Tax optimisation in distressed situations
March 2025 | TALKINGPOINT | BANKRUPTCY & RESTRUCTURING
Financier Worldwide Magazine
March 2025 Issue
FW discusses tax optimisation in distressed situations with Chris Hadfield, Elias Tzavelis and Daniel Ho at Deloitte.
FW: What are some of the key drivers of distress in today’s market? Do any sectors or industries appear particularly susceptible?
Tzavelis: There are two principal forces that are impacting companies today. The first is the increase in interest rates, which has added pressure on businesses as they contemplate their current capital structures, whether in terms of raising new funds or refinancing existing debts. The second driver is more focused on industry. Certain sectors, such as retail, healthcare and automotive, are experiencing increased activity in the US and globally. This trend is driven by a blend of consumer preferences and market forces that are reshaping industry landscapes. Companies within these sectors must navigate these changes to maintain competitiveness and adapt to shifting market dynamics.
Ho: In China, we have seen significant restructuring activity as the real estate and construction sectors have faced liquidity challenges, coupled with tighter regulation of large developers. Amid this landscape, Singapore, Hong Kong and Australia have emerged as debt restructuring hubs given their advanced insolvency laws and strong cross-border restructuring frameworks.
FW: What type of transactions are distressed companies and their lenders implementing as part of a turnaround process?
Hadfield: Liability management transactions (LMTs) are increasingly popular. These are implemented by borrowers ahead of maturity or liquidity crunches to improve their balance sheets. LMTs are commonly structured in two ways. First, via asset drop-downs, where valuable assets are transferred to a subsidiary outside the banking group, allowing new debt to be raised against those assets. And second, by uptiering transactions, whereby the borrower partners with existing lenders who can provide new senior debt facilities. In return, those lenders will have their existing debt elevated in priority above the debt of non-participating lenders. LMTs were originally a US innovation, often used to avoid a costly Chapter 11 process. However, they are increasingly common in Europe. This reflects the macro challenges facing many European companies and the flexibility in many ‘covenant-lite’ financing documents. While LMTs can be a creative solution, they can also be controversial, particularly if they disadvantage a subset of lenders. This can result in fierce litigation and significant implementation risk.
“Local tax advice is critically important to ensure that any tax costs arising on the debt waiver are mitigated to the extent possible.”
FW: What are the potential tax issues when a company is released from some of its debt liabilities?
Ho: The tax treatment of debt waivers can vary depending on the relevant territory. However, as a general principle, debt releases will normally give rise to taxable income for the borrower. It may be possible to shelter this income by relying on local tax exemptions for restructuring processes. Alternatively, the borrower may be able to use surplus tax losses or deductions to offset the income. To illustrate how the analysis can vary in each country, debt waivers in Singapore and Hong Kong can be classified as non-taxable capital gains, subject to the nature and purpose of the loan, while Indian companies that are going through a formal restructuring process can shelter a business debt waiver using brought forward business tax losses, and Australian rules will generally allow debt to be waived without triggering taxable gains. Local tax advice is critically important to ensure that any tax costs arising on the debt waiver are mitigated to the extent possible.
FW: Does a more straightforward amendment of existing debts have any tax impact?
Hadfield: If the terms of a debt are ‘substantially’ amended, the borrower may need to revalue the liability downwards in its accounts. This reflects the possibility of the debt ultimately not being settled in the future. Any accounting credits arising on the revaluation would typically be booked in the profit and loss and be taxable, depending on the jurisdiction. Some countries have brought in tax exemptions to ensure that this potential tax does not become a barrier to a commercially vital refinancing process. However, more commonly, the issue must be navigated with careful structuring and specialist input from tax and accounting advisers.
“Restructurings will often provide significant opportunities to create a more efficient tax profile moving forward. Tax assets on the balance sheet can be crucial in that respect.”
FW: Are there any opportunities to maximise the value of tax assets through a restructuring process?
