Debt and the tax pitfalls of not managing your compliance carefully
11 April 2019
In our experience of tax due diligence, issues with tax compliance of debt occur more commonly than any other area of tax and their impact ranges from reputational and the cost of ‘fixing’ the problem to significant delays in transactions and, in some cases, a price chip. Add to this the ever changing and increasingly complex tax rules around relief for interest and you have a perfect storm of issues that can go wrong.
Generally the more familiar technical issues such as thin capitalisation are well managed, and it is the more routine compliance that falls down. Often this is because it is not clear who is responsible for this once the deal has completed, or because of changes in management team 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.
These issues are often not picked up until vendor due diligence or due diligence, by which time it can be too late to minimise their impact and cost (not to mention noise at the time of a deal). The new anti-hybrid and corporate interest restriction (CIR) rules are particularly complex and give great scope for future due diligence findings.
Real life examples
- Managing withholding tax (WHT) on senior debt
We frequently see senior debt being syndicated and the WHT compliance not managed for the new investors
- Breaking all the tax groups
Changes to the terms of investor loan notes led to breaking the group relief group, capital gains group and stamp duty group causing additional tax costs
- When loan note interest becomes a distribution
Complex additional terms on loan notes resulted in all interest payments being treated as non-deductible distributions
- Tax relief for accrued interest
Tax relief being claimed for accrued management interest (deductible only when paid) resulted in disclosure to HMRC
- Have payment in kind notes been issued?
Failure to issue Payment In Kind (PIK) notes for over 10 years resulted in significant delays, additional costs and ultimately a price chip
- 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
- Managing Withholding Tax 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.
Avoiding these pitfalls - Independent review of debt structures
In nearly all of these cases a compliance review would have flushed out in advance that there were compliance issues that needed addressing, allowing the time to deal with these before tax due diligence or vendor due diligence started.
BDO have a team of experienced tax professionals who can undertake a health check of your debt compliance and make sure that it is ready for due diligence. We can undertake a review of your debt structure to check that the tax compliance has been implemented as planned at the time it was put in place, and the impact of any changes have been considered and managed.
The scope of work will be tailored as needed, and will 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.