Nidhi Bothra
Sikha Bansal
finserv@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 also has an impact on the securitisation transactions in India which now happens to be Rs. 84,000 crores odd industry. In this Chapter 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.
A. GST implications on PTC transactions
The implications of GST will have to be mulled over at each stage of the securitisation transaction. A securitisation transaction will have the following facets:
- Assignment of receivables by the originator to an SPV
- SPV acquiring receivables on discount
- SPV issuing PTCs to investors and servicing PTCs over the term
- Originator receives servicing fees for collections/ recovery of receivables
- 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 CGST Act.
Below is a detailed analysis.
i. Requisites of Taxability under GST
Section 9 of the CGST Act provides for levy and collection of CGST on all intra-State supplies of goods or services or both.
Hence, there must be “goods” or “services” or “both”, and the same shall be supplied.
“Goods” are defined in section 2(52) as –
“(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;”
“Services” are defined in section 2(102), as –
““services” means anything other than goods, money and securities but includes activities relating to the use of money or its conversion by cash or by any other mode, from one form, currency or denomination, to another form, currency or denomination for which a separate consideration is charged;”
Money, is therefore, excludible from the scope of “goods” as well as “services”.
Section 7 details the scope of the expression “supply”. According to the section, “supply” includes “all forms of supply of goods or services or both such as sale, transfer, barter, exchange, licence, rental, lease or disposal made or agreed to be made for a consideration by a person in the course or furtherance of business.” However, activities as specified in Schedule III of the said Act shall not be considered as “supply”.
It may be noted here that “Actionable claims, other than lottery, betting and gambling” are enlisted in entry 6 of Schedule III of the said Act; therefore are not exigible to GST.
The discussion below studies the nature of “receivables” and seeks to determine whether assignment of receivables will be treated as a supply of goods or services within the purview of the GST law.
Nature of “Receivables”
There is no doubt that a “receivable” is a movable property. “Receivable” denotes something which one is entitled to receive. Receivable is therefore, a mirror image for “debt”. If a sum of money is receivable for A, the same sum of money must be a debt for B. A debt is an obligation to pay, a receivable is the corresponding right to receive.
A “debt” is a sum of money which is now payable or will become payable in the future by reason of a present obligation, depitum in praesenti, solvendum in future. See, Web v. Stendon, (1883) 11 Q.B.D. 518, 572; Kesoram Industries and Cotton Mills Ltd. v. CWT, 1966 AIR 1370 : 1966 SCR (2) 688.
Coming to the definition of “money”, it has been defined under section 2(75) as follows –
“money” means the Indian legal tender or any foreign currency, cheque, promissory note, bill of exchange, letter of credit, draft, pay order, traveller cheque, money order, postal or electronic remittance or any other instrument recognised by the Reserve Bank of India when used as a consideration to settle an obligation or exchange with Indian legal tender of another denomination but shall not include any currency that is held for its numismatic value.”
The definition above enlists all such instruments which have a “value-in-exchange”, so as to represent money. A debt also represents a sum of money and the form in which it can be paid can be any of these forms as enlisted above.
So, in effect, a receivable is also a sum of “money”. As such, receivables shall not be considered as “goods” or “services” for the purpose of GST law.
ii. Receivables vis-à-vis Actionable Claims
As mentioned earlier, “actionable claims” have been included in the definition of “goods” under the CGST Act, however, any transfer (i.e. supply) of actionable claim is explicitly excluded from being treated as a supply of either goods or services for the purpose of levy of GST.
Section 2(1) of the CGST Act defines “actionable claim” so as to assign it the same meaning as in section 3 of the Transfer of Property Act, 1882, which in turn, defines “actionable claim” as –
“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;”
It may be noted that the inclusion of “actionable claim” is still subject to the exclusion of “money” from the definition of “goods”. The definition of actionable claim travels beyond “claim to a debt” and covers “claim to any beneficial interest in movable property”. Therefore, an actionable claim is definitely more than a “receivable”. Hence, if the actionable claim represents property that is money, it can be held that such form of the actionable claim shall be excluded from the ambit of “goods”.
There are views which, on the basis of the definition above, distinguish between — (a) a debt secured by mortgage of immovable property, and a debt secured by hypothecation/pledge of movable property on one hand (which are excluded from the definition of actionable claim); and (b) an unsecured debt on the other hand. However, the author opines that a debt, whether secured or unsecured, is after all a “debt”, i.e. a property in money; and thus can never be classified as “goods”. Therefore, the entire exercise of making a distinction between secured and unsecured debt may not be relevant at all.
In case it is argued that a receivable which is secured (i.e. a secured debt) shall come within the definition of “goods”, it must be noted that a security granted against a debt is merely a back-up, a collateral against default in repayment of debt.
iii. Assignment of receivables as “Supply”
Though, the fact that a debt is merely a representation of “money” and therefore there is no question of any “supply” under the GST law, yet it is important to study the scope of the word “supply” in this context.
