67A special supplement to International Tax Review June 2000

As outlined in the introduction, secu-

ritization is a powerful financing tool

that has gained prominence in recent

times. The following discussion out-

lines various ways in which an entity

can raise funds using otherwise illiq-

uid assets.

SECURITIZATION DEFINED

Securitization is a process whereby

assets are pooled and security inter-

ests in the pool are sold to investors.

In other words, securitization refers

to the process whereby securities are

issued to investors and these securi-

ties are backed by a dedicated pool of

assets as collateral. A typical securiti-

zation arrangement, if there is such a

thing, is illustrated in Box 1 overleaf.

Assume that the originator holds

illiquid assets, typically debt instru-

ments executed between the origina-

tor (say a bank) and numerous

obligors (such as individuals who

have a mortgage with the bank). The

assets are then packaged into pools by

combining them with other homoge-

neous assets (for example, other

mortgages issued on substantially

similar terms). The assets are then

transferred to a trust or special pur-

pose vehicle (SPV) which is the securi-

tization vehicle.

Depending on a number of factors,

it may be appropriate to enhance the

credit standing of the securitization.

Credit enhancement can be catego-

rized in three ways:

● Enhancements given by the origi-

nator of the assets such as repur-

chase commitments, indemnity

clauses and letters of support.

● Enhancements built into the fund’s

structure, including over-collater-

alization, subordination and cash

deposits or spread accounts.

● Enhancements from third parties

(especially banks and insurance

companies) such as letters of credit

or guarantees and swaps. Alterna-

tively, the enhancement may be

provided by way of a government

or government agency guarantee.

The securitization vehicle sells

security interests to investors. The

funds raised from this issue are

passed back to the intermediary or

originator in consideration for the

assets transferred to the securitization

vehicle.

During the term of the securitiza-

tion arrangement, the investor has a

right to certain cash flows paid by the

obligor. The entitlement of the

investor will be determined by the

terms of issue of the security interest.

The possibilities are numerous which

means that the quantum and timing

of the cash flow received by the

investor may not be identical to the

cash flows of the underlying asset

pool.

Securitizationoverview

Securitization: Overview

www.internationaltaxreview.com68

TYPES OF SECURITIZATION

Assets created in this manner have typically been placed

into two categories – mortgage-backed securities and asset-

backed securities. Within each of these classes there have

been numerous variations on the basic structure illustrated

above.

Mortgage-backed securities

Mortgage-backed securities (MBS) are a form of securitiza-

tion that is backed by mortgages. There are three core

types of MBS:

● mortgage pass-through securities;

● stripped MBS; and

● collateralized mortgage obligations (CMO).

Mortgage pass-through securities are backed by either

fixed or floating rate mortgages. The investor purchases

shares or participation certificates in the pool of mortgages.

The cash flows received by the investor will depend on the

cash flow characteristics of the underlying mortgages,

namely interest, principal and prepayments (adjusted for

the cost of service fees and the cost of credit enhancement).

A stripped MBS is a derivative mortgage security. In its

most common form, the distribution of interest and princi-

pal amounts between investors is altered so that the

price/yield characteristics will be different for each investor

class. At its extreme, a stripped MBS could be structured so

there is an interest-only investor class and a principal-only

investor class.

Finally, in a CMO the securitization vehicle purchases

whole mortgages funded by debt issued in different

tranches. As a result, cash flows from the underlying assets

are redistributed to various tranches based on varying

preferences and default risk or prepayment risk is amelio-

rated. Specifically, the securitization vehicle uses the prin-

cipal and interest it receives to pay interest to each tranche,

but only the first tranche also receives principal (ie the

fastest pay tranche). Once the first tranche principal is fully

repaid, the second and then third etc becomes the fastest

paid. In this way the CMO creates different risk/yield rela-

tionships between investor classes by taking a single-class

instrument (whole mortgages) and creating multi-class

instruments. In recent years, this class of MBS has devel-

oped very quickly and has been the subject of the greatest

degree of innovation and financial re-engineering.

Asset-backed securities

Asset-backed securities (ABS) are securitizations which are

backed by non-mortgage assets including (but not limited

t o ) :

● automobile loans and leases;

● credit and department store charge card receivables;

● computer and other equipment leases;

● accounts receivables;

● legal settlements;

● small business loans;

● student loans;

● home equity loans and lines of credit;

● boat loans;

● franchise loans;

● time share property loans;

● real estate rentals; and

● whole business securitizations.

ABS have been modeled on the MBS techniques. This

has given rise to a wide range and variety of different ABS,

such as collateralized debt obligations, that offer different

risk-return characteristics. The summary above does not

perhaps do justice to the flexibility of this financing tech-

nique given the diverse structuring alternatives available

and the fact that the resulting risk-return profile combina-

tions are potentially unlimited.

In recent times innovation has centred on an expansion

of asset classes. As an example, some securitized assets

involve no more than the right to collect a fixed or even

undetermined amount in the future, such as tax liens. Tax

lien securitizations may provide an affordable source of

funding for municipalities. Naturally, the future tax collec-

tion will depend on extraneous factors such as economic

and political influences. The benefit for the issuer is that it

receives certainty in terms of tax collections while also

reducing its cost of collection by passing this cost and

responsibility to the investor.

BENEFITS OF SECURITIZATION

Regardless of the type of securitization or the nature of the

underlying assets, securitization offers many unique and

important benefits to participants. Securitization is a

means for the originator to do the following:

● Transform an illiquid asset into a liquid financial instru-

ment. This allows the originator to use its illiquid assets

offering future revenue and principal repayment

streams as a means of raising current funding.

● Borrow at a better rate since the risk premium

Box 1: A typical securitization

Originator

ObligorSecuritiza-

tion vehicle

Guarantor

Investor

Asset

pool

Sale of

assets

Security

interest

Securitization: Overview

69A special supplement to International Tax Review June 2000

demanded by the investor is commensurate with the

underlying pool of assets (adjusted for credit enhance-

ment facilities) rather than the risk characteristics of the

originator. This advantage must be assessed after tak-

ing into account the costs of issue (which is of particular

interest for new structures):

● Remove risky assets from its balance, resulting in

improved balance sheet management with reduced

leverage and gearing ratios. This frees up capital to sup-

port further loan writing or investment and is particu-

larly important where the originator is subject to risk

based capital requirements.

● Pass the prepayment risk of the underlying assets to the

i n v e s t o r .

● Eliminate further exposure to credit risk or to adminis-

tration of the asset.

● Gain access to a wider banking/investor base in the

financial markets.

For an investor, securitization may be attractive for the

following reasons:

● Most deals entail some sort of credit enhancement (as

outlined above). This enables the securities to obtain

excellent credit ratings.

● The securities offer yields that exceed those on compa-

rable corporate bonds.

● The securities tend to be liquid (and are often actively

traded on secondary markets).

● It is an investment in a diversified pool. A risk-averse

investor will often prefer holding a portion of a pool of

risky assets than being exposed to a single risky asset in

its entirety.

SUMMARY

The following country specific analyses touch on the bene-

fits of typical and unique securitization structures. This

commentary will cover a selection of countries in alphabet-

ical order and briefly outline an application of the above

securitization model or commonly used variants. This sec-

tion seeks to provide a flavour for the extent of the fle x i b i l-

ity of securitization as a financing technique globally.

