News of HSBC's acquisition of Silicon Valley Bank UK (SVB UK) has brought huge relief to the UK tech community and wider economy – quite possibly the optimal result in the circumstances following the Bank of England's announcement of a likely insolvency procedure on Friday 10 March.
The broader implications of the steps undertaken by the Federal Reserve in relation to the entry into receivership of SVB's parent in the US (Silicon Valley Bank, or SVB) are less reassuring. However, for clients with monies on deposit with SVB or SVB UK, it appears that all deposits will be protected and - at least for clients dealing with SVB UK - business will continue to operate normally.
Tax issues for clients in distressed scenarios are frequently the topic of articles and commentary. However, with the situation at SVB and Signature Bank providing a stark reminder of the collapse of Lehman Brothers and the global financial crisis in 2008, this article considers some tax issues for clients to consider in circumstances where an otherwise solvent and healthy client suffers a bank or other lender collapse.
In such scenarios the survival of the client's business, recovery of funds and the ability to meet payroll and other creditors will be the overwhelming priority. However, there are various tax issues to consider in both the immediate-term and long-term, some of which we explore below.
Tax deductions where balances are lost due to bank failure
If a UK borrower suffers any loss due to bank failure, it can generally claim a tax deduction for an amount up to a maximum of the amount normally kept at the bank to meet ordinary banking requirements of the business.
Where a provision is made in respect of such a balance because it is expected that the balance will not be recovered, tax relief will be available for the provision to the extent that it reflects the reasonable expectation of loss.
The loss will also be deductible for UK tax purposes if the bank account balance was held solely to facilitate the issue of credit or guarantees to trade creditors, provided that the creditors are in respect of debts incurred on revenue account by the client's trade which suffered the loss.
Improve cashflow with tax reliefs
Cash flow will typically be paramount for businesses during a period of bank or lender instability. There are ways to help generate tax cash repayments and improve cashflow by submitting earlier claims for R&D tax credits and ensuring that all legitimate claims are pursued.
UK R&D tax credits can generate cash repayments of 33p per £1 spent on qualifying R&D for SMEs and just over 10p per £1 spent on qualifying R&D for large company, although changes to the rules are anticipated following the UK budget later this week. HMRC currently aims to either pay the payable tax credit or contact the taxpayer within 40 days, although their stated ambition is to process 95% of claims within 28 days.
Historic capital expenditure can also be reviewed to ensure all appropriate capital allowances have been claimed, which may be of benefit in particular to cash tax paying companies.
Mitigating HMRC penalties for late payment of taxes
Clients with funds on deposit at a bank in difficulty may find themselves struggling to pay their liabilities, including tax liabilities. HMRC typically charge a penalty if a taxpayer fails to pay tax on time unless the taxpayer has a reasonable excuse and puts the failure right without unreasonable delay after the excuse has ended.
Although there is no statutory definition of 'reasonable excuse' or 'unreasonable delay', HMRC considers reasonable excuse to be something that stops a person from meeting a tax obligation despite them having taken reasonable care to meet the obligation.
If a bank collapses and the taxpayer is unable to access funds in order to pay a tax liability to HMRC, we would expect that to likely be a 'reasonable excuse', although the taxpayer must still put the failure right without reasonable delay as soon as they are able to access funds in order to mitigate the risk of HMRC not imposing a late-payment penalty. Reasonable excuse is also not likely to prevent interest accruing on late-paid taxes.
Withholding tax and implications where debt is acquired by a new lender
If a debtor is due to make an interest payment to a bank (acting via its administrator or a new lender) in respect of any debt, it should continue to account for UK withholding tax where necessary.
Interest on a bank loan and interest paid by banks in the ordinary course of their business are both exempt from withholding tax. However, any assignment of debt to a new lender may impact the withholding tax position. A change in lender may mean that interest can no longer be paid gross or new treaty applications are required.
Where insolvency officeholders make a payment of statutory interest to creditors out of an estate's surplus (having paid creditors in full and retained or increased a valuable pool of assets), withholding tax of 20% must still be paid to HMRC, subject to any applicable treaty or other relief. This is supported by a Supreme Court's ruling in March 2019.
In that case, although Lehman Brothers had been insolvent in cash terms, its balance sheet held valuable assets that had been left over from the collapse and the administrators ended up recovering more than £40bn from Lehman. Approximately £5bn of that surplus constituted statutory interest, which HMRC successfully argued should have been subject to withholding tax of 20%.
Debt releases where a creditor is connected with a debtor
In some circumstances (and occasionally inadvertently) a debtor and creditor will be connected for tax purposes in circumstances of a creditor's insolvency. As part of an insolvency process or other restructuring, a creditor may 'release' a debtor from its debts. Typically, a release of debt will trigger taxable income for UK tax purposes in the debtor and a tax debit (deduction) in the creditor.
This rule generally does not apply where the debtor and creditor are connected companies (or would be connected but for the relationship being broken as a direct result of the creditor company entering insolvency proceedings) with both credit and debits 'switched off'. However, a creditor may still obtain tax relief in respect of an impairment or release, provided the relevant accounting debit accrues while the creditor is in a relevant insolvency procedure.
In circumstances of a creditor being in distress, the opportunity may arise for a group to 'buy-back' its debt from its lender at a discount, which may help strengthen the group's overall balance sheet position. However, care should be taken, particularly if the existing debt has already been impaired.
Where a company connected with a debtor (eg a group company) acquires the creditor rights under a loan relationship from an unconnected lender at a discount (for less than the 'pre-acquisition carrying value of the debt') a taxable deemed debt release will arise in the debtor company, equal to the difference between the consideration given by the new creditor and the 'pre-acquisition carrying value'.