GST on securitisation transactions.

By Nidhi Bothra, (gst@vinodkothari.com)

Transitioning into GST, assessing its impact on business and taking appropriate measures to bring about tax neutrality/ efficiency are the prime concern for all and sundry. GST therefore also has an impact on the securitisation transactions in India which now happens to be Rs. 85,000 crores[1] odd industry. In this article we are broadly trying to deal with GST impact on securitisation of standard as well as non-performing assets and its various facets.

In India, securitisation is undertaken through the PTC route (issuance of pass-through certificates or direct assignments. The distinction is not relevant when we talk about securitisation of non-performing assets through asset reconstruction companies.

GST implications on PTCs transactions

A securitisation transaction will have the following facets:

1. Assignment of receivables by the originator to an SPV
2. SPV acquiring receivables on discount
3. SPV issuing PTCs to investors and servicing PTCs over the term
4. Originator receives servicing fees for collections/ recovery of receivables
5. Originator receives excess interest spread (EIS) in the transaction after servicing of the investors with the receivables collected.

There is one more issue of whether the SPV will be considered as a related person as defined under the Central GST Act.

Before we delve into each of these it is pertinent to understand the colour of receivables under GST.

Actionable Claims

Section 2(52) of the CGST Act, defines “goods” to include actionable claim, the definition is as below:

(52) “goods” means every kind of movable property other than money and securities but includes actionable claim, growing crops, grass and things attached to or forming part of the land which are agreed to be severed before supply or under a contract of supply;

Under the CGST Act, “actionable claims” have been included in the list of activities or transactions which shall be treated neither as supply of goods nor as supply of services. Relevant extracts from the CGST Act have been reproduced below:

SCHEDULE III

[Section 7]

ACTIVITIES OR TRANSACTIONS WHICH SHALL BE TREATED NEITHER AS A SUPPLY OF GOODS NOR A SUPPLY OF SERVICES

XXX

6. Actionable claims, other than lottery, betting and gambling.

XXX

The term “actionable claims” has been defined in the CGST Act in the following manner:

2. In this Act, unless the context otherwise requires, –

(1) “actionable claim” shall have the same meaning as assigned to it in section 3 of the Transfer of Property Act, 1882;

Section 3 of the Transfer of Property Act, 1882 defines “actionable claims” in the following manner –

“actionable claim” means a claim to any debt, other than a debt secured by mortgage of immovable property or by hypothecation or pledge of movable property, or to any beneficial interest in movable property not in the possession, either actual or constructive, of the claimant, which the civil courts recognise as affording grounds for relief, whether such debt or beneficial interest be existent, accruing, conditional or contingent;

The definitions put together can be summarised in the following way:

1. Goods include actionable claims.
2. Actionable claims falls into the exclusion of taxable supply (of goods or services), that is, it falls under activities or transactions that are exempt from applicability of tax.
3. The definition of taxable claim is a claim to debt other than secured debt, this means, that secured debt shall be included in the list of taxable supply
4. In financial transactions, actionable claim is claim to money, that is to say, whether secured or unsecured the objective is recovery of money. Money, however is excluded from the definition of goods and a money for money transaction also does not fall under taxable supply.

If one was to extrapolate the above, the understanding that emerges is, unsecured debt clearly is excluded from taxable supply, secured debt is excluded from definition of actionable claim and therefore, two exclusions would make an inclusion seemingly.

If one was to mull further, it would be clear that in a secured debt the primary concern is recovery of money. Even if there was a case of default, the security/ collateral would be used to repay the debt due. Any additional amount recovered through enforcement of security interest would not belong to the lender and would rightfully go to the borrower. Therefore in case of a secured debt, the collateral is a mere case of recovery of debt due.

Therefore, it would be not be a caricature to say that whether secured or unsecured debt, the objective is to get repaid on financial transaction and that both, secured or unsecured debt are money for money transaction, which, anyway falls into the exemption list from taxable supply.

Therefore, the understanding that emerges is that in case of transactions in actionable claims, including such of assignment of receivables, there would be no tax applicable under the GST regime as well.

Servicing Fees

Typical to a securitisation transaction is that the originator continues to do the collection of receivables from the obligors for and on behalf of the SPV. The originator, therefore acts as a servicing agent and charges a servicing fees.

Under the current tax regime, servicing fees was subject to 15% service tax, charged by the originator to the SPV. The SPV would typically not be able to claim set off and this would be a sunk cost.

This cost under the GST regime goes up to 18%. Therefore if the servicing fees is 50 basis points, the increase in cost is 9 basis points. Since SPV cannot claim the set off, the GST is a dead loss.

In India, the typical servicing fees charged is 25 basis points. Whether or not the consideration for taxable supply of service is reasonable would depend upon the type of a pool. For instance, if the pool is a microfinance pool or a granular pool, it may not seem reasonable to charge a servicing of 25 bps as against a car loan pool. Therefore, where the servicing fees does not seem at arm’s-length, it may be challenged that servicing fees is not adequate consideration or the only consideration for collection of receivables.