Techniques used in one country may be applicable in

other jurisdictions or may provide the base structure for a

new or innovative strategy. When looking to raise funds

for business purposes, securitization should be reviewed as

a possible alternative.

The wide ambit of asset varieties and the flexibility of the

securitization techniques make securitization a powerful

and practical financial tool.

www.internationaltaxreview.com70

Typically a financial trust has been

used as the securitization vehicle in

Argentina. The trustee issues bonds

(which pay interest) and certificates

of participation (which pay profit

distributions). The Comisión

Nacional de Valores, the Argentine

equivalent to the US Securities and

Exchange Commission, must rate

the quality of the bonds. Interest

payments on the debt bonds are

always deductible, and profit distri-

butions on the certificates of partici-

pation can be deductible given the

right circumstances. Both the debt

bonds and the certificates of partici-

pation must be publicly registered in

order to have certain tax benefits.

TAXATION

Under the Argentine Tax Law, qual-

ified financial trusts are able to real-

ize many valuable tax benefits that

are not available to normal corpora-

tions. These tax benefits stem from

specific provisions of the legislation

that explicitly grant such benefits to

qualifying financial trusts. Thus, the

risk level that the participants

assume in this structure is essentially

limited to future law change.

The Financial Trust Regime

established in the Argentine Tax

Law provides for several potential

b e n e f i t s :

● Withholding tax on interest pay-

ments to foreign (non-Argentine)

recipients is eliminated as long as

the bonds are publicly-registered.

Withholding tax of up to 35%

(depending on the fact pattern)

may otherwise apply.

● Profit distributions paid with

respect to a financial trust’s cer-

tificates of participation are not

subject to this withholding tax.

Hence, the use of the trust struc-

ture eliminates the application of

Argentina’s 35% dividend with-

holding tax.

● Minimum Presumed Income Tax

(MPIT) is potentially reduced.

MPIT is a tax calculated at 1% of

the taxpayer’s assets and is

payable in a given year only to the

extent that the taxpayer’s MPIT

liability exceeds its regular corpo-

rate income tax liability. MPIT

has a potentially significant nega-

tive impact on unprofitable

Argentine companies. However,

a qualified Argentine financial

trust is not subject to MPIT.

Structured properly, the trust

structure can help reduce a tax-

payer’s MPIT burden by reduc-

ing the assets owned (for MPIT’s

purposes) by an originator.

● Interest payments made by a

qualified financial trust with

respect to its debt bonds are not

subject to value-added tax (VAT)

Argentina

Securitization: Argentina

71A special supplement to International Tax Review June 2000

as long as the bonds are publicly registered. Tax-

payers in an excess VAT credit position will realize

permanent tax savings under this rule.

● Generally qualified financial trusts are not subject

to specific rules regarding appropriate debt-to-

equity ratios (although a reasonableness standard

should probably be applied in most cases) and the

interest paid is deductible without limitation.

Accordingly, the trust structure also offers a signifi-

cant opportunity to achieve off-balance sheet

financing. As Argentine corporations are effectively

subject to debt-to-equity ratio limitations, a finan-

cial trust structure serves to allow further tax-effec-

tive financing of Argentine operations without

impacting the debt-to-equity ratio of the corpora-

t i o n .

● In some situations, it may be possible to effectively

refresh a portion of an Argentine taxpayer’s NOLs

using the trust structure. Assets can be transferred

to the trust by way of a sale of the assets or by way of

a fiduciary transfer of the assets. When the assets

are transferred via a sale, taxable gains may be cre-

ated in the corporation and will absorb the NOLs.

Meanwhile, the tax attributes of the transferred

assets will remain with the assets. In other words,

the expiring losses will essentially be transferred to

the trust afresh.

Notwithstanding the tax benefits described above,

certain costs from indirect taxes are applicable. In

general, a qualified financial trust will be subject to a

tax on gross receipts, this tax being levied by the

provinces in Argentina. For example, in Buenos Aires,

this tax will be levied on gross receipts ranging from

3% to 4.9%. In addition, an Argentine financial trust

in certain circumstances may incur an ultimate VAT

cost (incurred in respect of supplier invoices) with lit-

tle or no possibility of reclaiming the credit for such

payments (because it does not collect VAT). Finally,

the provinces typically impose a stamp tax on the face

value of certain contracts. In the case of the transfer

of assets from an Argentine originator to the trust, the

application of this tax will largely depend on how the

transfer is actually carried out. If the assets are moved

to the trust via a fiduciary transfer (ie there is no sale

in cash) then the stamp tax should generally not

apply. However, if the assets are sold in cash in a sales

transaction, then the stamp tax will probably apply.

From a planning perspective, the nature of the

assets securitized can have an impact on the ultimate

tax position of the trust. In addition to the above ben-

efits and costs, where the assets to be securitized are

certain financial assets and certain other require-

ments are met, the trust can deduct profit distribu-

tions made with respect to the certificates of

participation. The income tax burden of the trust

itself is thereby reduced to a nominal amount.

Furthermore, where the assets securitized do not

qualify as financial assets or a significant income tax

burden continues to exist, it is generally possible to

leverage the trust to a significant debt-to-equity ratio,

thereby exercising some control over the final income

tax burden of the trust.

FUTURE DIRECTION

As securitization continues to take hold as an innova-

tive financing technique that enjoys specific legislative

benefits, the emphasis must be on solid tax planning.

Structured correctly, securitization can be an effective

financing vehicle for all asset classes. In the near term

it is expected that the base trust securitization model

will be expanded further to provide differing risk-

return attributes to investors while also preserving the

preferential tax treatment.

www.internationaltaxreview.com72

Before the Asian crisis, the market for

securitization was starting to heat up.

The banks were shipping in experi-

enced staff and landmark deals were

being done. From mortgages in

Malaysia, to cars in Indonesia and Thai-

land, through buildings and apart-

ments in Hong Kong, to domestic

workers’ salaries in the Philippines, the

market was continuously looking for

new things to securitize, and new ways

to overcome the significant market,

legal, tax and accounting problems in

the region. Then in the second half of

1997, the market collapsed. The banks

retreated, and purchasers examined

closely what they had bought. By 1998,

there were limited signs of recovery. A

few organizations were trying to lower

their cost of funding in a high premium

demanding market. In total in 1998,

four deals were done, one in Hong

Kong, one in Taiwan, one in Korea and

an Asian basket deal (a CBO). How-

ever, 1999 was a different year, with a

s i g n i ficant increase in activity, the

majority of which focused on North

Asia, with some big deals being done in

Korea and Hong Kong, and the

prospects for 2000 are buoyant.

Generally, across most of Asia, fol-

lowing the crisis, accounting standards

have started to move more quickly

toward harmonization with IAS.

Therefore, the well-known accounting

issue of the derecognition of assets is

highly significant in most of these coun-

tries. Tax issues can be more demand-

ing with many countries still having

strict withholding tax regimes, which

can often only be addressed via tax

treaty arrangements, or transfer of

assets offshore.

The Asian securitization market

should grow to be considerable. The

main issues remain those of attracting

investors, and hence the focus has been

on credit enhancements (the cost bene-

fits thereof) and risk repackaging, so

that the deal can offer benefits for the

originator and yet remain suitably

attractive to investors.

