As a consequence of lockdown, many businesses are dealing with situations which may have unfamiliar tax implications. David Gregory highlights five issues that businesses may encounter.
As firms continue to focus on their options to protect, recover and create value, it's important to consider the tax implications, especially as they may have already built up higher-than-usual tax liabilities that may not fully unwind until 2022.
Not only should the repayment of these debts be factored into strategic planning, early consideration should also be given to ways to improve tax and operational efficiencies, minimising potential tax liabilities in a manner that ensures decisions are aligned with commercial and stakeholder objectives.
Five areas where tax liabilities may have a particular impact on shareholders, directors, creditors and other stakeholders of stressed or distressed businesses are summarised below:
1 The unwinding of government support measures
During lockdown, HMRC implemented a range of government stimulus measures. As some of these measures come to an end and more businesses seek to return to some degree of normal operation, they will need to think carefully about the impact of the unwinding support and how ongoing tax payments will be funded, especially those businesses whose operations are still limited by government restrictions:
Automatic deferral of VAT payments
Payments have been deferred until March 2021, with the option of paying the liability in 11 equal instalments up to March 2022.
It is important to ensure that this liability has been correctly factored into cash flow forecasts and consider how it might impact upon TTP arrangements for other tax debts. In addition, you need to be aware of what would happen in the event of an instalment payment being missed. With HMRC’s preferential status in insolvency being restored, it is worth considering how the deferral might impact on HMRC’s claim.
Many businesses obtained an initial agreement from HMRC for short-term deferrals of pay as you earn (PAYE), national insurance contributions (NIC) and other taxes.
Consider what has been agreed long term regarding repayment of these debts and how it aligns with the VAT deferral above. If the business is due a refund from HMRC in respect of other taxes it is likely to be set against tax debts before being repaid, so this should be factored into the cash flow forecast.
Coronavirus Job Retention Scheme (CJRS)
The CJRS brought relief to businesses and employees, but the speed at which it was introduced and the added complexities of the gradual unwinding of the CJRS means that the risks of incorrect claims are high.
There is a 90-day grace period to amend a claim, so it is worth ensuring that claims are checked in time and amended if necessary. New legislation makes directors personally liable for incorrect claims in some circumstances, particularly in cases of fraud.
Coronavirus Job Support Scheme (CJSS)
Available for six months from 1 November 2020, the CJSS will have various aspects that must be considered very carefully, both in terms of eligibility of the employer/employee and the amount that can be claimed as a grant. Care will be needed to ensure that claims are made and that they are not overstated.
2 Mounting HMRC liabilities
It is likely that most businesses will now be carrying substantial tax debt on their balance sheets, which can have broader consequences beyond the obvious financial impact.
While HMRC’s approach to TTPs has relaxed somewhat over the past few months, its starting point in discussions will often be for the maximum amount of debt that you can afford to be paid upfront, with the balance repaid over as short a period as possible.
This will be particularly challenging for businesses that cannot operate at full capacity and with the prospect of business activity not returning to previous levels until well into 2021 or beyond. Forcing such businesses to stretch cash flows will also leave them exposed to further shocks. This will often be a key aspect of what may need to be a robust discussion with HMRC.
Further, HMRC will want to know what steps the business is taking to address the default, including other funding options, ie, bank loans, shareholder loans, rent reductions and stretching creditors.
Businesses should engage early and pro-actively with HMRC, demonstrating that they are doing all that they can to address the default. The business will also need to ensure the TTP proposal is viable and takes account of potential bumps in the road. Missed payments of either the instalments or taxes falling due during the TTP period may have significant repercussions, often resulting in the whole debt becoming immediately payable in full.
HMRC’s preferential status
As the level of tax liabilities rises, the status of HMRC in a future insolvency will need to be taken into account by other creditors.
For insolvencies commencing on or after 1 December 2020, HMRC will be a preferential creditor in respect of VAT, PAYE, employee’s NIC, construction industry scheme deductions and student loan deductions, as I discussed previously.
HMRC will be paid ahead of floating charge and unsecured creditors in respect of its preferential debt, reducing the return to those creditors. This is particularly relevant at a time when businesses have higher-than-usual tax debts, including VAT deferred into 2021/2022 and other TTP arrangements for PAYE.