Further, if it was to be contested that the SPV is a related person to the originator as defined under the CGST Act, then the servicing fees charged could be subject to valuation rules which will subject the servicing fees to reasonable determination of value of such supply of service by the assessing officer.

SPV a related person?

One of the issues during securitisation transaction structuring is to ensure that an SPV is a distinct entity from legal and accounting perspective. It would be relevant to have independence established of the SPV from tax perspective as well.

The definition of related persons under CGST is as follows:

For the purposes of this Act,–– (

1. a) persons shall be deemed to be “related persons” if––

(i) such persons are officers or directors of one another’s businesses;

(ii) such persons are legally recognised partners in business;

(iii) such persons are employer and employee;

(iv) any person directly or indirectly owns, controls or holds twenty-five per cent. or more of the outstanding voting stock or shares of both of them;

(v) one of them directly or indirectly controls the other;

(vi) both of them are directly or indirectly controlled by a third person;

(vii) together they directly or indirectly control a third person; or

(viii) they are members of the same family;

(b) the term “person” also includes legal persons;

(c) persons who are associated in the business of one another in that one is the sole agent or sole distributor or sole concessionaire, howsoever described, of the other, shall be deemed to be related

One of the ways of establishing that the SPV and the originator are related persons, is by establishing control by the originator. The term control has not been defined under CGST and therefore, one may have to rely on accounting tests for control.

As per the accounting standards, if the originator is controlling the SPV, it would lead to consolidation thereby frustrating the purpose of doing securitisation itself.

So, to avoid consolidation it is pertinent to avoid control by the originator over the SPV. If there is no control, the other parameters for falling into related person definition could be meandered.

However, if the transaction structure was such that control could be established then the transaction is subject to arm’s-length test and valuation rules.

Treatment of EIS component

Another critical issue in structuring securitisation transactions is how the excess interest spread or EIS will be swept by the originator from the transaction. Typically, transactions are devised to give residuary sweep to the originator after servicing the PTCs. Therefore there could be a challenge that EIS is also a component of servicing fees or consideration for acting as a servicing agent. The meaning of consideration[2] under the CGST Act is consideration in any form and the nomenclature supports the intent of the transaction.

Since, the originator gets excess spread, question may arise, if excess spread is in the nature of interest. Therefore it is important to structure excess spread as IO strip.

Going forward it would be rather recommendable that the sweep of excess spread as IO strip. Since it is interest only.

Servicing of PTCs

Another facet of securitisation transaction that needs attention from GST perspective, is taxability of servicing of coupon and repayment of PTCs. PTCs being securities, servicing of securities is exempt from applicability of GST.

GST implications on Direct Assignment transactions

In case of direct assignment, as in case of PTCs transaction, the assignment of receivables will be tax exempt (going by the same rationale).

The servicing fees charged to the buyer, would be subject to GST. The only reprieve here being that the buyer would be a bank or an NBFC and would be able to claim set off on the GST levied.

GST implications on sale of Non-Performing Loans (NPLs)

In case of sale of NPLs to an asset reconstruction company (ARC), the receivables are acquired by a trust floated by an ARC. The receivables usually are not on the books of the ARC directly.

In case of ARCs, it would be a very strong contention that the trust of the ARC is a related person to the ARC and therefore the management fees, the carry amount etc charged by the managers would be subject to valuation rules.

With regard to the security receipts (SRs) issued by the ARCs, the taxability of such SRs would be the same as in case of PTCs, as both are securities and therefore not falling under taxable supply.

Conclusion

It is established that the GST regime requires mollification in the existing transaction structures such that tax inefficiency in the change of regime can be avoided.

It is important that we understand these nuances to avoid tax litigations at a later stage.

The securitisation industry as gone through several rounds of regulatory changes – some favourable and some not. From change in the regulatory guidelines of RBI to distribution tax applicability and subsequent roll-over. There have been several seasons of changes to come to some momentum as on date.

Therefore it is important to take cognizance of the changes and make the appropriate stitch now to save the nine later!

[1] Volume of securitisation transactions undertaken in India in the financial year 2016-2017 and includes both direct assignment and PTC route.

[2] (31) “consideration” in relation to the supply of goods or services or both includes––

(a) any payment made or to be made, whether in money or otherwise, in respect of, in response to, or for the inducement of, the supply of goods or services or both, whether by the recipient or by any other person but shall not include any subsidy given by the Central Government or a State Government;

(b) the monetary value of any act or forbearance, in respect of, in response to, or for the inducement of, the supply of goods or services or both, whether by the recipient or by any other person but shall not include any subsidy given by the Central Government or a State Government:

Provided that a deposit given in respect of the supply of goods or services or both shall not be considered as payment made for such supply unless the supplier applies such deposit as consideration for the said supply;

—

by Nidhi Bothra (nidhi@vinodkothari.com)