HONG KONG

Hong Kong’s big step forward in 1999

was finally the appearance of the Hong

Kong Mortgage Corporation as not

only a purchaser of secondary mort-

gages but also as effectively a securitiza-

tion conduit. The Hong Kong market,

like many in Asia, is hampered by the

fact that mortgages are priced by refer-

ence to an only semi-liquid rate (Prime),

and a rate that exhibits significant basis

risk when compared to the normal

interbank benchmark, the Hong Kong

Interbank Offered Rate (HIBOR).

One of the major factors slowing down

the widespread securitization of the

marketplace has been the limited num-

ber of counterparties who were willing

to swap Prime for HIBOR or even US

Asian region

Securitization: Asian region

73A special supplement to International Tax Review June 2000

LIBOR. This has limited the opportunities to construct a

truly off-balance sheet transaction. With the advent of the

HKME securitization conduit, mortgages are transferred

across to the HKME, which in turn wraps the mortgages

for a spread and returns far more marketable securities to

the originator. The originator is then free to sell down the

bonds into the market place.

Given the significance and value of the property sector

in Hong Kong, many opportunities exist to also securitize

other forms of receivables, primarily rental or lease linked.

Given the stresses which have occurred in the Hong Kong

property market due to falling property values, property

owners and developers have been keen to turn buildings

into cash in order to either obtain cheap financing for

other projects or in order to meet other more pressing cash

flow needs. The majority of deals done recently in Hong

Kong have for the most part relied on over collateralization

to increase the credit rating of the structure above the rat-

ing of the original asset holder. Some attempts, though

limited in success to date, have also been made by insur-

ance companies (mono-line or otherwise), to try and pro-

vide credit enhancement.

KOREA

The Korean banking sector and the wider economy has

been going through a significant restructuring, to some

extent driven by the International Monetary Fund (IMF).

As a result, a number of banks have been looking to mone-

tize their assets, often via the issuance of ABS offerings.

These again have succeeded generally through exception-

ally high levels of over collateralization, as have CLO and

CDO offerings.

Recently, the country’s debt restructuring agency, the

Korean Asset Management Corporation (KAMCO), has

also entered the securitization market as an originator

which should hopefully add some continual weight to

lengthening the yield curve.

CHINA

China remains a large, mainly untapped market for securi-

tization in Asia. It has significant numbers of assets, and a

generally low sovereign rating which limits cheap funding

and large needs for cash. However, in line with several

other nations in the region, a number of significant factors

still need to be addressed before the market can really take

off. Such factors include making bankruptcy proceedings

effective, foreign exchange controls, capital controls and

accounting quality (though this can be addressed through

external due diligence). To date a few deals have been

done but these have been for foreign currency assets, for

example receivables relating to containers.

THAILANDThailand is looking to clarify its bankruptcy laws. One of

the pre-crash deals has been going through the courts and

will be a test of the robustness of the Thai legal system.

JAPAN

The ABS market has rapidly developed in Japan over

recent years, due to the strong desire of the originators to

raise funds through the securitization of the assets, recent

improvement in the legal and regulatory environment

involving securitization in Japan and growing acknowledg-

ment of the ABS products among investors.

On September 1 1998, the Law Concerning Liquidation

of Specified Assets through a Special Purpose Company

(the SPC Law) came into effect. The SPC Law applies

where a Japanese SPC is used as a vehicle for securitiza-

tion. This law has significant implications for the way in

which securitizations are structured in Japan.

Example I: Two Cayman Islands special purposec o m p a n i e s

The diagram in Box 1 illustrates the typical structure using

two Cayman Islands based SPC. This structure was used

prior to the enactment of the SPC Law, and is still used

depending on the factual situation.

SPC2 is established in the Cayman Islands. SPC2 issues

notes to investors. The proceeds of the notes are used by

SPC2 to purchase bonds issued by SPC1, established in the

Cayman Islands. The bonds’ cash flows may correspond

Box 1: A typical Japanese structure usingtwo Cayman Islands SP C s

Obligors

SPC1

Tokyo branch

SPC1

Head office

SPC2

Investor

Obligors

Inter-

company

loan

Japan

Bonds

Notes

Transfer of

underlying

assets

Cayman Islands

Securitization: Asian region

www.internationaltaxreview.com74

exactly with the interest and principal of the underlying

assets (in this example, a loan). The proceeds of the bonds

are in turn transferred by SPC1 to its Japanese branch

through an inter-company loan. The amount borrowed

by way of this inter-company loan is used by the Japanese

branch to purchase, from an originator, a loan with a

Japanese obligor. The originator notifies the obligor of the

assignment of the loan. (After the enactment of the Law

Concerning Exceptions etc to the Requirements for Per-

fection of Assignment of Receivables under the Civil Code

in October 1998, it became possible to perfect the assign-

ment of receivables against third parties through registra-

tion at the appropriate Bureau of Legal Affairs.)

For tax purposes, SPC1 will be regarded has having a

permanent establishment in Japan by virtue of its registra-

tion in Japan and is taxed on its Japanese source income.

Taxable income for the Japanese branch is equal to the

interest income on the loan less related expenses (includ-

ing interest paid on the SPC1 bonds and other legal and

administrative expenses). Taxable income (if any) will be

nominal for the Japanese branch. Japanese thin capitaliza-

tion rules must be considered, which apply at a 3:1 ratio of

related party debt to equity held by the foreign controlling

corporation. In the case of the Japanese branch, the thin

capitalization rule should not apply. Though SPC1 raises

the funds necessary for the business from SPC2, it is under-

stood that SPC2 does not control the business policy of

SPC1, since SPC2 is a mere investor which just purchases

the bonds and it does not have a right or power to control

the business of SPC1. Thus, SPC2 should not be catego-

rized as a foreign controlling corporation of SPC1 for thin

capitalization rule purposes. Accordingly, the interest on

the SPC1 bonds should be fully deductible in determining

the taxable income in Japan for the Japanese branch.

Interest to be paid by the obligor to the Japanese branch

would not be subject to withholding tax (that otherwise

applies at the domestic rate of 20%). An exemption from

withholding tax applies if the foreign recipient of the inter-

est has a permanent establishment in Japan and the inter-

est income is included in taxable income for corporate

income tax purposes for that permanent establishment

and the recipient obtains a certificate from the Japanese

tax office and supplies this to the payer of the interest

before the payment.

When the Japanese branch remits funds to SPC1, no

withholding tax is assessed since the remittance is an inter-

company (legal entity) transaction which is not a taxable

event. There is no branch profits tax or any other similar

c h a r g e .

Provided SPC2 is a Cayman Islands resident or a resi-

dent of a country with which Japan does not have a tax

treaty, the Japanese branch is not required to pay the with-

holding tax on the interest paid to SPC2 on the SPC1

bonds notwithstanding the fact that the interest is

deductible for corporate income tax purposes. This is

because interest on the SPC1 bonds is not categorized as

Japanese-sourced income, since the interest paid on bonds

issued by a foreign corporation is not categorized as Japan-

ese-sourced income under the Japanese domestic tax law.

SPC1, as issuer of the bonds, is a foreign corporation and

accordingly the interest on the SPC1 bonds is not Japan-

ese-sourced income.

SPC2 is not subject to corporate income taxes in Japan

since it does not perform any business activities in Japan.

