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Capital gains tax on the restructuring of bonds - taking losses into account

January 2, 2019 | 100,00 EUR | answered by Steuerberater Knut Christiansen

Portugal Telecom
6.25% Portugal Telecom 2016 ISIN No. PTPTCYOM0008
The bond was exchanged into a listed loan.

I. About the Company and the Debt Restructuring

Portugal Telecom (PT) was a subsidiary of the Brazilian telecom company Oi SA (Oi) from May 2014 to 2015. Oi, as the former fixed-line monopoly in Brazil, had a leading market position in the fixed-line sector. As a result of the PT acquisition in 2014, Oi provided guarantees for the PT bonds. Ultimately, in the spring of 2015, Oi decided to sell the Portugal business to Altice. This transaction only included PT's activities in its home market of Portugal and in Hungary. PT's activities in Africa continued to be operated by Oi SA. Originally, the proceeds from the sale of the Portugal Telecom business were supposed to be used for the (early) repayment of the EUR-denominated Portugal Telecom bonds. However, this did not happen.

Due to a looming financial over-indebtedness, Oi SA filed for bankruptcy under Brazilian law in June 2016 and suspended all payments related to its financial debts. The Judicial Reorganization aims to have the company reach a private-sector agreement with all its creditors for debt restructuring. Originally, the restructuring of the capital structure was supposed to be completed by mid-2017. However, the plans presented in September 2016 and March 2017 were rejected by the creditors and had to be revised.

The final court-approved restructuring of Oi under Article 157 (4) of Law 6404/76 under the judicial CVM Instruction 358/02 under Brazilian law was accepted by the creditors' meeting on December 19, 2017 (see Annex 2).

The restructuring plan treats different creditor groups differently. Essentially, there were two preferred groups for private investments (I and II).

I. Small Bondholder - up to 50,000 BRL
Applies: 4.4. Mediation (i.e., the Small Creditor Program (as defined herein), see pages 35-36 in Comunicado ao Mercado_Aviso aos Bondholders_ing_VF.pdf, depending on whether professionals choose Option 1 or Option 2! Send by mail to the PO in Rio!
The SMALL-BONDHOLDER program is aimed at bondholders with a value of up to 50,000 R$ (approx. 12,500 EUR). For amounts up to 50,000 R$, the owner had to send a letter with a completed form to a postbox in Brazil. The letter to the postbox individualized the claim or the nominal amount of the bond and assigned it to a specific person. The debt restructuring then takes place according to point 4.3.3.1. (Annex 3/page 33).

II. Non-qualified Bondholders - between 50,000 BRL and 750,000 USD + x
Applies: 4.3.3.1. Restructuring of Bonds (Non-Qualified Bondholders - subject to making valid Non-Qualified Recovery Election and participating in the Non-Qualified Settlement Procedure),
see page 33 in Comunicado ao Mercado_Aviso aos Bondholders_ing_VF.pdf. This is where you should go if you have over 50,000 BRL! For Individualized Bonds + Vote Yes for Debt Restructuring.
The program is aimed at BONDHOLDERS with a nominal value of up to 750,000 BRL. In this process, you would need to consult a lawyer in Brazil who would carry out the individualization at court.

III. Qualified Bondholder professionals apply: Option 1 or Option 2, see pages 32-33 in Comunicado ao Mercado_Aviso aos Bondholders_ing_VF.pdf Here you have a choice! For Individualized Bonds + Vote

IV. The rest - do nothing. Applies: 4.3.6. General Payment (i.e., the Default Recovery), see pages 35-36 in Comunicado ao Mercado_Aviso aos Bondholders_ing_VF.pdf. Without Individualized Bonds. Here you have no choice!

For the Portugal Telecom bonds, the holders received a loan (unlisted loan) with the following terms (Annex 3/page 33).

Reduction of the original nominal value by 50%!
The remaining nominal amount (50% of the old nominal amount):

- 6.5 years the interest is compounded at 6% (no payments).

- From 6.5 years, in six half-years, 4% is repaid each.

- From 9.5 years, in five half-years, 12.66% is repaid.

- The final interest in twelve years is then 12.7%.

The interest during the repayment

Steuerberater Knut Christiansen

Good morning,

the question is indeed very complex. In the context of an initial consultation, I would like to give you the following recommendations:

In principle, the BMF letter you mentioned states that reducing the nominal value should not result in a loss that would be tax deductible. However, according to a Federal Fiscal Court (BFH) ruling dated 24.10.2017 (Ref.: VIII R 13/15), losses from loan claims (a bond is, in my opinion, to be treated like a loan) can be claimed for tax purposes in private settings if it is certain that the claim will default. It is not sufficient if insolvency proceedings are opened; the default must be definitively established. This should definitely apply to 50% of the original bond.

My recommendation here:
Claim 50% as a loss in capital income in your tax return and refer to the aforementioned BFH ruling.

If you receive interest payments, declare them in the corresponding year on the Annex KAP. Since no flat-rate withholding tax is deducted, you would have to pay it back within the respective year if you exceed the saver's allowance. If applicable, the preferential tax rate check (don't forget the application) may lead to a more favorable tax rate. Repayments are not to be recorded for tax purposes as long as they do not exceed the remaining acquisition costs of your loan. Only if you receive more than what you have spent on the acquisition of the loan would you also have to declare the excess amount in the Annex KAP.

I hope this answers your questions. Feel free to ask any further questions for free.

Sincerely,

Knut Christiansen
Tax advisor