In one of the background materials on GST published by the Institute of Chartered Accountants of India[1], it has been emphasised that a transaction where a person merely slips into the shoes of another person, the same cannot be termed as supply. As such, unrestricted expansion of the expression “supply” should not be encouraged:
“. . . supply is not a boundless word of uncertain meaning. The inclusive part of the opening words in this clause may be understood to include everything that supply is generally understood to be PLUS the ones that are enlisted. It must be admitted that the general understanding of the world supply is but an amalgam of these 8 forms of supply. Any attempt at expanding this list of 8 forms of supply must be attempted with great caution. Attempting to find other forms of supply has not yielded results however, transactions that do not want to supply have been discovered. Transactions of assignment where one person steps into the shoes of another appears to slip away from the scope of supply as well as transactions where goods are destroyed without a transfer of any kind taking place.”
A simple example of assignment of receivable is – A sells goods to B. B owes a certain sum of money to A. This sum of money is “receivable” in the hands of A. A has the right to get that sum from B. A decides to pass that right to C. He therefore, assigns the receivable to C, for a certain consideration. Therefore, A is actually passing on the benefits under the contract with B, to C. C is merely stepping into the shoes of A. There is no separate supply as such.
Also, as already stated, where the object is neither goods nor services, there is no question of being a supply thereof.
iv. 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 fee 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 fee 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 fee 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.
v. 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,––
(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.
vi. 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 is structured as IO strip. Since it is interest only.
vii. 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.
viii. GST on Securitisation – Global Overview
Since the Indian GST law is largely inspired by EU VAT laws, it would be quite relevant to go through UK and EU precedents pertaining to securitization and factoring transactions. It is important to understand that in every loan sale, securitization, factoring or assignment of receivables, the common thread is the assignment of receivables. Hence, if the assignment of receivables is taken as a “supply”, then, in each of these cases, there would be a question of applying VAT on the entire turnover, that is, the entire consideration involved in the supply of receivables.
In UK, a distinction is drawn between “sale of debt” and “assignment of debt”. The sale of a debt is a financial transaction, whereby the purchaser acquires ownership of debts from a creditor, at a nominal sum to the face value of the debts. The purchaser assumes all the rights and obligations of the original creditor and all legal and beneficial or equitable interest passes to the buyer to whom full title and risk is transferred. However, in an assignment only the equitable interest is passed to the assignee and the assignor retains the legal interest in the debt and any liability to obligations arising from the original contract. Often it will not be possible for the assignee to sell that which has been assigned.
The distinction is akin to the distinction between “assignment of a contract” and “assignment of benefits under contract” as pointed out in the article titled, “Law of Assignment of Receivables”, Vinod Kothari[3].
The sale of a debt is exempt from VAT under the VAT Act 1994, Schedule 9, Group 5, item 1. And, the assignment or re-assignment of a debt is not a supply for VAT purposes[4].
In Finanzamt Gross Gerau v. MKG Kraftfahrzeuge Factory GmbH[5], the European Court of Justice had to examine whether, in case of factoring transaction, VAT was applicable on the entire turnover of receivables, or was it applicable only on the commission charged by the factor for the assumption of the risk of default or other services of the factor. In this ruling, the ECJ held factoring to be an economic activity, by way of exploitation of the debts to earn an income by providing a service to the factor’s clients; however, it is not the debt itself which is a supply, but the commission charged by the factor.
In MBNA Europe Bank v. Revenue and Customs Commissioners[6], (2006) All ER (D) 104 (Sep); [2006] EWHC 2326 (Ch) , the Chancery Court discussed whether a credit card securitization amounts to a taxable supply for VAT purposes. After elaborate discussion on the nature of securitization, and referring to findings of lower authorities that securitization is nothing but a sophisticated form of borrowing, the Chancery Court held that the assignment of receivables in a securitization was not a supply at all.
The position thus held by Courts is well accepted by the administration itself. UK HMRC’s Internal Manual clearly puts the tax position on securitization as follows:
The assignment of the assets by the originator
The assignment of the receivables by the originator to the SPV is not a supply for VAT purposes. It is simply the fulfilment of a pre- condition so that the SPV can provide its ‘securitisation’ service.
The issue of securities to fund the purchase of the assets
The issue of a security for the purposes of raising capital is not a supply for VAT purposes (see VATFIN4250).
The administration of the assets
The servicer is the entity that deals with the receivables on a day to day basis, administering and collecting them and transferring the funds to the SPV, normally whilst maintaining the original contract with the underlying debtors. The servicer will receive a fee for this service from the SPV which is generally set at a percentage of the aggregate balance of the loans/receivables or the funds collected. The servicer services are supplies to the SPV in the course of an economic activity and the servicer fee is consideration for that supply.
B. 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, as in case of securitisation transactions).
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.
C. 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.
D. 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] http://idtc-icai.s3.amazonaws.com/download/pdf18/Volume-I(BGM-idtc).pdf; pg. last visited on 19.05.2018
[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;
[3] http://vinodkothari.com/wp-content/uploads/2013/12/Law-of-Assignment-of-Receivables-Vinod-Kothari.pdf; pg. last visited on 19.05.2018
[4] https://www.gov.uk/hmrc-internal-manuals/vat-finance-manual/vatfin3215; pg. last visited on 19.05.2018
[5]http://www.bailii.org/eu/cases/EUECJ/2003/C30501.html; pg. last visited on 19.05.2018
[6] http://www.bailii.org/cgi-bin/markup.cgi?doc=ew/cases/EWHC/Ch/2006/2326.html; pg. last visited on 19.05.2018