SPC2 is not subject to withholding tax on the interest on

the SPC1 bonds for the reasons discussed above. In addi-

tion, no Japanese withholding taxes are imposed on inter-

est paid by SPC2, since the interest is not categorized as

Japanese-sourced income due to the fact that the interest is

on bonds issued by SPC2. Assuming that the recipients of

the interests are non-residents of Japan, no other Japanese

income taxes should be imposed on the recipients.

In summary, this structure provides for securitization of

Japan-based assets to non-resident investors with a mini-

mum Japanese tax imposition. There is some tax risk asso-

ciated with this structure depending on the view held by

the Japanese tax authorities. On the other hand, the

Japanese tax treatment under the SPC Law is more stable.

A securitization structure relying on the application of the

SPC Law while creating the same outcomes is discussed

b e l o w .

Example II: Japanese SPC under the SPC Law

The typical structure for this example is illustrated in Box

2 .

In this structure, the originator establishes the SPC and

contributes the specified investment. The SPC purchases

s p e c i fied assets (monetary claims to a specific person and

real property as well as beneficiary rights of trusts in which

the above assets are placed) from the originator using

funds raised through issuing preferred investment certifi-

cates (PIC) and special bonds to investors.

Although SPC is generally treated as a normal corpora-

tion for tax purposes, SPC is specifically allowed to deduct

its dividend payments (including interim dividends) for

computing its taxable income if certain conditions are met.

The SPC is subject to corporate income taxes on its taxable

income after deducting the qualified dividend.

Box 2: A typical structure for a Ja p a n e s eSPC under the SPC Law

Obligors

SPC

Investor Investor

Originator & Servicer

Specified

investment

(capital)

PICs

Special

bonds

Transfer of

specified assets

Securitization: Asian region

75A special supplement to International Tax Review June 2000

From the perspective of the investor:

● The interest on the special bonds paid to a Japanese resi-

dent is subject to withholding tax, unless the recipients

are qualified financial institutions. When the special

bonds are issued to non-residents of Japan and interest

thereon will be paid outside Japan, the interest to the

non-residents is exempt from Japanese withholding tax,

provided that the recipient complies with procedures

for establishing their status as a non-resident.

● Dividends paid in respect of the PICs or specified invest-

ments are subject to withholding tax. The dividend

exclusion, which applies to normal domestic corpora-

tions, is not applicable to the dividends from the SPC.

Hence, the same low tax structure can be achieved using

a Japanese SPC as was possible with the two Cayman SPC

structures. As outlined above, the advantage is that the

Japanese SPC structure draws on specific legislative rules

and therefore offers a higher degree of comfort on the tax

i m p l i c a t i o n s .

Future direction

Secutization using a Japanese SPC under the SPC Law

requires relatively complicated administrative proce-

dures. At present, an amendment in the SPC Law and

the Law Concerning Securities Investment Trust and

Securities Investment Corporations is being discussed.

The purpose of this amendment is to provide variety

and flexibility in the structure for securitization in

Japan. As a result, it is expected that the establishment

procedure will be less complicated, including a reduc-

tion in the minimum capital requirement, deregulation

of the registration procedures, and exclusion of the

asset liquidation plan from the Japanese SPC’s articles

of incorporation. In addition, the Japanese SPC will be

able to issue various types of instruments, including

convertible bonds and bonds with warrants. Due to

these changes, the securitization market will be

expected to expand more rapidly in Japan in the near

term.

THE PHIL IPPINES

The level of interest in and understanding of securitization

in the Philippines has not developed as rapidly as in Japan

and can be fairly described as still at the infancy stage. Most

potential originators and investors have yet to fully appre-

ciate the opportunities and risks involved. The relevant

government agencies and the legislators must take positive

steps to recognize and respond to the need to provide a

sound and responsive framework for securitization. Mini-

mal reform in the legal and administrative structure have

been introduced to promote and regulate this new fin a n c-

ing scheme.

Compared to the US market, the Philippine market can

be seen as offering more opportunity for arbitrage. The

terms of commercial mortgage loans are shorter, one to

two years, and interest rates have seen more erratic trends.

Only government housing loans have longer terms of up

to 25 or 30 years. In the US, loans have longer terms and

interest rates are relatively more stable.

The Home Development Mutual Fund, more popularly

known as the PAG-IBIG Fund, is the Philippines’ manda-

tory provident fund for housing finance. Despite the expo-

nential growth it has experienced in the past, it has still

been unable to meet the demand for affordable housing. It

became evident that the institution cannot pursue its man-

date by operating exclusively from internally-generated

funds. In March 1994, the Fund issued Ps500 million

(US$12 million) worth of mortgage-backed certificates to

investment houses, provident/retirement funds, and trust

departments of big commercial banks. By April 1995, the

fund had fully paid its investors. The rate of return on the

c e r t i ficates reached 17.5%. On the back of this success, in

February 1997 the fund issued Ps430 million in mortgage-

backed securities. It was a pass-through scheme with the

underlying asset pool comprising 3,600 mortgage loans to

the members who were screened based on repayment his-

tory.

Example: Bond floatation by local government units

The Philippine Local Government Code specifically allows

local government units (LGUs) to issue bonds, debentures,

securities, collaterals, notes and other obligations to

finance self-liquidating, income-producing development

or livelihood projects. LGU issuers are subject to rules and

regulations of the Central Bank and the Securities and

Exchange Commission. The Development Bank of the

Philippines and the Bankers Association of the Philippines

established the Local Government Units Guarantee Cor-

poration (LGUGC) to provide guarantees and to set up a

credit rating system for LGUs.

At least three LGUs have opted for securitization in

financing economic enterprises such as a public market,

slaughterhouse and sea port. In all cases, the LGU

appointed a trustee bank and an underwriter bank. Rev-

enues from the economic enterprise were pledged to a spe-

Securitization: Asian region

www.internationaltaxreview.com76

cial purpose trust from which the amounts committed to

the subscribers will be paid out. The LGUs further

pledged their Internal Revenue Allotment (their annual

share of national government revenues) to cover commit-

ments in case of collection shortfalls from the economic

enterprise. The bond is likewise guaranteed by the

LGUGC. These enhancements significantly reduced the

risks for the investors, thereby making the floats more

attractive.

Ta x a t i o n

There are no comprehensive laws or regulations that

s p e c i fically address the taxation of the various stages

and/or individual transactions in the securitization process.

The existing statutory provisions on the taxation of fin a n-

cial products and transactions are not well-defined, caus-

ing a degree of confusion and uncertainty regarding the

appropriate tax liability of various parties involved in such

u n d e r t a k i n g s .

In the absence of specific rules, tax liabilities are sepa-

rately determined for each event and transaction and for

each player in the securitization process.

In a typical securitization model (such as that defined in

the opening paragraphs of this section), the originator will

sell assets to an SPV. Income tax on any net gain (or loss)

and documentary stamp tax apply. VAT will also apply if

the assets transferred are receivables arising from services

and the originator is registered for VAT. Alternatively,

gross receipts tax is payable if the originator is a fin a n c i a l

i n s t i t u t i o n .

Stamp duty applies to the issue of the securitization

instruments by the SPV to the investors. Distributions to

investors will typically be subject to withholding taxes. The

investor may also be subject to both stamp and income tax

on the sale of the securitization instrument in the sec-

ondary market.

