Amendments to new rules on taxation of hybrid capital instruments

The government has published details of amendments to new rules on the taxation of hybrid capital instruments, which are designed to ensure they work as intended for instruments with a takeover or change of control clause

Hybrid capital instruments are a form of debt with some features of equity. This can lead to uncertainty as to whether the payments under the hybrid instrument should be taxed as interest (which is typically deductible) or as distributions (which are not).

At schedule 20 of Finance Act 2019, the government introduced new rules on the taxation of hybrid capital instruments across all sectors to ensure that, subject to certain conditions, interest payments on all debt-like instruments are deductible, thus removing tax uncertainty.

Previously, the regulations had only confirmed the tax treatment for companies in the financial sector. Tax deductions and the exemption from stamp duty and stamp duty reserve tax were available for debt instruments of this type issued by financial sector companies, in accordance with the Taxation of Regulatory Capital Securities Regulations 2013 (RCS Regulations). Following regulatory changes, the RCS regulations were repealed and replaced by the new rules in Schedule 20 to Finance Act 2019.

One of the criteria used in the new rules covers a provision for the debt instrument to convert into shares of the debtor’s parent. However, the legislation as originally enacted defines the parent company in a way that excludes some instruments that should be within the scope of the new rules. This meant that unless the legislation was amended, certain companies will not be able to obtain the intended relief for interest payments on these instruments.

Numerous debt instruments issued by financial sector companies to fulfil regulatory requirements would also be affected because they will no longer be entitled to the deductions provided under the RCS Regulations. This was not the intention of the new rules and if they had not been amended, this would have resulted in increased costs for the companies in question.

Now, following a technical consultation, the government has published draft legislation to amend the definition of a conversion event used in the new rules.

This is to ensure that they operate as intended for instruments whose terms include a takeover or change of control provision. The amendment allows tax deductions for interest paid on instruments of this type, so long as they meet other conditions in legislation.

Schedule 20 to Finance Act 2019 introduced new rules on the taxation of hybrid capital instruments, including new section 475C. The new rules apply from 1 January 2019 (and 12 February 2019 in relation to stamp duty and stamp duty reserve tax).

Draft legislation, the taxation of hybrid capital instruments amendment of section 457c of the Corporation Tax Act 2009 regulations 2009, is here

By Pat Sweet

Pat Sweet |Reporter, Accountancy Daily [2010-2021]

Pat Sweet was the former online reporter at Accountancy Daily and contributor to the monthly Accountancy magazine, pub...

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