CFM96310 - Interest restriction: related parties: debt restructuring

TIOPA10/S469

When a company encounters trading difficulties, it might be unable to service any debtor loan relationships it is party to, and the creditor may release all, or part of, the debt as a result. This might precipitate the creditor becoming a related party of the debtor where they were previously unrelated.

This will typically be the case, for example, where the creditor agrees to release the debt in consideration for shares in the company, with the expectation that the shares will increase in value in the long term and they will be able to recoup their loss.

If only part of the debt was released, any debt still owed to the creditor would be payable to a related party which could reduce the company’s interest capacity at a time when it is in financial distress. The rules therefore treat the debtor and creditor as not being related parties where they only became related in consequence of a relevant release of debt.

The exemption applies to the original loan relationship, and not to new loan relationships. In certain debt rescue situations where the original loan is replaced by a new loan, the new loan may be considered to be a continuation of the original loan relationship. If you are unsure whether the conditions are met, you may seek clarification from your Customer Compliance Manager, or if you do not have one, you may submit a non-statutory clearance application .

Relevant release of debt

The rule applies in respect of a relevant release of debt which is where:

  • D (or a related party of D) has a liability to pay an amount under a debtor relationship which is released under the arrangements, and
  • Immediately before the release, it would be reasonable to conclude that without it, there would be a material risk that D (or the related party) would be unable to pay its debts within the next 12 months.
Example

C lends £10m to an unrelated party (D Ltd).

D Ltd experiences financial difficulties and C agrees to release half of the debt and convert it into equity. This results in D Ltd and C becoming related parties because C’s equity stake means it now has a 25% investment in D Ltd (S463).

D Ltd and C continue to be treated as unrelated in respect of the remaining loan amount because, immediately before the release, it was reasonable to conclude there was a material risk that D Ltd would be unable to service the debt in the next 12 months.