A c c o u n t i n g

Philippine accounting guidelines do not provide compre-

hensive rules on accounting for securitization. Philippine

accounting, however, generally follows and takes guidance

from International Accounting Standards (discussed fur-

ther below in the Australian commentary) and other inter-

national standards such as the Statement of Financial

Accounting Standards (FAS) No. 125 issued by the US

Financial Accounting Boards on "Accounting for Transfers

and Servicing of Financial Assets and Extinguishments of

Liabilities." The following guidelines have been provided

on the transfer of assets qualifying as a sale:

● Derecognize all assets sold. The transferred assets are

isolated from the originator or its creditors.

● Recognize all assets obtained and liabilities incurred in

consideration as proceeds of the sale, including cash,

put or call options held or written, forward commit-

ments, swaps, and servicing liabilities, if applicable.

● Initially, measure at fair value assets obtained and liabili-

ties incurred in a sale or, if it is not practicable to estimate

the fair value of an asset or a liability, apply alternative

m e a s u r e s .

● Recognize in earnings any gain or loss on the sale.

● The securitization vehicle has the right to pledge the

assets or to exchange them freely.

If the transfer does not qualify as a sale, the originator

and securitization vehicle shall account for the transfer as a

secured borrowing with pledge of collateral.

Future direction

Financial resources are scarce, particularly in developing

countries like the Philippines. Every bit of available capital

must be mobilized to somehow compensate for the scarcity

and thus maximize benefits from the limited resources.

The surging interest in adopting securitization as a vehicle

to achieve this goal should therefore be encouraged by

putting up the necessary structural and administrative

framework for its operation.

The need to promote the long-term savings necessary to

develop the Philippine capital market has long been recog-

nized. The Philippine Conference on Securitization iden-

t i fied some constraints in the development of the

Philippine capital markets and proposed measures for leg-

islation or administrative action:

● The lack of understanding among prospective origina-

tors and investors should be addressed by information

programmes.

● An appropriate administrative and regulatory frame-

work should be facilitated. Procedures and costs should

be streamlined and standards and rules should be laid

d o w n .

● A private sector Secondary Market Institution (SMI) for

ABS should be established. Trading rules and conven-

tions must be crafted.

● The tax regime is perceived as onerous and burden-

some and thus creates uncertainties. There is a need to

initiate legislation or issue BIR rulings on: (a) the non-

applicability of the VAT to the transfer of assets from the

seller to the SPV; and (b) exemption from the documen-

tary stamp taxes on the transfer of the security accompa-

nying the asset to the SPV, as well as on subsequent

transfers of the ABS.

● Foreclosure proceedings are lengthy and the redemp-

tion period is too long.

● There is an existing law on the rights of property buyers

to seeks refunds on payments already made subject to

certain conditions. Amendments need to be introduced

to limit such rights or provide safety nets to avoid dis-

rupting the ability of the SPV to enforce the security.

In addition, to tap the participation of insurance compa-

nies, the coverage of admitted assets for insurance compa-

nies should be expanded to include investments in ABS.

This can be done by the Insurance Commission.

A special supplement to International Tax Review June 2000 77

The securitization market in Aus-

tralia has grown considerably over

the last decade. From almost noth-

ing in the early 1980s, the market

grew to total outstanding issues of

approximately A$45.8 billion by the

end of 1998. Despite this growth,

like its neighbors in the Asia-Pacific

region, the Australian securitization

market remains relatively unsophis-

ticated compared with the scale and

the complexity of the US market.

For example, it was only in 1998 that

investors first bought paper for the

securitization of assets such as air-

craft leases, equipment leases

(including automobiles), hire pur-

chase contracts and credit card

receivables.

EXAMPLE: FIXED RATEMORT G A GES

The structure illustrated in Box 1

(overleaf) was recently implemented

by an Australian bank to securitize a

pool of mortgages covering residen-

tial property. This structure is a typ-

ical example of securitization in

Australia. This securitization

process involved the sale of an

amount of fixed rate mortgages to

an SPV, in this case a trust, at fair

market value.

The trust used the funds raised

from the issue of the bonds to pur-

chase the loans from the bank. The

servicer collects the income and

other money owing to the trust (ie

the bank need not continue to

process the loans). A swap and

hedge facility was established to

minimize relevant risks, such as cur-

rency and interest rate fluctuations.

TAX TREATMENT

There are no specific taxation rules

governing securitizations in Aus-

tralia. Accordingly, the tax treat-

ment concerned with a

securitization transaction must be

examined under general tax princi-

ples.

General principles dictate that the

originator (bank) will be assessable

on any gain made on the transfer of

the loans to the trust.

In this example the securitization

vehicle is a trust. In Australia trusts

are treated as a flow-through vehicle

provided that the unitholders (or

beneficiaries) are presently entitled

to all of the income of the trust.

However, under the recent Review

of Business Taxation in Australia it

has been proposed that trusts will be

taxed as companies unless they qual-

ify as a collective investment vehicle.

In order for a trust to be a collective

investment vehicle it will be

required to be "widely held" and to

Australia

Securitization: Australia

www.internationaltaxreview.com

satisfy certain other provisions concerning the rights

attaching to units and the activities it engages in. As

the trust’s net income in the structure above would be

minimal (that is, interest expense on an accrual basis

would basically equal interest income), the recom-

mendations of the review are not likely to have signifi-

cant impact. However, securitization trust

arrangements in which income merely flows through

the trust (rather than being paid out as interest) will

be affected by the proposals.

The investor (bondholder) will ordinarily be assess-

able on an accrual basis on interest income received

from the trust. If, however, the bondholder used a

cash-based system of tax accounting, the interest

income would be assessable when received. If any of

the bondholders are non-residents, the trust would be

required to deduct interest withholding tax of 10%.

An exemption from withholding tax would be avail-

able under some securitization programmes where

the SPV acquiring the receivables that are securitized

is a company that widely issues debentures to non-res-

i d e n t s .

A CCOUNTING TREATMENT

The main benefit from securitization for originators is

that securitization can move the assets off balance

sheet for accounting purposes (since trusts are recog-

nized as separate entities from the mortgage origina-

tor). The move to off balance sheet status for the loans

increases the bank’s return on assets and return on

equity ratios.

However, Australian accounting standards do not

specifically deal with accounting for securitizations.

The conceptual frameworks adopted in Australia, the

US, the UK and by the International Accounting Stan-

dards Board (IAS) are consistent in that they require

that an asset be recognized when an entity has "con-

trol" of the asset. When an entity ceases to control an

asset, it should cease to recognize that asset. How-

ever, there is some divergence of opinion relating to

securitizations where an asset is legally disposed of yet

the entity also retains some of the risks and/or benefits

associated with ownership of the asset.

International Accounting Standards Committee( IA SC) approach

In an effort to help achieve uniformity in the account-

ing principles used by businesses and other organiza-

tions in relation to the financial reporting treatment

of securitization, the IASC issued IAS 39, Financial

Instruments: Recognition and Measurement. This

standard establishes rules for recognizing, measuring

and disclosing information about an enterprise’s

financial assets and financial liabilities. The standard

requires that all financial assets and financial liabilities

be recognized on the balance sheet, including all

derivatives. IAS 39 is operative for financial state-

ments covering financial years beginning on or after

January 1 2001, although earlier application is per-

mitted as of the beginning of a financial year that ends

after March 15 1999, the date of issuance of IAS 39.

