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HMRC internal manual

Corporate Finance Manual

Loan relationships: connected companies and impairment: exceptions: debt-equity swaps

Exchange of debt for equity

Where a borrower is in difficulties, a creditor may take shares in the borrower instead of a repayment. This is usually called a debt/equity swap, and may be part of a corporate rescue.

The value of the shares may be less than the amount of debt outstanding, but as part of the arrangement the creditor discharges all liabilities.

For example, JH Ltd lends £100,000 to KF Ltd. KF Ltd gets into difficulties and JH Ltd agrees to accept 500 x £1 shares in full and final settlement of the debt. Because of the poor state of KF Ltd, these shares are only worth £1,000.

If the companies are not connected, before or after the debt/equity swap, the creditor can have relief for the amount released (£99,000 in the above example) as an impairment loss. If the companies are connected - including becoming connected simply because of the exchange CTA09/S354 would apply to disallow relief. For example, the creditor could acquire a controlling shareholding in the debtor company because of the swap.

This might discourage rescues from taking place, so CTA09/S356 allows limited impairment relief where the creditor satisfies certain conditions.


CTA09/S356 has three conditions.

  • The creditor must treat the liability as discharged.
  • It must do so in return for ordinary shares in the debtor (which means all share capital apart from fixed rate preference shares).
  • The creditor was not connected to the debtor before the swap took place.

The creditor is allowed relief for the amount released relating only to the debt that was swapped and only in the accounting period in which the swap took place. All other existing debts are treated in the same way as debts where the parties are connected. There is no relief for subsequent write-downs or releases, including any amounts released in further swaps, because the creditor and debtor are now connected parties.

See CFM35400 for the CG implications of the disposal of the remaining debt (the amount not released, but treated as consideration for the shares).

CFM35390 has examples that show the treatment in the creditor’s accounts for the amount released.

Treatment of debtor

The debtor company is unaffected by the provisions of CTA09/S356. Where appropriate the debtor company is therefore treated as connected to its creditor and taxed accordingly. If the bargain between the parties involves release of part of the debt for no consideration, the debtor is not required to bring in any amount that is treated as released - CTA09/S358.

The treatment of the debt/equity swap itself by the debtor company is dealt with at CFM35430.