Tzavelis: Restructurings will often provide significant opportunities to create a more efficient tax profile moving forward. Tax assets on the balance sheet can be crucial in that respect. These might include losses, credits or existing ‘tax basis’ in assets. For example, a company might utilise its tax losses as part of a restructuring process to increase the tax basis in its assets going forward. This could give rise to future tax deductions for the company, reducing its longer-term cash tax costs. This can be particularly valuable if the losses would otherwise be restricted because of the restructuring. These may also be exemptions which can be claimed on a restructuring to shelter taxable income. These can preserve tax losses which would otherwise be offset against that income. Navigating these considerations can significantly enhance the company’s longer term tax profile and, in some cases, help bridge the value gap between the company and its lenders when negotiating the deal.
FW: Are there any special features associated with the new money provided in these challenging situations?
Hadfield: New money is often viewed as high risk. Lenders are therefore very focused on enhancing their returns as compensation. Many new facilities include a multiple on invested capital clause – often referred to as a ‘MOIC’. This guarantees a certain level of return, regardless of when the facility is repaid. In some cases, the return can look exceptionally high, particularly if repayment is early. This can cause the debt to be viewed as quasi-equity from a tax perspective, which can lead to various problems. For example, some jurisdictions may levy dividend withholding tax on future debt payments. Additionally, the issuance of new ‘equity’ in the structure can break tax groups, which may trigger degrouping charges, prevent tax loss surrenders or even trigger gains in the underlying territories. Transfer pricing benchmarking can often help to provide comfort on this issue. This should be started early in the process – when there may still be some flexibility on commercial terms and how these are structured.
“We expect more companies will seek a tax ruling during their restructuring processes, minimising the risk of future challenge from the tax authorities or a due diligence team.”
FW: What role can tax play when a company needs to improve its cash flow?
Tzavelis: A significant current trend among companies is the focus on working capital and reducing overall costs. This often involves reviewing supply chain efficiencies and vendor payments, but cash taxes can also be a substantial consideration. Typically, the focus from a tax perspective falls into two categories. First, performing strategic reviews of current tax compliance procedures to identify overpayments or inefficiencies. The biggest cash recoveries or savings are usually from operational taxes, such as value added taxes. And second, overlaying tax-efficient procedures as part of broader supply chain and operational changes. This can include optimising the tax impact of cross-border transactions in a way which is fully consistent with the underlying business model. Companies are also increasingly leveraging technology and data analytics to enhance their tax planning and compliance efforts. This can drive cost efficiencies, identify opportunities for savings and minimise compliance risks.
FW: How do you see the landscape developing in the months ahead?
Hadfield: We are not expecting a flood of restructurings in 2025. However, it feels that we are in an extended downcycle which will take several years to play out. Some of this is driven by persistently higher interest rates and inflation. Geopolitics may also have a big impact, particularly if trade tariffs are introduced. From a tax perspective, Pillar Two will be an important issue for many larger restructurings. This is a new global tax regime which applies a minimum rate of tax on international businesses, limiting the use of tax avoidance structures. Pillar Two could trigger ‘top-up tax’ on restructurings which benefit from tax exemptions under local law. While there are some Pillar Two carve outs for restructuring processes, these are untested and tightly drafted. The tax at stake can often be very significant. We expect more companies will seek a tax ruling during their restructuring processes, minimising the risk of future challenge from the tax authorities or a due diligence team.
Chris Hadfield is a partner in Deloitte’s credit & restructuring tax team based in London. He has more than 25 years of experience and leads the European special situations tax desk. He also supports companies and lenders through significant turnaround and restructuring processes. He can be contacted on +44 (0)20 7007 8153 or by email: chadfield@deloitte.co.uk.
Elias Tzavelis is a partner in Deloitte’s M&A tax group based in New York. He has more than 25 years of experience and leads the Americas special situations tax desk. This group advises debtors and creditors of distressed businesses, focusing on tax aspects of restructurings both in and out of bankruptcy court. He can be contacted on +1 (917) 523 3923 or by email: etzavelis@deloitte.com.
Daniel Ho is a partner in Deloitte’s M&A tax group based in Singapore. He has more than 24 years of experience and leads the regional M&A tax practice and Asia-Pacific special situations tax desk. He supports corporates and their stakeholders in financial and business restructuring situations. He can be contacted on +65 6216 3189 or by email: danho@deloitte.com.
© Financier Worldwide