IAS 39 adopts a modified components approach to

securitizations. Under the components approach, the

asset that is sold is broken down into its component

parts and each component is accounted for separately

(subject to some overriding conditions). If the sale of

a component of a financial asset is to be recognized,

the originator must have no further involvement with

that component (notwithstanding the ownership of

other components of that same financial asset).

The following principles govern the determination

of whether control over a transferred asset (or its com-

ponent parts) has been surrendered by the originator:

● Control is not surrendered if the originator can

revoke the transfer and essentially put things back

the way they were. If the originator has the ability

to revoke a transfer of financial assets, it has not

really surrendered control of the assets. Thus, if the

originator retains rights that taken together

amount to this, then the transaction should be

accounted for as a borrowing, not a sale.

● Control is surrendered if the securitization vehicle

has the option, in the normal course, to acquire

control of the underlying assets. For this to be the

case, the securitization vehicle must have the ability

to obtain future economic benefits related to the

assets and to restrict the access of others to those

benefits. Thus, it is important to examine the con-

tract establishing the transaction for any constraints

placed on the securitization vehicle’s use of the

a s s e t s .

● Control is not transferred if the originator is enti-

tled or obligated to purchase the transferred assets

at a fixed price that effectively provides the securiti-

zation vehicle with a rate of return that is equivalent

to interest on the funds it has provided to the origi-

nator.

78

Box 1: Fixed rate mortgages

Manager Trustee

Bank

mortgage

originator

Mortgage

insurers

Bonds

Loans

Bond-

holders

Swap

provider

Arranger &

servicer

Trust/issuer

Securitization: Australia

79

In assessing a particular securitization, it is neces-

sary to consider the entire transaction, including any

side agreements or sets of simultaneous agreements.

Such transactions should reflect rational business pur-

poses. If a transaction appears to lack such logic from

the point of view of one or more of the parties to it,

this may indicate that not all related parts of the trans-

action have been identified, or that some parts have

not been correctly assessed. For example, if a finan-

cial asset transfer is determined to be a secured loan,

and the loan does not bear a reasonable interest rate

given current market interest rates and the inherent

risks in a particular situation, this may indicate there

is another component that should be identified and

valued as part of the consideration.

However, it should be noted that an entity cannot

automatically apply the components approach when a

Special Purpose Entity (SPE) is used to effect the

transaction. This is because Standing Interpretations

Committee Interpretation SIC 12, Consolidation –

Special Purpose Entities, is likely to apply. SIC 12

requires that an SPE must be consolidated when the

substance of the relationship between an entity and an

SPE indicates that the SPE is controlled by that entity.

Control may arise through the predetermination of

the activities of the SPE or otherwise. The application

of the control concept requires, therefore, that in each

case a judgment be made regarding the true economic

substance of the arrangement.

Australian approach

In the past, most Australian entities have followed the

risks and benefits approach. This approach requires

that significant rights to benefits and exposure to risks

be transferred to others before an enterprise discon-

tinues recognition of an asset. This is consistent with

the Australian accounting standards’ approach to

transactions such as leases and to revenue recognition

g e n e r a l l y .

Australian Accounting Standard AASB 1001

Accounting Policies provides a hierarchy of pro-

nouncements that should be considered when select-

ing an accounting policy. IAS standards take

precedence over the pronouncements of other

national accounting standard setting bodies. There-

fore, since the issuance of IAS 39, which adopts the

modified components approach, the components

approach is gaining acceptance within Australia.

FUTURE DIRECTION

Securitization has been used in Australia by a number

of non-bank lenders to fund their ability to lend to

home buyers. The banks have responded to the

threat to their home loan markets by also securitizing

their own home loan portfolios.

The market has since developed, and this is illus-

trated by offshore bond issues (for example,

Eurobond issues) and with the range of receivables

being securitized widening to include trade receiv-

ables, lease receivables and credit card receivables.

The securitization programs are also beginning to

offer different rated securities within the one vehicle;

for example, Citibank’s home mortgage securitization

included senior AAA-rated debt and subordinated A-

rated debt. The issue of different rated securities has

allowed the mortgage originators to alleviate investors

concerns that they were becoming over exposed to the

limited number of mortgage insurers.

Although the Australian market is constrained by

size, securitization is expected to continue to grow,

both in terms of deal capacity and assets securitized.

A special supplement to International Tax Review June 2000

www.internationaltaxreview.com80

The use of securitization as a financ-

ing technique has increased consider-

ably in the last few years in Belgium.

The Belgian legal framework pre-

viously did not favour an extension of

securitization practice in Belgium.

This was due to two inherent difficul-

ties. First, in the past no specific secu-

ritization vehicle existed in Belgium

to promote ABS and MBS issuances.

Similar to experience abroad, this

financing technique increased at

exponential rates in Belgium after a

securitization vehicle was introduced

by legislation in 1992. Second, the

legal aspects surrounding a transfer

of receivables was troublesome since

the intervention of an

huissier/gerechtsdeurwaarder was

required. The law of July 6 1994 rec-

ognized such transfer agreements as

valid and enforceable against third

parties without the requirement for

further procedure.

LEGAL AND REGULATORYFRAMEWORK

SICs can be organized in the form of a

(closed-end) investment fund (fonds

de placement en créances (FPC)/fonds

voor belegging in schuldvorderingen

(FBS)) or organized in the form of a

company (société d’investissement en

créances (SIC)/vennootschap voor beleg -

ging in schuldvorderingen (VBS)). It is

important to note that unlike a com-

pany, a fund does not have a legal

personality separate from that of its

members. The unitholders of a

FPC/FBS are co-owners of the fund’s

assets and liabilities. Such a fund,

given its transparency, must be repre-

sented by a management company

which is responsible for carrying out

the investment policy.

As incorporated entities, SICs are

normally subject to the Commercial

Companies Law, with the exception of

a few provisions. They may take the

legal form of a société anonyme/naamloze

v e n n o o t s c h a p or a société en commandite

par actions/commanditaire vennootschap op

a a n d e l e n. In the latter company form,

the partner managing the investment

company has an unlimited liability,

while the liability of the shareholders is

limited to their contribution. As in

practice, for legal reasons, a special

purpose securitization vehicle will most

commonly take a statutory corporate

form. The general overview of the tax

treatment below will focus on SICs

o n l y .

Entities that solicit funds from the

public are supervised in Belgium by

the Banking and Financing Commis-

sion (BFC) which requires that various

additional rules apply. Private SICs,

however, merely have a requirement

to register on a list held by the Ministry

of Finance (and this ministry does not

exercise any prudential control).

Belgium

Securitization: Belgium

81A special supplement to International Tax Review June 2000

TAXATIONFrom the perspective of the originator, the transfer of

loans to SICs will be subject to the normal applicable fis c a l

provisions. Depending on the difference between the mar-

ket interest rate the SIC offers at the time of transfer com-

pared with the interest rate applicable for the transferred

loans, a taxable income/loss may be realized by the origina-

tor. Any capital gain is subject to corporate income tax at

the normal rate of 40.17% while any loss is tax deductible.

Moreover, it is not possible to shift the taxation of these

capital gains. No indirect tax is payable on transfer of the

receivables to the SPV.