Therefore, floating charge lenders may use their powers to protect themselves, ie, by asking for higher reserves. This could have a material impact on cash flows and businesses may wish to revisit their debt structure to minimise the impact.
HMRC can require businesses to provide security where it considers there is a risk of non-payment of certain taxes, including PAYE and VAT. This could be particularly relevant where a business is bought out of insolvency by the existing management team, leaving behind HMRC liabilities.
The security requested by HMRC could be material, ie, up to six months’ VAT and four months’ PAYE and it is a criminal offence not to provide it. The cost of any potential bond should be factored into funding decisions when purchasing a business.
Tax abuse and insolvency
Finally, in relation to mounting tax liabilities , it should be noted that, with effect from 22 July 2020, directors and other officers can be made jointly and severally liable for a business’s tax liabilities in certain circumstances, including where there are repeated insolvencies.
Some directors may consider prioritising HMRC ahead of other creditors in order to avoid personal liability, but this could open them up to other claims in the event of an insolvency.
3 Debt restructuring
The restructuring of debt, especially in a distressed scenario, can give rise to unexpected tax charges, so planning in advance is key. This is particularly relevant as businesses look to renegotiate debt or strengthen their balance sheets.
Some of the more common scenarios that can trigger tax consequences and that need careful consideration include:
Renegotiations of terms of debt
Where the changes in terms, including covenants, give rise to an accounting adjustment or modification in the borrower then there are likely to be tax implications. If it results in a cash tax liability that cannot be sheltered, how will that be funded?
Debt for equity swaps
This is a popular transaction that can be done in a tax-neutral manner, but it's essential to ensure the conditions for the exemption are met. The terms of the shares being issued or rights that are granted are areas that can lead to unintended tax consequences.
The elimination or release of debts
There are various tax exemptions available to distressed businesses, for example, the corporate rescue exemption. However, this exemption is more subjective in nature and so careful consideration must be given to whether t the relevant conditions are met.
The acquisition of distressed debt by a connected party or a lender taking control of the debtor
These situations could lead to a deemed release, so that, without corrective steps, an unexpected tax charge can arise in the borrower. Swift action can prevent this from happening in some situations.
4 Transactions involving distressed business or debt
We are already seeing a substantial increase in transactions involving distressed businesses, and care will need to be taken to ensure that the acquisition structure minimises tax leakage when closing the transaction, throughout the life of the investment and upon any ultimate exit.
Acquire shares or the business?
Acquiring assets rather than shares can be advantageous as the purchaser is not inheriting the vendor’s tax history, but valuable tax attributes may be lost, such as capital allowances, losses and tax refunds.
These are more likely to be preserved on a share deal, subject to rules restricting their availability in some situations, but this potentially opens the purchaser up to historical tax liabilities in the company acquired and, potentially, in other previously connected companies, eg, VAT liabilities. Careful consideration should be given to the risks and rewards of either scenario.
Where the seller is in or about to enter an insolvency process, this may be unfamiliar territory for buyers. At the very least it will mean there is greater risk for the purchaser, who is unlikely to obtain the benefit of any tax warranties or indemnities.
Acquiring debt at a discount
An alternative could be to acquire debt at a discount, especially where it gives the debt holder effective control. However, it can result in deemed tax charges arising, so tax planning is crucial.
When acquiring a distressed business or debt, commercial risks will need to be balanced against implementing a tax-efficient structure. By engaging with tax advisers at the outset, the best balance can be struck and deal value maximised.
5 Long-term considerations
As the focus of the government support measures changes and a return to normal trading looks a long way off, liquidity remains tight. Maximising tax assets, and therefore reducing tax liabilities, is key to helping a business succeed. Some other areas to consider in stressed or distressed businesses include:
maximising the tax deduction available for interest payments
protecting accumulated losses and other tax attributes
utilising tax losses in the most efficient way possible, including early carry back claims to generate tax repayments
ensuring tax groups, which allow tax efficient transfer of assets and use of losses, are not broken, eg, through an insolvency appointment over part of a group
If you would like to discuss any of the above issues, or other restructuring and insolvency tax liabilities more generally, contact David Gregory.