Tread carefully when considering debt-to-equity restructuring

26 July 2023 ,  Dr Candice Reynders 408
Converting or exchanging debt that is owed by a company into shares in that same company has long been used as a debt restructuring tool. There are, however, very fine lines that surround this solution and it needs to be structured correctly to ensure that no unintended tax consequences arise. In this article, we briefly highlight a few considerations in relation to such restructuring.

The conversion or exchange of debt into shares is called a concession or compromise. This means that where a debt is converted or exchanged for inadequate consideration, the resultant concession or compromise may amount to a debt benefit. The tax that will be applicable will depend on what the debt funded. For example, if the debt funded the purchase of trading stock, the debt benefit will be income in nature and subject to normal tax rules. If the debt funded a capital asset, the debt benefit will be capital in nature and subject to capital gains tax.

When a concession or compromise is concluded, the company has extinguished their debt liability without having actually paid for the debt. The notion is that the company is in a better position than it would have been had it extinguished the loan in the conventional way. This in essence capsulates what it means to have a debt benefit. If this is the result, the amount of the debt benefit would then be taxed in the hands of the company in the year of assessment that the debt benefit arises.

A concession or compromise in respect of a debt, however, is not always applicable. On the contrary, it is a specific anti-avoidance provision to prevent taxpayers from reducing their tax liabilities by merely changing the nature from debt into equity and will only be taxed as a last resort. Where the debt is subject to estate duty, donations tax or employee tax, the debt benefit will not be taxed as a compromise or concession. There are also specific debt benefit exclusions that apply to concessions and compromises which can be used to efficiently restructure debt. 

Importantly, the days of converting or exchanging a debt into shares as a simple means to extinguish a debt are gone. This does not mean it is not possible, but the structuring of debt needs to be precisely calculated and correctly implemented to ensure that there are no tax consequences for the affected company. So, ensure you consult with your tax advisor before you undertake any debt-to-equity restructuring exercise. 

Disclaimer: This article is the personal opinion/view of the author(s) and is not necessarily that of the firm. The content is provided for information only and should not be seen as an exact or complete exposition of the law. Accordingly, no reliance should be placed on the content for any reason whatsoever and no action should be taken on the basis thereof unless its application and accuracy have been confirmed by a legal advisor. The firm and author(s) cannot be held liable for any prejudice or damage resulting from action taken on the basis of this content without further written confirmation by the author(s). 
Related Expertise: Tax Advisory
Related Sectors: Wealth Management