The SICs themselves are in principle subject to corpo-

rate income tax. However, the SICs are liable for income

tax only on the total amount of the abnormal or gratuitous

advantages received and disallowed expenses (other than

the decrease in value and losses on shares). Consequently,

SICs are not taxable on the actual profits reserved or dis-

t r i b u t e d .

Abnormal or gratuitous advantages are those obtained

by the SICs under conditions which are similar to the con-

ditions applicable in the market (for example, the SIC

obtains a loan at a below-market interest rate). SICs are not

taxable on the actual profits reserved or distributed. The

imposition of tax on abnormal or gratuitous advantages

seeks to prevent companies shifting profits toward SICs

during a securitization process. This rule requires that ser-

vices rendered by other companies are charged an arm’s-

length remuneration. Notwithstanding the taxable basis of

the SICs is restricted, the SICs are subject to a ‘secret com-

mission tax’ at the rate of 309% of commissions, fees and

other charges, all for which the identity of the benefic i a r y

has not been properly identified and the expenses are not

validly documented. Any VAT cost should be minimal

since, although input VAT is not deductible for the SICs

and this could otherwise represent substantial cost, the

VAT legislation allows a VAT exemption on some services

rendered to SICs (such as management services rendered

to an SIC and the investment advisors). The contribution

of capital to SICs is subject to an exemption from capital

duty (normally levied at a rate of 0.5% of the capital contri-

bution). Finally, SICs can benefit from the exemption of

the annual tax of 0.06% which is normally due by invest-

ment companies.

Tax implications do arise for investors. Given that

investors can participate in SICs not only through bonds

but also via shares, the return will be classified as interest or

dividends respectively. In either case, in general the reim-

bursement of the invested amounts is not taxed, whereas

the return on investment will, under normal circum-

stances, be subject to a withholding tax of 15%. There are

exceptions to this rule. No dividend withholding tax is due

if the shareholder, being a Belgian or EU resident com-

pany, has a participation of at least 25% during a minimal

period of one year (some discussion continues however

within the tax authorities with respect to the applicability of

this exemption on investment companies). More impor-

tantly the non-resident investors should also benefit from

an exemption of withholding tax. This exemption is also

valid for the interests granted to non-resident investors.

Other investors, such as financial institutions and insur-

ance companies, can also benefit from certain exemption

on interests.

The tax treatment at the level of the investors mainly

depends on the category to which the investors belong,

and can be summarized as follows:

● For a Belgian resident individual receiving dividends or

interest from an SIC, no additional income tax is due on

the dividend or interest income if the withholding tax

has been levied at a rate of 15%. If this is not the case, the

dividends and interests are taxable at the basic rate of

withholding tax and local taxes (presuming that the

shares/bonds are allocated to a trade or business activ-

ity). If a capital gain is realized by transferring the shares

or bonds, no tax liability arises provided that the transfer

occurs within the course of normal or ordinary manage-

ment of a private portfolio (ie is not considered as a busi-

ness asset). If, however, this capital results from the

speculative management of a private portfolio, tax at the

rate of 33% (increased by local taxes) applies.

● The interests or dividends received by Belgian resident

companies are taxed at the normal corporate income

tax rate. No participation exemption is granted on the

dividends received by corporate shareholders of SICs.

The withholding tax is creditable and, possibly, recover-

able. Any capital gains realized at the occasion of trans-

fer of the bonds of the SICs by a Belgian resident

company will constitute part of the taxable basis for the

computation of the corporate income tax. If any capital

losses are realized (or decrease in value) these are tax

deductible. With respect to capital gains realized on

shares of SICs, tax is applicable. No deduction is

allowed for tax purposes for the decrease in value or

capital losses on shares of SICs (except if the capital

losses occur at the occasion of the liquidation of the com-

pany to the extent of paid-in capital).

CONCLUSION

It is important to acknowledge that since the legal frame-

work has changed in Belgium, securitization is becoming

an important financing technique for the Belgian fin a n c i a l

markets, and its role as a financing instrument will con-

tinue to increase. From a tax perspective, the tax treatment

of a Belgian securitization vehicle is favourable due to the

computation of the tax basis. At the level of the investor the

financing of the securitization of the receivables can be car-

ried out either through bonds or shares, although some

inconsistencies still remain at a tax level. Non-residents

investing in Belgian securitization vehicles can obtain a

return that is not subject to Belgian withholding tax. Con-

sequently, it can offer a valid and interesting investment

v e h i c l e .

www.internationaltaxreview.com82

The securitization market in Brazil

is experiencing growth. The market

has little depth, although mineral

exporters, electric utilities and

financial institutions have used secu-

ritization transactions as a financing

tool to advance cash flow. Mineral

exporters that use securitization

financing deliver the future exports

as a guarantee for the funding. This

procedure has been used to reduce

the working capital costs and

thereby improve competitiveness.

Energy companies have used the

securitization process to capture

funds for investment in equipment

and to supply working capital

through the delivery of future

energy production as a guarantee.

Securitization by financial institu-

tions has been prompted as a result

of capital adequacy requirements

imposed by the Central Bank. By

using securitization, receivables con-

sidered to be doubtful have been

sold to an SPC established for this

particular purpose. Special purpose

companies that acquire receivables

in this manner are subject only to

general rules of tax and accounting

that are applicable to financial insti-

tutions. However, due to the partic-

ular nature of this structure and the

administrative cost of implementing

the securitization process, small

businesses have not had access to

this instrument.

EXAMPLE I: MORT G A GEL O ANS AND RECEIVABL ESDERIVED FROM SALE OFRESIDENTIAL HOUSES UNDERCONSTRUCTION

There is potential for expansive

growth in the market for securitiza-

tion of mortgage loans and receiv-

ables derived from sales of

residential houses under construc-

tion. These loans and receivables

are regulated by federal law. The

law allows financial institutions and

construction companies to sell

receivables to special entities known

as Real State Securitization Compa-

nies (RSSC) (Companhia Securiti-

zadora de Creditos Imobiliarios).

The RSSC typically issues securities

known as Real State Receivable Cer-

tificates (Certificados de Recebiveis

Imobiliarios) in order to purchase

the receivables or other securities.

The RSSC derives income from the

difference between the borrowing

rate and the interest rate of the

banking mortgage. In the case of

properties under construction, the

income source is the difference

between the borrowing rate and the

financing rate charged by the

b u i l d e r .

The market for this type of securi-

tization is still under development.

One issue that needs to be resolved

Brazil

Securitization: Brazil

83A special supplement to International Tax Review June 2000

is the tax impact on the home construction industry.

The profit derived from sales of residential houses can

be recognized on a cash basis under the specific tax

rules applicable for the construction industry. There-

fore, a construction company can recognize profit

from the sale on a cash basis during the time of financ-

ing.

This tax treatment is an exception and is not applic-

able to other types of transactions. For example, if the

receivables are transferred to others from the con-

struction company, it is considered a taxable event to

the builder. This is an important issue that must be

resolved before implementing the securitization

process.

Financial institutions are the main suppliers of

funding to the construction industry. In general,

banking financing received by the builder is liqui-

dated when construction is complete. The settlement

is made through bank transfers by the builder of

accounts receivables derived from sales of real estate.

As a part of this transaction, the financial institution

becomes the new creditor for the house purchaser

through concession of the mortgage loan. For tax

purposes, this event is considered a realization and

the builder must recognize the deferred profit.

