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Intragroup Debt Restructuring: On the Tax Treatment of Debt-Equity Swaps in Belgium

  • Belgium
  • Other

06-11-2020

The Court of Cassation recently delivered an important decision regarding the accounting and tax treatment of debt restructuring operations performed by way of a debt-equity swap. Although the decision has the merit of being clear, its effective consequences are that tax will remain a key consideration for deciding whether to perform such operation. One may wonder whether that is sensible at a time when company groups may have to envisage such operations to save related entities from bankruptcy.

Debt waiver - Basic principles

A group of companies may restructure its members’ debt in several ways.

A company may for instance decide to waive a receivable it holds against a distressed related entity. The creditor will then realize a tax deductible loss on the receivable. The debtor will have to book the amount of the waived debt as an exceptional (taxable) income. As a distressed company, one would expect that the debtor could offset this income with current year or carried forward tax losses. However, the neutralization of such income is often not so straightforward in practice:

  • Since 2018, certain (carried forward) tax deductions can only be used subject to certain limitations, with a minimum taxation as a result. The use of eg. carried forward tax losses is limited to 1 million EUR plus 70% of the taxable income exceeding that amount;
  • The tax authorities may try to invoke that by waiving its receivable, the creditor is granting an abnormal or gratuitous advantage to the debtor. If the tax authorities’ claim is successful, the distressed debtor will effectively become taxable on the amount of the received abnormal advantage, irrespective of eg. its current year or carried forward tax losses.

To avoid such claim by the tax authorities, it is recommended to submit a debt waiver operation for advance clearance to the Belgian ruling commission. The advanced rulings delivered on the subject show that the inclusion of an improved financial status clause is essential. The ruling commission has published last year a template request for taxpayers on its website.  The template can be found here (French) and here(Dutch).

Debt-equity swaps – Basic principles

Intragroup debt may also be restructured by having a creditor contribute its receivable into the debtor’s capital. For years, uncertainty reigned on whether the creditor and debtor had to book such operation at nominal or economic value. The matter is crucial for tax purposes as there are no separate tax rules on the matter.

The value at which a receivable must be contributed to the debtor’s capital has the following fiscal impact:

  • The contribution at economic value would result in the creditor realizing a tax deductible loss on the receivable. The debtor would have to recognize a taxable extraordinary income amounting to the difference between the nominal and the economic value of the debt.

Example: Company A holds a receivable of 100 against distressed Company B. The economic value of the receivable is 30. Upon the contribution of the receivable by Company A in Company B at economic value, the former will realize a tax deductible loss of 70 and Company B will have to book a corresponding taxable income of 70.

  • The contribution of the receivable at nominal value would prevent the creditor from claiming a tax deduction, as it will have to substitute its receivable with a participation in the debtor at the same (nominal) value. Subsequent value reductions or capital losses on such participation would moreover also not be tax deductible. The contribution at nominal value would however not result in an income at the level of the debtor. The debtor would see its liabilities decrease and its equity increase by the same (nominal) amount without a tax impact.

We should finally add that the Court of appeals of Brussels has ruled in the past that a contribution of a receivable at economic value encompassed a debt waiver (decision of January 18, 2001). The Court ruled that the debtor had received an abnormal or gratuitous advantage, which resulted in the debtor being effectively taxed on the received “advantage” (ie. the difference between the nominal value and the economic value of the receivable). The ruling was strongly and, in our opinion, justly criticized by the legal doctrine. That said, with that precedent in mind, it is routinely advised to avoid a potential recharacterization by performing such debt-equity swap at nominal value.

Court of Cassation – June 11, 2020

In 2011, the Belgian Accounting Standard Commission kind of solved the issue of “economic vs nominal value” by stating that both methods are acceptable. The question arose subsequently whether a debt-equity swap may be treated asymmetrically, so as to allow the creditor to perform the operation at economic value (with a tax deduction as a result) and the debtor to book the operation at nominal value (without income recognition by the debtor).

The Ghent Tribunal of first instance and Court of appeals rejected the asymmetrical treatment. The Court of Cassation ruled in the same way in its decision of June 11, 2020: if the debtor books the debt-equity swap at nominal value, the creditor has no choice but to also treat the operation at nominal value. One must hence conclude that the asymmetrical treatment is not an option.

Comments & Conclusion

As mentioned above, it is generally advised to treat a contribution at nominal value at the level of the debtor. The Court of Cassation’s decision rules out the possibility in such case for the creditor to treat the operation at economic value. The pathway to double non-taxation is thus inaccessible, which should not come over as a shock.

Having said that, a group company wishing to save a related company will necessarily be confronted with a strongly dissuasive fiscal dilemma. It will be prevented from fiscally deducting the loss on the receivable, even though it is in fact disposing of the receivable in return for a (increased) participation in the debtor.  Also, the loss the creditor may realize at a later stage on its participation will not be tax deductible, as capital losses on shares are not deductible under Belgian tax law. From a purely fiscal perspective, the creditor would even yield more benefit by having the debtor go bankrupt and by subsequently claiming a loss on its receivable.

The question that begs to be answered is whether these tax consequences should have to weigh in so heavily in such context. At a time when government is seeking for efficient measures to support the economy, one could possibly think of introducing a specific fiscal regime that would deviate from the accounting rules. One could consider to eg. allow the creditor a tax deduction under certain specific conditions, with a recapture in the event the creditor eventually realizes a capital gain on its participation in the debtor.

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