To QCB or not to QCB
You – or perhaps your client – are selling a trading company. The buyer either cannot afford to pay cash in full or does not want to. The buyer is prepared to offer loan notes to be redeemed at some point in the future. But how should those loan notes be structured from the tax perspective? The simple choice is that these can be qualifying corporate bonds or not. It is almost always the seller who has to make this choice.
Qualifying Corporate Bonds are in fact the default plain vanilla loan note. If the notes are denominated in sterling and non-convertible, they will be QCBs. But for reasons I will go into later, QCBs are not always the best option. When they are not the best option non-QCBs will be preferable. Non-QCBs can be created by ensuring that they do not meet the usual conditions for QCBs.
If QCBs are selected, the gain arising on disposal in exchange for them is frozen at the date of exchange, QCBs themselves being exempt from capital gains tax (not as generous an exemption as might be thought as a loss on a QCB is far more likely than a gain). Irrespective of the future value of those QCBs, the gain crystallises on redemption or earlier disposal. If the issuer fails to pay, CGT on the earlier gain is still payable, and there is no possibility of any allowable loss arising. The seller may elect to crystallise the gain at the date of exchange, especially if that GAIN will benefit from reliefs such as business asset disposal relief (BADR). However that gain may give rise to a ‘dry’ tax charge with little or no cash proceeds to pay the tax.
On the other hand if non-QCBs are created, the gain on exchange rolls into the notes: and no tax arises at that time as the exchange is treated as a reorganisation for capital gains tax purposes. Reorganisation treatment can be disapplied by election, which may be done again when reliefs such as BADR are available, or where the risk of an increase in CGT rates is considered significant. Unlike exempt QCBs, non-QCBs are chargeable assets for CGT purposes. Although they are equally unlikely to give rise to a capital gain in themselves, this does mean that any loss that might arise, for example, because the issuer’s business fails, is an allowable loss for CGT purposes.
So what are the factors to be weighed up in deciding whether to QCB or not to QCB? The first is the buyer’s covenant – in other words the likelihood that the buyer will actually pay what they owe the seller. If that risk is considered significant, non-QCBs will at least enable any loss to be allowable for CGT. And it should be borne in mind that elections to trigger again on exchange are subject to strict time limits.
We advise clients and their professional on these issues frequently and regularly and are happy to assist if advice and support are needed.