Corporate tax 101! Or so it has been described to me on occasion.
I refer to the write-off of inter-company debt between connected companies and the assumption that this will be tax-free.
This is typically considered pre-sale, as part of a reorganisation or reconstruction, or in preparation for liquidation.
Uncertain economic times bring this to the fore.
In brief:
For write-offs within a corporate group where the lender has reserves sufficient to match the debt extended, it is almost certainly the case that this will be tax free.
Complications can arise where companies have common shareholders.
On write-off the lending company will be treated as if it had made a distribution to its shareholders of the amount of the recoverable debt.
This distribution will be subject to income tax.
The amount of the distribution is equal to the collectible debt and may therefore be £nil if the debt was irrecoverable.
If there was no real intention at the time the debt was extended that it would be repaid, or it was unlikely the recipient would be able to repay it, the initial loan may be treated as a distribution to the shareholders of the lending company.
The usual caveats and conditions for distributions apply, such that if distributable reserves of the lending company were insufficient, the dividend would be illegal and an obligation to repay it may arise: effectively, the debt remains in place.
Even if the shareholdings are common but not an exact mirror, and a distribution does not arise, the write-off of debt could cause a shift in value of the shares, possibly causing an employment-related securities charge and/or constituting a transfer of value for IHT purposes.
Conclusion:
The current trading environment may cause companies to review their debt profile.
The tax consequences for all parties need to be considered before debt is restructured.
If you find yourself contemplating a reorganisation or refinancing and are deliberating this issue, we would be very happy to help
