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Forgiveness of Corporate Loans

Úna Ryan and Thomas Donohoe

By Úna Ryan and Thomas Donohoe

In this article Úna and Thomas discuss the various tax treatments that can arise when a debt is released.

Introduction

Despite the upturn in economic fortunes over the last number of years, debt restructuring remains a topical issue for tax practitioners. As part of group restructuring, practitioners would generally undertake to review the current intergroup financing arrangements in place with a view to rationalising these arrangements as part of a larger restructuring. In order to achieve the best possible outcome for the group it is essential that any debt restructuring is achieved with a minimum tax charge and that no adverse tax implications arise as a result of any debt restructuring undertaken within the group or company.

The corporation tax treatment of any debt restructuring is dependent on the original purpose of the loan forgiven. Generally speaking, the tax implications for corporate entities in receipt of loan forgiveness is as follows:

Forgiveness of Loans Used for Trading Purposes

The forgiveness of a loan used for trading purposes should give rise to a taxable receipt in the hands of the recipient under Section 87 TCA 1997. This section provides that where a deduction has been taken for any debt incurred for the purposes of a trade or profession, and subsequently, the whole or part of that debt is released, the amount released shall be treated as a taxable receipt. The taxable receipt arises in the period that the debt is released and arises where a corporation tax deduction was previously taken for the expenditure incurred. Section 87 predominantly relates to where the debt released is in relation to a trade creditor. A deduction should be available to the lender in respect of the trade creditor debt balance forgiven.

Forgiveness of Loans Used for Capital Purposes

The forgiveness of a loan used for capital purposes should not give rise to a taxable receipt in the hands of the recipient. As the borrower is not considered to have received a taxable receipt, no corresponding deduction is available for the lender for such loan forgiveness. Given that such a loan would not have been provided by a trade creditor and a corporation tax deduction would not have been taken for such expenditure, Section 87 TCA 1997 does not have application in such scenarios. However, it is also important to consider the provisions of Section 552 TCA 1997 outlined below.

Forgiveness of Loans Used to Acquire Capital Assets

The forgiveness of a loan which was used to purchase a capital asset which has subsequently been disposed of at a capital loss may result in the capital loss being reduced by the amount of the loan forgiven under Section 552(1B) TCA 1997. In the event that the loan is forgiven in a subsequent period to the disposal of the capital asset, the receipt of the loan forgiveness is treated as a chargeable gain.

Prior to the introduction of this subsection, a capital loss was calculated without taking account of borrowings used to acquire or enhance the capital asset (which could equal the cost of the asset) that were subsequently released in whole or part by the lender. The introduction of this provision was considered necessary given the level of debt restructuring during the difficult economic climate of the time and applies to disposals made on or after 1 January 2014 regardless of whether the loan was forgiven before, on or after this date.

It should be noted that the purpose of this provision is to restrict the vendor’s capital loss to the economic loss incurred and accordingly the provision does not apply to scenarios where a capital gain arises on the disposal and does not seek to convert a capital loss into a capital gain.

Please note that the above is not exhaustive but a more detailed analysis is outside the scope of this article.

It is essential that the original purpose of the loan(s) to be forgiven is confirmed in order to determine the tax implications of the forgiveness of that loan. While the tax implications are unlikely to be the sole or primary consideration facing an entity involved in debt restructuring, there may be an option to structure any loan forgiveness in a tax efficient manner, particularly in cases of intergroup financing. For example, in the event that it is possible for the entity to choose which loan is forgiven, a capital loan should be forgiven in preference to a trading loan or a loan used to acquire a capital asset which may be subsequently disposed of, given the favourable tax treatment of the forgiveness of such loans.

Interest Deductibility

Consideration should also be given to the deductibility of an interest expense when advising on debt restructures. Generally speaking, the deductibility of interest for corporation tax purposes can be divided into one of four categories outlined below:

  • Interest arising on loans used for trading purposes;
  • Case V interest deductions where the loan has been used to purchase, improve or repair a rental property;
  • Section 247 interest as a charge (interest on loans used to acquire shares in trading or rental subsidiaries or to loan to trading or rental subsidiaries for use in the trade, where certain conditions are satisfied);
  • Non-deductible interest.

Again, the above list is not exhaustive but a more detailed analysis is outside the scope of this article.

Prior to any debt restructuring, it is important to carry out a complete analysis of both the original purpose of the loans and the interest deductibility of each individual loan involved. Naturally, where possible in intergroup scenarios, it is best to agree loan forgiveness on loans which carry no entitlement to interest deductions.

CAT Implications of Loan Forgiveness

When considering debt restructuring arrangements in practice, often overlooked is the potential CAT implications of any debt forgiveness benefit arising to the borrower.

Under Section 5 of the CATCA 2003, a person is deemed to take a gift where, under or in consequence of any disposition, that person becomes beneficially entitled in possession to any benefit otherwise than for full consideration in money or money’s worth paid by such a person. Included in the definition of a disposition under Section 2 CATCA 2003 is the release, forfeiture, surrender or abandonment of any debt or benefit. Therefore, the recipient (deemed to look through a company to the ultimate shareholders) of debt forgiveness may be subject to CAT on that benefit in certain circumstances.

However, there are a number of exemptions to the above provision. Where a financial institution enters into a debt restructuring arrangement with a customer which includes an element of debt forgiveness, Revenue’s view is that the financial institution is not intending to provide a gift of any sort to the customer by way of loan forgiveness and accordingly the customer would not be subject to CAT where a benefit was received under such circumstances. It should be noted that in order for this exemption to apply, Revenue need to be satisfied with the bona fide nature of the arrangement which may be subject to a Revenue enquiry. Revenue would deny the above exemption, for example, where they are of the opinion that the transaction took place for the purposes of tax avoidance. Further to the above, any debt relieved under the Personal Insolvency Act 2012 is also not considered a benefit on which CAT may arise.

In the event of an intergroup debt restructuring where one group company forgives an outstanding loan to another group company and the ultimate beneficial owner of both companies is the same, the provisions of Section 83 CATCA 2003 should remove any potential CAT issues. Under this section, CAT is not chargeable on a gift or inheritance taken by a donee or successor under a disposition made by that donee or successor i.e. CAT should not arise on a gift to oneself.

Such an intergroup scenario should not be confused with situations where a “golden share” arrangement is in place between two entities which are ultimately held by different beneficial owners. Such an arrangement is commonly seen in practice. The issue of a golden share creates a “group” for company law purposes which facilitates loan financing between the two entities.

However, the imposition of a golden share between the two entities does not alter the beneficial ownership of those two entities. Where such loan financing is subsequently forgiven between two entities with a golden share arrangement in place, the borrower in receipt of the loan forgiveness should be considered to have received a taxable gift from the beneficial owner of the other entity.

The above is a taste of potential scenarios that can arise in practice where care is required when considering the CAT implications of debt restructuring.

Conclusion

While commercial considerations are likely to be the primary driver of any debt restructuring, it is essential that tax, legal and accounting advice be sought before implementing any debt restructuring to ensure the most efficient outcome for both the borrower and the lender. As outlined above, depending on the purpose of the loans to be forgiven, there may be significant tax implications of forgiving the loan and opportunities in how this is structured.

Úna Ryan is a Tax Director at Grant Thorton Dublin.

Thomas Donohoe is an Associate Tax Director at Grant Thorton Dublin.