- Background
Insurance companies are (along with banks) large scale issuers of subordinated debt. Debt is subordinated if it ranks behind policyholders and other creditors on a winding up and if in certain circumstances (such as capital less than the SCR) payments of interest and redemption of the debt are suspended. There might also be provisions for certian trigger events to result in the right down of the subordinated debt or its conversion to share capital.
In the absence of specific tax legislation the "interest" payable on subordinated debt would (arguably) be a distribution as payment is dependent on the results of the issuing company. The possibility of issuing a capital instrument with tax deductible "coupons" was attractive to insurers and banks and, presumably, felt to be desireable by the government.
As a result SI 2013 / 3209 and SI 2015 / 2056 provided that interest paid on regulatory capital of banks and insurers would be tax deductible interest.
The legislation in SI 2013 / 3209 has now been repealed and is replaced by direct legislation. The motivation for the change was that Holland also had special tax rules for regulatory capital of insurers and banks which were challenged by the EU commission.
The Legislation
Schedule 20 FA 2019 repeals SI 2013 / 3209 and SI 2015 /2056 and replaces a specific deduction for coupons paid on regulatory capital with a wider relief for payments on hybrid capital instruments. This legislation is incorporated into the loan relationships legislation in part V of CTA 2009 as follows.
Section 420 A (2) provides that any qualifying amount payable in respect of the hybrid capital instrument is not a distribution.
420 A (3) defines a qualifying amount as one that would not be regarded as a distribution if it is assumed that any provision made by the loan relationship under which the debtor is entitled to defer or cancel a payment of interest under the loan relationship had not been made. It's worth noting this is a weaker provision than was included in SI 2013 / 3209 and it is still necessary to consder whether terms of the subordinated debt other than deferring or cancelling interest (such as bailing in creditors in certain circumstances) might make the payments a distribution.
Hybrid Capital Instrument
The definition of a hybrid capital instrument is at CTA 2009 475 C, reproduced below,
475C(1) For the purposes of this Part, a loan relationship is a “hybrid capital instrument” for an accounting period of the debtor if–
(a)
the loan relationship makes provision under which the debtor is entitled to defer or cancel a payment of interest under the loan relationship,
(b)
the loan relationship has no other significant equity features, and
(c)
the debtor has made an election in respect of the loan relationship which has effect for the period.
Sections 475C (3) - (7) define the term "has no other significant equity features". I have only read through this wording once but it seems to be that it is envisaged most subordinated debt issued by insurers will meet the criteria and coupon payments will be tax deductible interest provided an election is made.
Implications
The repeal of SI 2013 / 3209 and its replacement with new legislation for hybrid capital instruments extends the range of companies that might be able to benefit from tax deductible payments on loans that have limited equity features.
For insurers it is tempting (and perhaps largely true) to say nothing has changed as I think most subordinated debt within SI 2013 / 3209 will be hybrid capital instruments. But there are a couple of additional hoops to jump through:
Previously the tax adviser could be pretty happy that provided a subordinated debt was regulatory capital then coupons payable on it would be tax deductible. Now it will be necessary to decide whether the subordinated debt is a hybrid capital instrument, which would, presumably, require a detailed review of the terms of the instrument (even if in most cases you kind of know the answer will be, yes it is). Additionally an election has to be made if amounts payable are not to be treated as distributions.
The election
The time limits and other conditions for the election are set out at section 475 C (8). The election is irrevocable, applies to the period the company becomes party to the loan relationship and all subsequent periods.
The election must be made within 6 months from the day the company becomes a party to the loan relationship, but
If the relationship is in force on 1 January 2019 the six months referred to above is changed and the election is to be made before 30 September 2019. (This extension is retained in FA 2019 schedule 20).
Other Rules
In addition to the above the legislation makes provision for:
Subordinated debt that was within the SI 2013 / 3209 regime but which does not come within the hybrid capital instruments legislation. (Looks as if this stays within the old rules until 2023).
Ensures amounts in respect of hybrid capital instruments accounted for in equity are still treated as being brought into account for the purposes of the loan relationship legislation.
An anti - avoidance provision.
Exemption from all stamp duties for hybrid capital instruments.
Unlike SI 2013 / 3209 the legislation does not automatically provide for relief from withholding tax for interest payments made on hybrid capital instruments. So the withholding tax position is another issue to be dealt with "from scratch".
