The new ‘Dutch scheme’ and key tax considerations in financial restructuring

January 2022 | SPOTLIGHT | BANKRUPTCY & RETRUCTURING

Financier Worldwide Magazine

January 2022 Issue

With the global coronavirus (COVID-19) pandemic dominating headlines throughout 2021, many countries across the world went through insolvency law reforms. While some of the legislation was incidental, meant to address the immediate impacts of the crisis, more profound legislative amendments have been made to facilitate a business rescue culture. In Europe, the implementation of the European Union’s (EU’s) Directive on Restructuring and Insolvency has resulted in the introduction of new restructuring instruments in various jurisdictions. In the Netherlands, a new restructuring tool was introduced with the Act on Court Confirmation of Composition Plans – Wet Homologatie Onderhands Akkoord (WHOA), often referred to as the ‘Dutch scheme’. The Dutch scheme is inspired by the UK scheme of arrangement (hence the name) and US Chapter 11 proceedings. It provides borrowers with an advanced restructuring tool.

When working on financial restructurings, tax considerations are crucial. Tax is a critical component in the decision-making process, with jurisdiction-specific tax consequences to be considered in any cross-border debt restructuring. For both borrowers and lenders, there are tax-related pitfalls and opportunities that might arise in international debt restructurings, which must be at the forefront of any restructuring to ensure that the process is successful.

Three commonly considered debt restructuring scenarios are sales of distressed debt, debt waivers and debt-to-equity swaps. The fact that the tax treatment varies according to the rules of each jurisdiction emphasises the need for careful consideration of the tax consequences in any proposed restructuring. In this article, we will discuss these three options and highlight some of the tax considerations for lenders and borrowers.

Dutch scheme

On 1 January 2021, the Dutch scheme entered into force. The scheme provides borrowers in distress a pre-insolvency proceeding to restructure their debt. It is a debtor-in-possession (DIP) proceeding whereby a borrower prepares a composition plan to restructure its debt. The borrower offers the composition plan to creditors and shareholders which can be divided into classes for purposes of voting on the plan. The composition plan is adopted in a class if a vote in favour is cast by creditors or shareholders that hold two-thirds of the value of all claims of creditors or shareholders that have cast a vote in that class. This enables a financial restructuring outside of a formal bankruptcy proceeding or suspension of payments, as a one-third minority can be crammed down. If the plan is not adopted by all classes, it is still possible to request the court to confirm the plan under a cross-class cram down provision.

Like the cross-class cram down feature, the Dutch scheme has many advanced features inspired by the UK scheme of arrangement and US Chapter 11 proceeding. There is a moratorium under the new legislation of a maximum eight months to facilitate the restructuring. In addition, ipso facto clauses are deactivated to avoid business disruption. Further, the Dutch scheme provides rescue funding protection – for example security provided for rescue funding is protected against claw-back risks in a subsequent bankruptcy. Moreover, the Dutch scheme has certain features which makes it stand out compared to other global restructuring tools. Under the Dutch scheme, it is possible to restructure or terminate onerous contracts like lease contracts. The Dutch scheme also facilitates restructurings of group companies: guarantees provided by other group companies may be restructured under the same composition plan offered by the borrower. Meanwhile, creditors are protected with a best-interest-of-creditors test and an absolute priority rule.

The Netherlands is home to many special purpose vehicles (SPVs). Multinational companies from all over the world have used Dutch financing-SPVs to raise bond or bank debt. These structures are often driven by tax reasons. As a result, the issuer or borrower under bond or bank debt is located in the Netherlands. Therefore, a significant part of the restructuring will take place in the Netherlands when such international corporates experience financial distress. The Dutch scheme provides an excellent instrument for such restructuring. Both the borrower’s group companies that are in the Netherlands as well as those which are not located in the Netherlands have access to the Dutch scheme to restructure their debt.

Given the advanced restructuring opportunities in various jurisdictions globally, lenders will need to make an assessment as soon as their borrowers are in financial distress. A lender may prefer to sell the distressed debt and ‘step out’ of the financial restructuring. If the lender opts to keep the debt, the lender may be confronted with requests for debt waivers or modifications. In return, lenders may insist on a debt-for-equity swap, so that the debt is not simply waived but is swapped with equity in the capital of the borrower. All these options require close consideration from a tax perspective.

