Hybrid capital instruments

The measure

It was announced that the Taxation of Regulatory Capital Securities Regulations 2013 will be revoked. These regulations deal with the tax treatment of certain regulatory capital securities issued by banking and insurance groups. Some of those provisions will continue to apply for a five-year transitional period (e.g. exemption from obligation to withhold UK income tax).

HMRC have issued a technical note detailing proposed new tax legislation on ‘hybrid capital instruments’. The new legislation will not be specific to banks and insurers, but is expected to be of particular relevance to them.

A ‘hybrid capital instrument’ is intended to include loan relationships with the following features:

  • the debtor is allowed to defer or cancel interest payments;
  • there are no other significant equity features (e.g. voting rights);
  • the debtor has made an irrevocable election within six months of issue; and
  • there is no tax avoidance purpose.

The consequences of an instrument being a ‘hybrid capital instrument’ include that:

  • amounts recognised in equity, except for exchange gains and losses, are brought into account for tax purposes;
  • coupon payments will not generally be considered to be non-deductible distributions; and
  • stamp duty will not be charged on their transfer.

These are similar to the provisions which currently apply to regulatory capital securities issued by banking and insurance groups.

There are a number of other proposals set out in the technical note. One is for new legislation to eliminate potential tax mismatches which could apply where a company applies fair value accounting.

There will also be consequential amendments to the hybrid mismatch legislation from 1 January 2019. The intention is to mirror the existing exemption for regulatory capital securities and to extend this to include certain new instruments that qualify under minimum requirement for own funds and eligible liabilities (MREL). Further changes are also expected in 2020 to meet the requirements of the EU Anti-Tax Avoidance Directive.


Who will be affected?

Banking and insurance groups will be the main affected taxpayers.

These proposals will also be of interest to any other company which has issued a ‘hybrid capital instrument’ or intends to do so.


When will the measure come into effect?

The proposals will apply with effect from 1 January 2019.

Draft legislation is expected to be published as part of the Finance Bill on 7 November 2018. 

Our view

The proposals cater for changes in the regulatory environment and the emergence of new MREL requirements for banks. Banking and insurance groups will need to assess whether their existing regulatory capital securities are impacted by these changes. They will also need to consider the impact on instruments to be issued in the future, in particular any new instruments to be issued this year to meet their MREL requirements that take effect from 1 January 2019.

It is not clear whether the new definition of a hybrid capital instrument will include all instruments that are within the current definition of regulatory capital securities and those that are issued to meet MREL requirements. This means that there is uncertainty over the tax deductibility of coupon payments on such instruments. We understand HMRC will be issuing updated guidance to address this concern.

The details of the election to qualify as a hybrid capital instrument are limited. For some instruments the six month time limit will already have expired. We would therefore expect that an alternative date will be included in the final legislation.

It is also possible the new provisions may be of some interest to those outside the financial services industry.