to tax, and the correct process must be followed to make sure we get tax symmetry and we’re not getting a taxable credit in one entity, and no relief in the other. 

Does that usually mean you need to engage with the tax authorities to ensure that anything that is put in place goes through their approval process first thing? 

 Generally there’s not a pre-approval process for this type of transaction, but rather it’s knowing that you need to take advice in advance and making sure all the procedural documentation supports the filing position you’re going to take. 

  What about if you get some sort of international entity involved? Is there again, other things to think about there in which case? 

 Yes and again, something we see quite often, generally the additional factor to consider where you have international loans is withholding tax. So commonly interest will have been allowed to accrue, and then when you’re considering waiving debt balances or perhaps offsetting balances between group companies in different countries without seeking the appropriate clearances from HMRC. 

So this is withholding tax clearance rather than a statutory clearance, withholding tax liabilities can crystallise, which you may be able to recover in due course or possibly not. So again, just taking some advice in advance to understand the position there and whether any liabilities can be mitigated is really important. 

 Quite often in transactions we see situations where a company may be sold outside of a group and that there’s some sort of inter-company borrowing in the organisation that’s being sold, or in fact, things like director’s loan accounts, for example, where the directors may have borrowed or lent money to a business prior to a transaction. How are they typically dealt with? And are the tax implications of those in trying to get those balances settled, part of a transaction? 

 So I suppose speaking more generally where we’re talking about connected party lending, there are various pieces of the UK tax legislation which seek to deny relief for interest expense or other sort of loan related debits, or restrict it where borrowing is not considered to be arm’s length or where there’s considered to be an overall tax advantage because of different rates in different countries, or different treatment of debt instruments between different jurisdictions. 

 Generally, where there’s commercial purpose and not a tax avoidance motive, it’s fine. But again, it’s easy to slip up and it’s really important to consider the tax implications before either entering these arrangements in the first place or restructuring them. 

 So we’ve got a client at the moment we’re working with who are looking to restructure their debt and one of the things that we’re having to consider is the cashflow implications that were trying to model that within the financial plans of the business. Do I need to be thinking about tax payments and how they work with interest payments and other things? 

Yes, absolutely, and we see clients come unstuck on this point from time to time. Again, there are rules within the UK tax legislation, which although they don’t seek to deny a deduction for interest, they might only allow that deduction when the interest is paid rather than accrued in the accounts. 

 The first regime is corporate interest restriction. This applies even where we’ve got an entirely third party lender-borrower relationship, and very broadly speaking, that will seek to defer relief for interest where the economic activity in the UK, equivalent to the level of borrowing it has, so where it has excessive borrowing, compared to the HMRC rules. So, relief for that interest might be possible, but not until the activity of the UK company or the profitability increases. So that might defer relief, which is going to therefore increase your tax charge and potentially even accelerate your tax payments, it might push you into the QIPs regime for example.  

 Slightly less common, although we see it quite a lot in private equity lending situations, are the late paid interest rules. So typically, where we have a non-corporate lender who is offshore, the UK legislation says you cannot have relief for interest payable to that lender, until the interest is actually paid. So where interest is being allowed to roll up for several years that can defer relief for quite a long time.  

 So thinking about what are the top tips in which case, from your perspective, when it comes to thinking about tax implications of debt restructuring, what are your top picks if you like, in terms of the most important things to consider? 

It’s a very basic one but just takes some tax advice before you do anything. It’s much harder to fix after the event and there are plenty of reliefs within the UK regime, but you just need to make sure that the paperwork and the conduct allow you to benefit from those reliefs.”