Welcome to the second edition of Treasury Matters, our newsletter for those responsible for Tax and Treasury.
Over the past three months we've seen a large amount of change that will impact tax and treasury activities, so in issue 2 we'll be highlighting the main areas of interest. In December, HMRC released proposed anti-avoidance legislation on so-called "Group Mismatch Schemes" and we start by giving our view on this proposed legislation. We also reflect on the recent decision in DCC Holdings.
Chris Skinner, a Director in our Global Debt Markets Advisory Team, then gives his views on the current state of the debt markets. Whilst debt markets remain volatile, there are some opportunities to issue competitively priced debt and we consider how groups could go about doing this, as well as related tax issues.
Finally, there have also been some further updates to the Worldwide Debt Cap rules we discussed in Issue 1 of Treasury Matters and we briefly run through these.
As always, we're interested to hear your feedback on our newsletter and if you'd like to discuss any of the items in more detail, or have suggestions for future topics, please contact us.
Stephen and Ben
PS. We're delighted to share the news that our team has received the award for "Best Tax Advisor 2010" from Treasury Management International magazine. We look forward to seeing any of you who will be at the awards ceremony on 27 January!
New anti-avoidance rules
Group mismatch schemes (GMSs) and derecognition
HMRC have issued draft legislation targeting tax avoidance resulting from Group Mismatch Schemes and "derecognition" of loans and derivatives
HMRC released a discussion document in March 2010 on proposed legislation targeting so-called "Group Mismatch Schemes" (GMSs). These schemes broadly cover transactions resulting in a tax advantage from loans and derivative transactions, due to asymmetries in the way different group companies tax such transactions. The tax advantage could be a timing benefit (for example, a deduction could be claimed before the equivalent income is taxed), or an absolute advantage (a deduction is claimed without income ever being taxed).
HMRC released a further Technical Note, including draft legislation, on 6 December 2010. It is natural to think the rules would have a relatively narrow application; however, groups will need to recognise that the rules are intended to apply to any transactions where a tax advantage will arise even if there is no tax motive. It is also possible that commercial hedging operations could be affected.
HMRC's objective is to introduce rules with wide application, to move away from the current model of responding to disclosures under the "Disclosure of Tax Avoidance Schemes" rules with highly prescriptive anti-avoidance measures; consequently, the rules may have wider application than anticipated. The rules are proposed to take effect from Royal Assent to the 2011 Finance Act (likely to be July 2011) and HMRC have invited comments on the draft law by 9 February 2011.
We see the GMS rules as a fundamental shift in anti-avoidance relating to loans and derivative transactions. If you would like more detail on the rules, please contact Stephen Weston or Ben Moseley.
HMRC have also introduced further targeted anti-avoidance legislation relating to transactions resulting in a tax advantage from the accounting "derecognition" of loans and derivatives. Draft legislation was issued on 6 December 2010, effective from that date.
The legislation widens the existing rules so that any arrangements with a tax avoidance purpose that result in amounts being derecognised for accounting purposes will be caught. Given the potentially wide application of the rules released, it's important to consider the impact on any transaction involving the derecognition of a loan or derivative asset, and/or the income thereon – derecognition here could simply mean the repayment/release of a loan or close out of a derivative, as well as the more complex arrangements targeted by HMRC.
Taxpayer's appeal dismissed in Supreme Court
The Supreme Court has dismissed the taxpayer's appeal in DCC Holdings, but the decision should have limited wider ramifications
The Supreme Court recently dismissed the taxpayer's appeal in the DCC Holdings case. The case concerned the pre-2005 loan relationships legislation and the application of the deeming provisions for manufactured interest under sale and repurchase ("repo") arrangements.
The case potentially had wider ramifications as it also discussed the interpretation of the "fairly represents" principle which lies at the heart of the loan and derivatives tax regimes, although arguably less relevant in the 2005+ GAAP based regimes which by their nature produce a "true and fair view". A "magic wand" or some form of economic override approach to applying the "fairly represents" principle had been helpfully ruled out by the Court of Appeal.
Ultimately, the DCC judgement turned on the Lords' desire for symmetry between the actual accrued interest and the deemed manufactured interest to restrict the deemed amount in that case; this is most likely the common sense approach and should have limited wider ramifications.
What's happening in corporate debt markets?
The availability and pricing of debt is beginning to improve, however this window of opportunity may not remain open for long.
As debt markets continue to be complex and volatile, there are currently large differences in the availability, cost and length of debt facilities on offer. This can depend on the individual bank, their opinion of the credit worthiness of the borrower, the sector in which the borrower operates and the type of funding sought.
Borrowers can stand to benefit from this environment, by presenting their credit needs to the widest possible banking audience to achieve lower interest rates with extended periods and improved terms. The banks aren't the only places to look for debt either, and we're seeing some borrowers begin to consider alternative funding solutions, such as the bond markets or private debt placements, to add to their funding mix. We'll go on to look at both of these points in more detail.
