New legislation is set to give UK banks' use of subordinated debt a lift following an announcement from the financial secretary to the Treasury, Greg Clark, that existing and future Tier 2 instruments would be tax-deductible.

Banks breathe a collective sigh of relief over the news as many have recently held back from releasing this form of debt over concerns it would fall foul of HMRC.

A provision will now be included in the Finance Bill 2013 to ensure securities which are part of a bank's regulatory Tier 2 capital for the purposes of the FSA Handbook, are excluded from section 1015(4).

Section 221 of the Finance Act 2012 contains a power enabling regulations to be made once the Capital Requirements Directive (CRD 4) is finalised. But this does not allow the Treasury to make regulations which have retrospective effect, so any regulations could not apply to change the tax treatment of capital instruments issued before the regulations come into force.

Tax-deductibility is a key consideration for any borrower as it makes debt a far more attractive option.

An HMRC release in June followed a lengthy consultation but it failed to completely clarify issues.

But in a written statement by Clark, he said that in future, Tier 2 and instruments already issued would be tax-deductible to ensure complete consistency with the tax treatment provided abroad.

New regulations covering Tier 2 instruments are set to include descriptions that may be subject to a regulatory requirement to be written down or converted to share capital at the key moment at which a bank nudges insolvency.

The clarification will ensure that the coupon on Tier 2 capital already in issue - or yet to be issued - will be deductible for the issuer in computing its profits for corporation tax purposes.

The provision kicked in on 26 October 2012, to instruments already in issue, as well as instruments that will be issued in the future. However, section 1015(4) will continue to apply to any terms of a security that are not required for the instrument to qualify as Tier 2 capital for the purposes of the FSA Handbook.