DES is an abbreviation for debt equity swap, a transaction in which a creditor transfers its monetary claims to a debtor in exchange for the debtor’s equity.
DES is an abbreviation for debt equity swap, a transaction in which a creditor transfers its monetary claims to a debtor in exchange for the debtor’s equity. In other words, it is a contribution of non-cash assets (monetary claims) by a creditor into a debtor. From the debtor's viewpoint, monetary claims and associated debts are offset with each other and the debt obligation will be released.
In practice, DES is used as a way of restructuring companies with financial difficulties as they will be able to reduce excessive debts and cash outflow with respect to interest and repayment of debt principal.
Since DES is generally conducted in the form of investment in kind under the Companies Act, regulations regarding investment in kind apply for corporation tax purposes. DES is treated as non-tax qualified investment in kind except in certain cases where a creditor and a debtor are in wholly owned/owning relationship.
In non-tax qualified investment in kind, a transferring corporation (Creditor) is deemed to transfer its monetary claim to a receiving corporation (Debtor) at the fair market value. From the creditor's viewpoint, if fair market value of transferred monetary claim is lower than its book value, the difference would be treated as loss. If the transaction is viewed as excessive support with no economic rationality, the loss might be deemed as donation and hence non-deductible.
On the other hand, from the debtor's viewpoint, the debtor receives the monetary claim at the fair market value, and will be offset with the associated debt. If the fair market value of transferred monetary claim is lower than the book value of its debt, the debtor would recognize taxable debt cancellation income.
(As of January 2015)
This article is general in nature and is not intended to provide any tax advice on specific transactions. This article may not be relied upon by anyone and we accept no liability to anyone who took actions based on this article.