Improving access to corporate loans
The recent Deloitte CFO Survey1 of larger companies reported an increase in the availability of debt at a lower cost, with the cost of new credit being lower than at any time since the survey started in Q3 2007. While debt volumes remain low relative to the credit boom years, expectations of future M&A activity continue to increase, which will drive corporate loan issuance. Debt is being offered for longer periods and lower costs, with banks offering four to five year terms rather than the traditional three years.
Whilst the mid-market tends to lag behind the larger market, the same points apply. Four and even five year loans are achievable, but at an incremental cost. Some corporates which refinanced as recently as the last twelve to eighteen months have refinanced again, resulting in cheaper, longer term financing. For those considering this strategy, key factors driving the pricing of debt include the size of the borrower, levels of existing debt, the ability to present accurate forecasts and availability of security.
For smaller borrowers, obtaining bank finance continues to be more challenging. Convincing investment cases and impressive management teams remain essential to obtaining debt finance.
A further concern for all borrowers is the scale of the debt that is due to be refinanced between 2011 and 2013 (see graph above2). With this impending peak in refinancing, it is advisable for borrowers to approach banks earlier than they might usually consider doing, in order to try to secure finance on competitive terms.
1 Q4 2010, Deloitte CFO Survey, January 2011
2 Thomson Reuters LPC/DealScan .
Corporate bonds and private placements
There are alternatives to bank funding in the bond market and private placements. The bond market is most suitable for large repeat borrowers and the minimum issue size is around £150m. For many mid-sized corporates this minimum size is too large and the requirement for formal credit ratings too great an investment. However, the benefits of the bond markets can be replicated in the private placement market without the minimum issue size restrictions or formal credit rating process.
Private placements are increasingly being used by borrowers who are attracted by longer term funding at coupons which are at all time lows. The private placement market provides a borrower with the opportunity to access funding for as long as 7 to 12 years, without the requirement for external credit ratings. Additionally, much smaller funding levels of £35m upwards can be raised.
Whatever source of funding you choose, the tax efficiency of your funding structure will remain critical. In addition to matters which have always needed to be considered in relation to new borrowing, such as interest deductibility and withholding taxes, recent developments in tax also require thought. For example, the impact of the worldwide debt cap rules (see below and Issue 1 of Treasury Matters), and the proposed Group Mismatch Scheme rules if funding is being routed intra-group (see above).
Also, if using debt in the bond or private placement markets, most likely an element of interest rate or foreign exchange hedging, or both, will be entered into. In an IFRS or FRSME (the Financial Reporting Standard for medium sized entities – expected to become 'UK GAAP' for most UK companies from mid-2013) world, the accounting and tax implications need to be thought through in advance (see the next issue of Treasury Matters for a detailed look at the FRSME).
The availability and pricing of debt is beginning to improve, but this window of opportunity may not remain open for long, particularly while European Government debt concerns persist. We recommend borrowers consider their position and available alternatives carefully, not purely in terms of annual costs but also the related accounting, legal and tax issues.
This is an example of why treasury, finance and tax departments need to work together, and our integrated Treasury Team can help you understand the options available to your business and the resulting implications.
The latest changes
HMRC have introduced further changes to the worldwide debt cap rules regarding fair value accounting and where interest deductions are deferred until settlement
Further changes to the "Worldwide Debt Cap" ("WWDC") rules (see Issue 1 of Treasury Matters for more details on the rules generally) have been introduced, with retrospective effect (subject to elections), to resolve known mismatches in the rules.
Primarily, the rule changes seek to resolve two mismatches:
- problems arising from 'fair value hedge accounting', or actual fair value accounting, for certain debt instruments – which could result in mismatches between the accounts-based 'available amount' and the tax comps-based 'tested expense amount' and potentially result in unanticipated disallowances under the WWDC rules; and
- problems caused by deductions for interest, or discount, on certain loans being deferred until settlement, whereas the 'available amount' would always be computed on an accruals basis.
- The rules also deal with potential mismatches relating to compound financial instruments (containing features of equity and debt) and certain debt restructurings, which are likely to be less commonly encountered.
- The amended regulations, although slightly rushed through pre-31 December, do appear in the main to resolve these two problems (subject to some points of detail, which we will be feeding back to HMRC). However there are elections to defer or prevent application of the amendments if groups so wish and therefore any groups which fair value hedge account, or fair value account, for their debt instruments, or which have interest deductible on a paid basis, should seek appropriate advice. As always, we or your usual Deloitte contacts would be happy to explain further.
Next time ... Treasury Matters aims to keep you abreast of current hot tax and treasury topics.
With this in mind, in forthcoming issues we will update you on:
- In order to manage cash flow constraints, companies are considering different methods of managing their pension fund obligations. We'll focus on one method, growing in popularity, the Pension Funding Partnership ('PFP').
- The proposed introduction of the Financial Reporting Standard for medium sized entities (FRSME) for most UK companies from mid-2013, and what this may mean for tax liabilities.
- The IASB's hedge accounting proposals.
- The recent debate about the taxation of dividends paid out of reserves created on a reduction in capital, and some changes taking effect in July 2011 which may affect many groups' plans for entity reduction.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.