Sale of distressed debt

The sale of distressed debt is a mechanism for a lender to reduce its balance sheet exposure to debt which may currently be non-performing or have a significant risk of future default. In such circumstances, the debt would be expected to be sold at a discount to face value in view of the distressed financial circumstances of the borrower.

The common response to the question of whether the borrower should suffer any tax consequences because of the sale of distressed debt to a new lender is understandably ‘no’, but this is not always the case. The situation may be complicated where the parties are connected, such as where a borrower wants to acquire a debt into a group to remove the controls placed on it by third-party lenders. Furthermore, in the Netherlands, stringent anti-avoidance provisions are in place to ensure that a lender cannot avoid Dutch tax liability from an upward valuation of a loan which has previously been written down (where the parties are affiliates).

The selling lender will expect to realise a tax-deductible loss on any discount to the carrying value. Where the buyer and seller are connected parties or the transaction is otherwise than at an arm’s length, tax loss restrictions may apply. From the perspective of the buying lender, the base cost in the debt will usually be the price it paid, assuming that the acquisition is on arm’s length terms. The buying lender will also need to consider transfer taxes which may apply, particularly if the loan is equity-like in nature, because it carries results-dependent interest, for instance, and the withholding tax position and whether any structuring is needed to mitigate any such tax.

Debt waivers or modifications

A debt waiver, debt modification or debt cancellation relieves, either temporarily or permanently, the borrower of its financial obligations under a debt instrument. It is a common element in restructurings.

The starting point for a standard debt waiver is that borrowers can expect to be subject to tax on the value of the waived debt. Several jurisdictions provide borrowers with relief in distressed situations. For connected parties, the situation may be tax neutral in some jurisdictions, such as the Netherlands and the UK. However, there may still be a tax liability in other jurisdictions, such as France and Germany.

A lender involved in a debt waiver is generally able to obtain tax relief for the debt forgiven. When the terms of a loan are amended, it is necessary to consider whether this gives rise to a new loan such that new treaty formalities need to be undertaken from a withholding tax perspective.

Debt-to-equity swap

A debt-to-equity swap, substitution or restructuring is a capital reorganisation of a company in which a lender, usually a bank, possibly together with other banks, bondholders or creditors, converts indebtedness owed to it by a company into one or more classes of that company’s share capital.

From a lender’s perspective, a debt-to-equity swap should generally be a tax neutral transaction, with the tax book value of the shares received equal to the tax book value of the converted debt. Having said that, where the lender is a related party of the borrower, the treatment may be different. Several jurisdictions, including the Netherlands, have legislation that prevents a lender from depreciating a debt and subsequently converting that debt into equity in a tax neutral way. In related-party situations, the conversion leads to a recapture of the loss arising from depreciation at the level of the lender, where the recaptured amount could be added to a reserve to avoid an immediate cash tax payable.

The borrower may suffer a reduction in its tax losses (which can be used to reduce future income) or be treated as receiving an amount of taxable income if the value of the equity is less than the value of debt released. However, in some jurisdictions, such as the UK, a debt-for-equity swap may be treated as tax neutral.

If there is a change of control of the borrower arising from the debt-for-equity swap, this may lead to further tax considerations, such as restrictions on carry forward losses or de-grouping charges. There will also be a change in the tax profile for the parties going forward – interest paid on a debt will likely be taxed differently to any dividends while the treatment of the parties on any future exit would again likely be different.

Conclusion

The entering into force of the new Dutch scheme provides various advanced restructuring options for borrowers. Not only Dutch borrowers, but also foreign borrowers may be looking with great interest at the Dutch scheme to restructure their debt going forward, especially keeping in mind that the Netherlands is home to many financing SPVs. While doing so, tax considerations should not be overlooked. While there are many general principles that apply to the tax treatment of debt, restructuring solutions across jurisdictions, minor nuances and major deviations can be found which should be at the forefront when considering the options available.

Omar Salah and Bart le Blanc are partners at Norton Rose Fulbright. Mr Salah is also a professor at Tilburg University and can be contacted on +31 20 462 9482 or by email: omar.salah@nortonrosefulbright.com. Mr le Blanc can be contacted on +31 20 462 9387 or by email: bart.leblanc@nortonrosefulbright.com.

Omar Salah and Bart le Blanc

Norton Rose Fulbright