Following the introduction of the Finance (No. 2) Act 2005, the opportunities for UK portfolio companies of leveraged buyout and private equity funds to generate tax deductions for interest on the financial instruments frequently used in leveraged buyout transactions have been significantly restricted. Typically in these transactions, interest on loans to the portfolio company by the private equity fund will accrue on a regular basis but will not be payable until the private equity fund achieves its exit.

This Guide describes one of the few remaining alternatives, the issue of Payment-in-Kind notes on the Channel Islands Stock Exchange.

It is recognised that this Guide will not completely answer detailed questions which clients and their advisers may have. It is intended to provide a sketch of the subject matter covered. The Guide is, therefore, designed as a starting-point for a more detailed and comprehensive discussion of the issues.


The changes introduced in 2005 (which came to effect for all loan relationships created from 4 March 2005) provide for limited exceptions which allow deductibility of interest payments (or the discount on a deep discount bond) on an accruals basis if the borrower is a small or medium sized enterprise and the creditor is either UK resident or not resident in certain offshore centres, or where the loan is from a limited partnership which qualifies as a collective investment scheme and the borrower is a small or medium sized enterprise, all of the partners are either UK resident or not resident in certain offshore centres and the partnership provides written confirmation of that fact. Otherwise, the portfolio company will only be entitled to tax deductibility of interest payments when they are actually paid (or in respect of deep discount bonds when they are redeemed).

One solution, which allows a tax deductibility of interest as it accrues, is the issue by the portfolio company of funding bonds or payment in kind (PIK) notes. In this way, interest payment obligations are met by the issue of further PIK notes and no cash is required to be paid. The issue of the further PIK notes is treated as payment of interest equal to the value of the PIK notes issued for tax deduction purposes.


Where note holders or limited partners (as the private equity fund is likely to be tax transparent) are not UK resident, they will be subject to UK withholding tax on the value of the notes issued. There is however a statutory exemption from UK withholding tax where the PIK notes are issued as quoted funding bonds and, as the Channel Islands Stock Exchange (CISX) is a recognised stock exchange, a simple quotation can be achieved by listing the funding bonds on the CISX.

The CISX is an extremely flexible exchange and is a convenient and inexpensive route to achieve this tax saving.

In many cases the CISX will treat the funding bonds as specialist debt issued by a special purpose vehicle to sophisticated investors and the listing requirements and continuing obligations are in this case not particularly onerous. Detailed in Appendix 1 are the applicable conditions for listing and in Appendix 2, the applicable continuing obligations. Whilst a listing document will be required, generally no additional accounting information will need to be prepared beyond the existing audited accounts of the issuer or its subsidiaries, and listing fees will be limited to £4,175 plus £750 for each separate issue of funding bonds (together with £125 for the publication of formal notice in respect of each issue). No further annual listing fees are required (other than the sponsor's annual fees).

The CISX has been designated as a recognised stock exchange by Her Majesty's Revenue & Customs in the UK under s1005(i) Income Taxes Act 2007, and as a designated investment exchange by the Financial Services Authority in the UK under the Financial Services and Markets Act 2000. The Securities Exchange Commission of the USA has categorised the CISX as a designated offshore securities market within the meaning of Rule 902(b) under Regulation S of the Securities Act of 1933 and the CISX is an affiliate member of the International Organisation of Securities Commissions.


Appleby Securities (Channel Islands) Limited is a listing sponsor to the Channel Islands Stock Exchange. Appleby Securities (Channel Islands) Limited would expect to charge a moderate sponsorship fee and would charge an annual responsibility fee so long as the securities continued to be listed on the exchange. When compared to the withholding tax liabilities which would otherwise be incurred on the payment of interest for issue of non-listed PIK notes, the issuer will obtain substantial overall savings and will generally recover the cost of listing within the first year.

It should be noted that certain UK resident limited partners may be liable to tax on the receipt of PIK notes issued to them and US limited partners may also face tax liabilities. However, it may be possible to structure the funding bonds so that those bond holders who would otherwise be liable to withholding tax may elect to receive PIK notes, while those bond holders who would incur an unfunded tax liability on PIK notes can elect to receive cash interest. Alternatively, the issuer may issue PIK notes to all bond holders but those who would be liable to an immediate tax charge could redeem such amount of PIK notes as is necessary to meet the liability to tax.


Conditions for listing

(1) An issuer must be duly incorporated or otherwise validly established according to the relevant laws of its place of incorporation or establishment and be operating in conformity with its memorandum and articles of association or other constitutional documents.

(2) With the exception of securities issued by a Special Purpose Vehicle, a private issuer of debt securities listed pursuant to this Chapter must normally have produced independently audited accounts for the two financial years preceding the application for listing. In exceptional cases the Exchange may accept a shorter period. Where such an issuer is guaranteed, the guarantor of the issuer must also provide copies of its latest independently audited accounts to the Exchange. [Note: the CISX will generally be prepared to accept subsidiary accounts where the holdco is newly incorporated or treat holdco as a special purpose vehicle in which case no accounts will be required].

(3) The applicant's securities must be eligible for deposit in a clearing and settlement system acceptable to the Exchange. The Market Authority will, in consultation with the issuer's Sponsor, designate an approved clearance system to be used for each security. This information will be published by the Exchange on its trading system.

