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Private equity-backed companies: Top ten tax compliance pitfalls for debt

06 July 2022

In our experience of due diligence on private equity-backed groups, issues with tax compliance for debt occur more commonly than any other area of tax. The impact of these issues ranges from embarrassment and the cost of ‘fixing’ the problem to significant delays in transactions and, in some cases, a price chip.

Often it is routine compliance around debt that falls down with the more familiar technical areas, such as thin capitalisation, generally well managed. This is frequently because it is not clear who is responsible for this compliance once the deal has completed, or because of new management teams and/or advisers who are not familiar with the tax structure and how it is intended to work. Refinancing of the original debt is also very likely to create new compliance requirements, including the need to re-examine the thin capitalisation/transfer pricing position.

These issues are often not picked up until due diligence by which time it can be too late to minimise their impact and cost. The anti-hybrid and corporate interest restriction (CIR) rules are particularly complex and give great scope for future diligence findings!

Top Ten debt tax compliance issues illustrated by a number of real-life examples

  1. Anti-hybrids position on PE fund debt
    On several deals, the required detailed analysis (which requires input from the PE fund) had not been carried out leading to either expensive last minute tax work or price chips for the issue.
     
  2. Tax relief for accrued interest
    Tax relief being claimed for accrued management interest (deductible only when paid) resulted in disclosure to HMRC.
     
  3. Managing withholding tax (WHT) on senior debt from debt funds
    We frequently see senior debt being advanced by a collection of entities when a debt fund is used. The WHT compliance is often not managed for the various debt fund entities. Multiple entities may well mean multiple tax actions.
     
  4. Have PIK notes been issued?
    Failure to issue PIK notes to the private equity backer for over 10 years resulted in significant delays, additional costs and ultimately a price chip.
     
  5. Managing WHT when debt is moved
    Transaction delayed whilst treaty clearance had to be obtained for debt which had been moved from a UK to a Luxembourg fund.
     
  6. PIK note documentation
    Board minutes supported only three months of the annual interest being covered by PIK notes  - further PIK notes were required urgently to secure tax relief for 12 months of interest.
     
  7. Managing WHT on syndicated debt
    As for debt funds and the movement of debt, syndicated debt requires careful WHT compliance for the new investors. It is often not managed well (or at all).
     
  8. Loan note and PIK note listing
    Loan notes and PIK notes not actually being listed as ‘quoted Eurobonds’, leading to a WHT liability where none was expected.
     
  9. When loan note interest becomes a distribution
    Complex additional terms on loan notes resulted in all interest payments being treated as non-deductible distributions.
     
  10. Breaking tax groups
    Changes to the terms of private equity fund loan notes led to breaking the group relief group, capital gains group and stamp duty group causing additional tax costs.

Benefits of an independent review of private equity-backed debt structures

In nearly all of these cases a compliance review would have flushed out in advance that there were issues that needed addressing, allowing the time to deal with these before tax due diligence started.

Our team of experienced tax professionals will undertake a health check of your debt compliance and make sure that it is ready for diligence. A review of your debt structure will check that the tax compliance has been implemented as planned and that the impact of any changes in structure or tax law has been considered and managed.

The scope of work will be tailored to your needs and can cover areas including management of withholding tax, PIK note compliance, CIR, anti-hybrid rules and checking whether there have been changes to the debt structure which require action to manage the tax position.

Given the ever-changing and increasingly complex tax rules around relief for interest as well as the ‘basic’ compliance requirements, you have a perfect storm of issues that can go wrong. Review those debt structures and avoid the pitfalls!