Global distressed debt restructurings

A report on a session at the IBA’s 15th Annual London Finance and Capital Markets Conference held on 26 and 27 January 2026

Chair

Gordon Warnke, KPMG, New York

Panellists

Wiebe Dijkstra, De Brauw Blackstone Westbroek, Amsterdam

Joanna Linfield, Triton Partners, London

Stefan Mayer, Gleiss Lutz, Frankfurt

Edward S Wei, Gibson Dunn & Crutcher, New York

Reporter

Javier Calle, Cuatrecasas, Madrid

Introduction

In this panel, the discussion examined the tax consequences of a cross-border corporate restructuring involving a distressed European portfolio company held by a private equity fund. The panellists – practitioners specialising in United States, United Kingdom, German and Dutch law – walked through a detailed hypothetical scenario and analysed the issues that arise for lenders, borrowers and the private equity sponsor at each stage of the workout. 

The case study

Gordon Warnke presented the case study, which involved a group of companies held by a private equity fund through a chain of European holding entities, culminating in a European TopCo. Financing was provided by two classes of lenders through a European FinCo, which in turn on-lent the proceeds to three subsidiaries: a US HoldCo, a Dutch HoldCo and a German HoldCo. The company had underperformed, creating significant capital problems, and the lenders had agreed to inject additional new money, write off a portion of the existing loans and convert part of their debt into equity in the European TopCo. After the transaction, the lenders own a 97 per cent stake of European TopCo (with the first-class lenders receiving a disproportionately larger share), while the original private equity fund is diluted to three per cent. A new management incentive plan grants management ten per cent of the company’s equity to retain key personnel. 

A critical observation was made: during these workouts, frequently the equity ends up with the creditors, so any adverse tax consequences borne by the borrower, such as real estate transfer taxes or cancellation-of-debt income (CODI), ultimately come out of the creditors' pockets. 

US tax issues for the lenders

The discussion of US tax issues by Warnke and Edward S Wei focused primarily on private credit and private debt funds, a market estimated at approximately $2.5tn in assets under management and growing rapidly. The panellists highlighted several key concerns.

Firstly, they discussed that loan origination risk is a major issue. When US-managed funds provide new money to a distressed company, that activity may constitute loan origination, which can trigger concerns about effectively connected income (ECI) for foreign investors, commercial activity for sovereign wealth funds and unrelated business taxable income (UBTI) for US tax-exempt entities. Even a debt-for-debt exchange, modifying or restructuring existing debt, can be treated as a new issuance and, thus, a loan origination event. Fund managers will typically rely on internal guidelines to ensure their participation does not cross the threshold into origination activity. 

Secondly, the panellists flagged recently proposed regulations, described as ‘very taxpayer-unfriendly’. These regulations would presume that even passive participation in a creditor committee constitutes commercial activity, potentially meaning the loss of the US tax exemption not just for the specific investment, but also for all of the US activities conducted through that particular entity. 

Thirdly, they pointed out that in regard to the debt-for-equity conversion, lenders generally want to recognise losses because they hold built-in loss positions in a distressed scenario. However, under US tax rules, if transferors collectively own more than 80 per cent of the stock of the receiving corporation, the exchange is treated as tax free whether that is desired or not. A common approach in these situations involves the implementation of a ‘grandparent stock’ mechanism, where a European TopCo would contribute its own shares down the chain to a European FinCo, which then would distribute them to lenders in satisfaction of the debt, making the transaction fully taxable and allowing for loss recognition.

Fourthly, the panellists discussed back-to-back loan structures and US conduit rules. In the context of the case study, if the European FinCo lacks sufficient substance and merely serves a treasury function, the structure may be collapsed for US tax purposes, treating lenders as having lent directly to the US HoldCo. This could trigger US withholding tax obligations and, in a distressed context where debt functions like equity, this could invoke the anti-inversion rules, with potentially adverse results. 

Finally, the controlled foreign corporation (CFC) and passive foreign investment company (PFIC) risks were highlighted. US limited partners in the fund that hold non-US stock may face income allocation under the CFC rules if they are ten per cent shareholders. In insolvency situations, operating asset values decline, causing passive assets and income to rise as a percentage, which can lead to ‘accidental’ PFIC status. The panellists emphasised the adage that ‘once a PFIC, always a PFIC’, underscoring the importance of negotiating the information and diligence rights in the shareholders’ agreement.

Private equity (PE) fund perspective

From the PE fund’s viewpoint, Joanna Linfield pointed out that the restructuring presents both challenges and opportunities. The speakers pointed out that the fund shall not realise a loss from a US tax perspective to the extent that it continues to hold the same shares. In terms of the case study, there is no sale or exchange at the top level, only dilution due to the European TopCo issuing new equity to lenders. The fund should typically consider structuring the management incentive plan carefully: rather than common stock, it may issue instruments such as warrants or stock with performance-based vesting, linked to a hurdle rate, to align the incentives around recovery. The fund will also focus on the CFC exposure for its investors and may seek tax risk insurance to manage these uncertainties. 

German tax considerations

From a German perspective, Stefan Mayer explained that the cancellation of intercompany debt would typically generate fully taxable CODI, as there is no exemption for intercompany loan waivers under German law. Relief would depend on a restructuring provision that may or may not be available and does not apply directly to intercompany loans. Even when net operating losses (NOLs) exist, Germany’s minimum taxation rules mean that only a portion of income can be offset, meaning that approximately 40 per cent of the gain remains taxable. Moreover, a change of control can cause forfeiture of existing NOLs before the waiver gain is even recognised, increasing the tax cost. 

Mayer flagged that the German real estate transfer tax (RETT) is another significant concern (generally ranging from five per cent to 6.5 per cent of the full fair market value of real estate) and multiple restructuring steps can trigger multiple RETT charges. 

Dutch tax considerations

Weibe Dijkstra pointed out that, under Dutch law, structuring the debt release as a debt-for-equity swap (in the case study, specifically by having the European TopCo contribute the debt down the chain as equity) can achieve tax neutral treatment. Where that structure is not possible, taxable CODI will typically arise. 

He stated that the Netherlands has a debt waiver exemption, which will apply to the extent the waiver income exceeds the available tax losses. A legislative change that previously limited loss carry-forward utilisation to 50 per cent of taxable profits has been resolved, now allowing full offset against the CODI. The speakers cautioned about discrepancies between tax and financial accounting treatment, which can create pay-as-you-go (withholding) obligations even where the transaction is tax neutral. 

Tax insurance and practical considerations

The speakers mentioned as a recurring theme throughout the discussion the growing role of tax risk insurance in European restructurings. Mayer mentioned that premiums are reported to be at approximately two per cent in Germany, making it cost effective even for high-value transactions. Dijkstra stated that, in the Netherlands, insurers have become willing to cover even known tax risks, although premiums vary according to the assessed risk percentage.
Finally, the panellists noted the importance of additional issues that were not discussed during the session because of the time constraints, including backstop fees (compensation paid to lenders guaranteeing full subscription of new money), steering committee fees and related structuring questions.