A clearance system may be one of the following:

  • Euroclear
  • Cash settlement via the Sponsor

However, despite the foregoing, the CISX will generally grant issuers a derogation from this requirement where the issuer considers that the level of liquidity anticipated in respect of the transaction does not merit putting the securities into a clearing or settlement system.

(4) A trustee or other appropriate independent representative appointed to represent the interests of the holders of asset-backed debt securities must have the right to access appropriate information relating to the assets [Note: this is not generally applicable to PIK notes].

(5) Listed securities must be freely transferable and tradable and fully paid securities must be free from all lien. Securities may, however, be subject to transfer restrictions or compulsory redemption:

  1. where the holding of such securities may result in a regulatory, pecuniary, legal, taxation or material administrative disadvantage for the applicant or the holders of its securities as a whole; or
  2. to maintain a minimum holding per holder, as specified in the Listing Document. In certain circumstances approved by the Exchange, an applicant may be allowed to place restrictions on the transfer of securities provided that the exercise of such power would not disturb the market in those securities.

5. APPENDIX 2 Continuing obligations

(1) It is a prerequisite of listing that an issuer executes a Listing Undertaking in the form set out in the Listing Rules, undertaking to comply with the Listing Rules and, in particular, with all relevant continuing obligations. Observance of the continuing obligations is essential to the maintenance of an orderly market in securities and to ensure that all users of the market have simultaneous access to the same information. Failure of an issuer to comply with any applicable continuing obligation may result in the Exchange taking the enforcement actions described in Chapter III of the Listing Rules.

(2) Generally, and apart from compliance with all the specific requirements of the Listing Rules, the issuer shall keep the public, the Exchange, the holders of the securities of the issuer and other holders of its listed securities informed as soon as reasonably practicable of any information relating to the issuer (including information on any major new developments in the issuer's sphere of activity which is not public knowledge) which:

  1. is necessary to enable them and the public to appraise the position of the issuer;
  2. is necessary to avoid the establishment of a false market in its securities; and
  3. might reasonably be expected materially to affect market activity in and the price of its securities.

(3) Information that is required to be disseminated pursuant to Rule 2 above or otherwise under the Listing Rules must not be given to a third party before it is notified to the Exchange except as permitted in this Rule. An issuer may give information in strict confidence to its advisers, an agent employed to release the information, and to persons with whom it is negotiating with a view to effecting a transaction or raising finance, including prospective underwriters of an issue of securities, providers of finance or loans or the placees of the balance of a rights issue not taken up by shareholders. In such cases, the issuer must advise the recipients of such information that is confidential and that they should not deal in the issuer's securities before the information has been made available to the public. An issuer shall notify information to the Exchange by the method laid down by the Exchange from time to time.

(4) An issuer whose securities are listed on the Exchange and on any other exchange must ensure that equivalent information is made available at the same time to the Exchange and such other exchanges.

(5) As soon as practicable following the publication of the annual report, relevant annual accounts or interim financial statements, the issuer shall send two copies of such annual report, relevant annual accounts or interim financial statements to the Exchange, or refer the Exchange to publicly available information placed on the internet or central depository.

(6) The issuer shall immediately disclose to the Exchange:

  1. any change in the rights, powers or privileges of any class of listed debt securities, including any change in their rate of interest, and any change in any of the rights, powers or privileges of any class of securities into which the listed debt securities are convertible or for which they are exchangeable;
  2. any decision to call, purchase, redeem or cancel any of the listed debt securities by the issuer. The information must also state the amount of the debt securities to be called, purchased, redeemed or cancelled and the amount of debt securities to be outstanding after the transaction or series of transactions is completed. Such transactions in listed debt securities may be aggregated so that no report need be made until five per cent of the outstanding amount has been subject to such transactions (or a decision made to enter into such transactions for five per cent or more of the outstanding amount of listed debt securities), but once that threshold has been crossed, each additional one per cent of the amount of outstanding debt securities must be reported; and
  3. any proposed changes in the constitution or capital structure of the issuer.

(7) If the listed debt securities may be converted into or exchanged for securities of another company, or are guaranteed by another company, the issuer must ensure that adequate information is at all times available to the Exchange and the holders of the listed debt securities:

  1. concerning the business and affairs of the other company; and
  2. concerning the rights, powers and privileges of the securities into which the listed securities are convertible or for which they are exchangeable.

    As a minimum, the information provided to satisfy subsection (a) of this Rule must include the annual report and accounts of the company, any interim financial accounts, and all other information necessary for a realistic valuation of the listed debt securities to be made.

(8) In addition to the specific requirements set out in the Listing Rules, the issuer shall submit to the Exchange for review copies of drafts before they are issued of any announcements or advertisements, the subject matter of which involves a change in or relates to or affects arrangements regarding trading in the listed debt securities on the Exchange, including suspensions or cancellations of listings.

(9) The issuer shall send to the Exchange, as soon as practicable after they are issued, one copy of the following:

  1. all shareholder resolutions of the issuer passed other than in the ordinary course of business;
  2. any document relating to take-overs, mergers and offers;
  3. all notices of meetings;
  4. forms of proxy;
  5. reports;
  6. announcements; and
  7. any other similar documents.

(10) The issuer shall submit two copies to the Exchange of any document sent to shareholders of the issuer's listed securities as soon as practicable after such documents are issued.

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.