As Robert Richards of Dentons explains, just because a business is organized or located in a particular jurisdiction doesn’t mean that is where its restructuring will occur. This reality creates uncertainty for debtors, creditors, and advisors trying to manage risk across multiple legal and tax regimes.

When a restructuring crosses borders, tax issues can become even more complicated, particularly as foreign lenders, offshore subsidiaries, and overseas operations enter the picture. Different tax systems collide, priorities shift, and timing becomes critical.

Insolvency and Tax Consequences

For insolvent businesses, bankruptcy is often the most visible option, but many restructurings take place through receiverships, assignments for the benefit of creditors, or informal out-of-court workouts. Each approach carries its own tax consequences. For example, US bankruptcy courts have the authority to determine certain tax liabilities and establish payment priorities, while non-bankruptcy processes may leave those determinations to taxing authorities.

Tax claims follow a distinct priority scheme that can significantly affect recoveries. When proceedings are happening in more than one country, recognition and coordination issues can arise, adding another layer of complexity. Governmental units often have extended filing deadlines and priority rights that differ from those of trade creditors or lenders. In some cases, tax claims may outrank unsecured creditors but fall behind secured claims and administrative expenses.

Applicable Taxes

Cross-border restructurings can trigger a wide range of taxes that may not be top of mind early in a deal. These include withholding taxes on interest or dividends, value-added taxes (VAT) or goods and services taxes (GST), payroll and employment taxes, excise taxes, and customs duties.

The default US withholding rate on certain types of income is 30%, but that rate may be reduced or eliminated through statutory exemptions or income tax treaties. Interest payments may qualify for the portfolio interest exemption, while treaties often reduce withholding on interest and dividends. Still, these benefits apply only if technical requirements are satisfied.

It can be easy to underestimate tax exposure. “Anytime you have funds moving across borders, you should think about whether or not there’s a triggering event,” advises Stephanie Drew of RubinBrown. Indirect taxes, in particular, often surface late in the restructuring process, when operational changes or asset movements have already occurred.

Where Does the Tax Burden Fall?

One of the most common sources of confusion in cross-border restructurings is identifying who actually bears the tax burden.

At a fundamental level, “the filing of bankruptcy does not exempt the debtor, its affiliates, or even certain asset purchasers from federal, state, and local tax laws,’ notes David Agler of Agler Law. Taxpayers in a restructuring can include the debtor, subsidiaries and affiliates, officers and directors, creditors, guarantors, fiduciaries, and even asset purchasers. Misunderstanding who falls into which category can lead to unexpected liability and disputes later on.

US tax classification rules focus on federal income tax principles, which do not always align with how foreign jurisdictions classify entities. Foreign entities are not automatically subject to US taxation. The analysis typically turns on whether the entity has income that is effectively connected to a US trade or business, or whether it is classified as a controlled foreign corporation (CFC) or passive foreign investment company (PFIC).

Potential Pitfalls

Cancellation of Debt Income (CODI)

Cancellation of debt income (CODI) is a recurring issue in restructurings. Even when debt forgiveness occurs outside the United States, US tax consequences may arise for shareholders or partners. While insolvency and bankruptcy exceptions can exclude cancellation of debt income from current taxation, those exclusions often come with attribute reductions that affect net operating losses, tax credits, and basis. These long-term effects must be factored into restructuring decisions.

Debt Modifications

Not every debt modification results in immediate tax consequences, but a significant modification can be treated as an exchange of old debt for new debt, i.e., a ‘deemed exchange,’ which, as John Harrington of Dentons notes, can create tax exposure.

In a cross-border context, these exchanges can trigger foreign currency gain or loss, raise questions about foreign tax credits, and even cause a lender to be treated as engaged in a US trade or business if similar transactions occur regularly.

Debt-for-Equity Conversions

Debt-for-equity conversions are often attractive from a balance sheet perspective, but they fundamentally change the tax profile of an investment. Interest income may become dividend income, subject to higher withholding rates, and foreign investors may suddenly face US filing obligations.

If the equity interest is in a partnership engaged in a US trade or business, the foreign investor may be allocated effectively connected income and become subject to US income tax and withholding at the partnership level.

Foreign Tax Credits and Double Taxation Risks

Foreign tax credits are designed to prevent double taxation, but they are subject to strict requirements. The tax must be a qualifying income tax, must be legally owed, and must relate to foreign-source income.

Timing mismatches can eliminate the benefit entirely, particularly in debt exchanges where foreign jurisdictions and the United States characterize transactions differently. Credits are also treated as tax attributes that may be reduced when cancellation of debt income is excluded.

Payroll and Employment Taxes

Employees working across borders introduce payroll and social security issues that are often discovered late in the restructuring process. Both the home country and host country may assert taxing authority over wages and benefits. Totalization agreements can help prevent double social security taxation, but only if properly applied and documented. Failing to address payroll taxes early can disrupt operations during an already fragile period.

Practical Takeaways

Cross-border restructurings reward proactive planning. Bringing tax advisors into the conversation early allows deal teams to identify red flags, model alternatives, and avoid surprises that could derail an otherwise viable restructuring. Even seemingly small changes in structure, ownership, or timing can significantly alter tax outcomes.

Understanding how tax rules interact across jurisdictions allows deal professionals to manage risk, preserve value, and move forward with greater confidence in an inherently complex environment.