Taxation issues in securitisation transactions essentially concern originator taxation, SPE taxation and taxation of the investors.
The key issue in originator taxation is whether the transfer of the asset in the process of its securitisation will be considered as a transfer for tax purposes, and if so, whether the transfer results into a gain or a loss on sale. The second question does not arise, if the first one is answered in the negative.
The former question is more important: the latter is merely computational. Unlike in case of accounting standards, tax laws in most cases will not require split-accounting of the fractions of interests retained in securitisation deals to compute the gain on sale: hence, the computation part is essentially likely to be straight forward.
On whether there is a transfer of an asset or not, there are two issues involved: whether the receivables being transferred were an asset for tax purposes at all, and if so, whether the economic benefits therein have been transferred to amount to a transfer for tax purposes. The first question is quite significant: lots of receivables may not be a recognised asset for tax purposes: hence, there will be no question of any asset sale. Example: all sorts of future flows.
Economic interest in the asset for tax purposes, and therefore, the test for a "transfer" is essentially based on similar rules as for accounting purposes. The leading case law on this is US Supreme Court ruling in Frank Lyon and Co.
SPV taxation is much more difficult than it is thought to be. In countries like the USA, where specific tax status is granted to certain SPEs as REMICS or FASITs, the tax treatment of SPVs is certain due to the law. However, where there is no specific law, the tax officer is entitled to apply usual entity taxation rules.
Quite often, people presume an SPV does not have much of an income to report for tax: since what it earns is what it spends. However, there is a significant distinction between debt and equity for tax purposes. Certain funding sources may be regarded as equity rather than debt, and the servicing of those sources may be a distribution of income rather than charge against income.
Since SPVs, for tax purposes, are similar to any other taxable entity, but are extremely thinly capitalised, it is quite likely that tax officers in the long run will dispute the nature of payments to subordinate tranches.
SPV domicile of SPVs for purpose of international taxation [7th Nov 2006]
SPVs are quite often domiciled in certain jurisdictions with withholding tax as the overriding consideration. For instance, if the payments are to go to an SPV located in a country with which the payer country has a favourable tax treaty, than compared to payments going directly to the investors located in different country/countries, the SPV's location helps to reduce or mitigate withholding tax.
The way SPVs are structured, they are not the beneficiaries of the income.
A concept of determination of double tax treaty benefits based on beneficial ownership has been there for years and there is also an OECD guidance on this, but recently, the UK Court of Appeal in Indofood International Finance Limited v. JPMorgan Chase Bank N.A. upheld the beneficial ownership principle for DTT benefits.
While UK HMRC has been quick to assure that the ruling will not be used to affect securitisation transactions where the DTT benefits were not being misused, the question of misuse or otherwise is one of factual examination of each transaction. So it is clear that going forward, withholding tax applicability for payments to SPVs will not be based on their domicile alone but based on beneficial ownership, whence the question of whether the DTT was misused or not can be determined.
Some significant materials on the issue are:
- ruling of Court of Appeal in Indofood
- HMRC draft guidance on Indofood ruling
- OECD model tax convention
Taxation of SPVs in some countries:
UK: See text of the Taxation of Securitisation Companies Regulations 2006
- A site dedicated to taxation of securitisation, centering on the author's very detailed book on securitisation taxation. Also downloadable chapters from Peaslee and Nirenberg's Federal Income Taxation of Securitization Transactions [published by Frank J Fabozzi Associates]
- Article on Buchanan Ingersol website on New Disclosure Rules Required Detailed Tax Reporting of Securitization Transactions and Hybird Securities (Tax Advisory, January 2003)