Loan note investments and redemption premiums

An important tax point for individuals

Existing investors are sometimes asked to inject further capital into existing businesses to help funnel future growth. This often comes in the form of a new company-issued loan note.

However, investors may already have capital in the business and therefore, to balance working capital cashflow yet ensure a sufficient return on the additional capital invested, we sometimes see a redemption premium asked for. While we understand the commercial driver for such a feature, it can often create an unexpected tax issue for investors.

This is because when a redemption premium exceeds a low bar (broadly 0.5% per year), the loan can be classed as a qualifying corporate bond (QCB). The impact of being a QCB is that the loan note is exempt from capital gains tax for investors who are individuals. This might sound good, but the corollary effect is that no capital loss relief is available if the loan goes bad.

In our experience, investors are often concerned about preserving downside protection through being able to claim a tax deduction where they have incurred a capital loss. So rather than seek return through premiums, they might consider other options such as:

a 'normal' loan note with the usual ‘Non-QCB’ features but with an increased interest rate
the use of a preference share, with similar characteristics to the originally intended loan note.

Actions to take

Investors should review the terms of the current loan notes they hold or any future loan notes to be issued to assess the QCB or Non-QCB position and whether downside protection is available. Where problem loan notes are identified, taking professional advice to identify any corrective actions should be sought.

For more information, please get in touch with your usual Crowe contact.