EXAMPLE II: BANKING LOANS

Brazilian law allows financial institutions to sell

accounts receivable through the securitization

process. Assets eligible for sale include solid and

doubtful debts. The purchaser of these assets must be

an SPC and the funds used to acquire the assets can be

derived from local or foreign sources under the fol-

lowing conditions:

● The funds derived from local sources must be

raised through stock issues or debentures. The

debentures must be of non-convertible type with a

subordinated clause or non-subordinated clause.

The debenture can be offered in a private place-

ment or public offering. The law specifies that the

originator is the only person who can subscribe for

the subordinated debenture offered in a private

placement.

● The foreign source funds can be derived from notes

and securities accepted in international financial

m a r k e t s .

Brazilian corporate law requires that the establish-

ing documents of the SPC include special provisions

that protect the purchaser of the securities. For

instance, one corporate law provision requires that

the payment of stocks, debentures and other securi-

ties depends on the realization of underlying assets.

These kinds of requirements can be eliminated in cer-

tain limited circumstances.

FUTURE DIRECTION

Many financial managers are not aware of the benefits

and the impact of securitization in the financial and

tax areas. Likewise, there are the investors who also

need to know about these investments. In addition,

the credibility and potential growth of securitization

as a financing tool is negatively affected by the bad

publicity created by the bankruptcy of some construc-

tion companies.

Securitization has great future potential in Brazil,

and a robust and healthy market is likely to develop

once the challenges are overcome.

www.internationaltaxreview.com84

In contrast to the countries reviewed

thus far, Canada has a more sophisti-

cated securitization market. In order

to draw out some unique aspects of

Canada’s activity, this commentary

outlines the evolution of the asset-

backed securities market in Canada

over the last 10 years as it applies to

the leasing industry, with particular

emphasis on the income tax aspects of

the applicable legal structures. It is

important to note that where the

underlying securitized assets are con-

tractual in nature and involve non-

leasing assets such as record royalties,

credit card receivables and inventory,

the basic structures are similar.

It is not a coincidence that with the

introduction of Large Corporations

Capital Tax (LCT) in 1989, the popu-

larity of securitization structures

increased in Canada. Off-balance

sheet financing became critical to

leasing companies to reduce federal

and provincial capital taxes. A trust

was selected as the securitization vehi-

cle as trusts are not subject to capital

tax. Where debt is incurred by the

lessor corporation to finance the

acquisition of leasing assets and the

debt remains on the balance sheet,

the annual cost to the lessor can be

between 37-60 basis points after tax.

With the razor-thin profit margins

lessors are experiencing in Canada,

this cost, if incurred, is fatal from a

competitive standpoint. LCT is

0.225% and provincial capital tax

rates range between 0.25% and

0.64%. LCT is non-deductible while

provincial capital tax is deductible for

income tax purposes. Both taxes are

levied on taxable capital, which is

generally based on a shareholder’s

equity, loans, advances, long-term

debt and other indebtedness. An

investment allowance is available to

reduce taxable capital for certain

investments, loans and advances.

However, for this purpose a lease is

not considered a loan or advance to

another corporation. Therefore,

there is no investment allowance

available to the lessor to shrink the

amount of debt borrowed by the leas-

ing company to finance the acquired

leasing assets. In the absence of secu-

ritization, the taxable capital base

remains inflated for a lessor that bor-

rows to finance the acquisition of leas-

ing assets. This cost forced lessors to

become creative and seek innovative

structures to reduce their capital tax

burden and place them on a level

playing field compared with financial

institutions for which the capital tax

base is fundamentally different.

Another key reason for the

increased popularity of securitiza-

tions to lessors is the ability to acceler-

ate profit recognized for book

purposes in the year of securitization

for future streams of lease payments

that would otherwise be booked as

Canada

Securitization: Canada

85A special supplement to International Tax Review June 2000

income in future years. The hot stock market and

reliance by investors on P/E multiples drove such com-

panies to package and sell future receivable streams and

thereby qualify (provided the GAAP requirements are

met) to adopt gain-on-sale accounting. Such decisions

were further influenced by the fact that many employ-

ees of such companies had stock-based compensation.

Accordingly, the built-in bias towards pushing the earn-

ings envelope contributed to the use of securitizations

to meet this need. Securitizations have now become a

primary rather than an alternative source of funding to

such corporations. It is interesting to note that spreads

to leasing companies tightened recently in North Amer-

ica due to the proliferation of non-traditional leasing

products. Many non-leasing companies decided to

monetize their receivables, inventories and other non-

leasing assets using securitization vehicles in an effort to

clean up their balance sheets in anticipation of Y2K

problems.

EXAMPLE I: SALE-SALE-LEASEBACK

At present, the most common legal structure used in

Canada to securitize assets for a leasing company origi-

nator is the sale-sale-leaseback structure. The sale-sale-

leaseback was originally developed in 1990 and was

known as Leaf. It is often organized as a permanent

single member conduit structure that involves a regular

sale of receivables by the originator into the conduit

vehicle, which is organized as a trust. The main benefits

of securitization to the originator are :

● availability of a lower cost of funds due to the bank-

ruptcy remote status of the trust conduit that pro-

vides the financing to the leasing company after the

origination phase;

● off-balance sheet financing, provided Canadian gen-

erally accepted accounting principles (GAAP) are

met;

● reductions in capital tax;

● the ability of the lessor to accelerate income recogni-

tion (for book purposes) in the period of sale of the

assets to the conduit for the future lease streams; and

● the ability to defer income tax on the book gain.

For investors, the senior notes issued by the trust pro-

vide an attractive money-market alternative, since they

are guaranteed by a bank. The senior notes issued by

the trust are typically held by the more conservative

investor. Subordinate debt, mid-term notes and junior

debt tranches are often issued by the trust to attract the

more risk-oriented investor. Accordingly, the leasing

company is able to tap an attractive source of financing

as an alternative to conventional financing. To achieve

the desired results outlined above, it is critical that the

lessor be able to record a sale under Canadian GAAP.

This commentary will not deal with specific accounting

rules or commodity tax issues.

A typical sale-sale-leaseback transaction is as shown in

the simplified diagram in Box 1.

The transaction contemplates these distinct steps:

● The purchase by the Trust (SPV) of the equipment

and related lease rights from the lessor/originator of

the leases, funded with proceeds from the issuance of

notes to the investor. Typically, there is a mix of

senior and subordinated debt that is geared to attract

different risk-oriented investors and, therefore,

broadens the source of funds available to the origina-

tor.

● Payment for the equipment.

● The execution and delivery of a master lease between

the lessor/originator, and the SPV as lessee.

● The purchase by the originator of the original equip-

ment (not including any rights to the receipts under

the related leases) for a purchase price equal to the

sale price and subject to the terms of the master lease.

● The prepayment by the SPV of a portion of the

rentals arising under the master lease.

● The originator uses prepayment proceeds to pay

down debt otherwise subject to capital tax.

Where there is a securitization of ‘true leases’ and an

assignment of the future lease streams (other than

purely for security purposes), an income inclusion to

the originator is triggered (for income tax purposes)

equal to the proceeds of the sale/assignment. This

results in a tax mismatch that is undesirable to a taxable

originator. A sale-sale-leaseback structure provides a

solution to this problem as there is no recapture or

income inclusion to the selling company (in the absence

of tax class changes and provided the originator has not

filed certain tax elections). The capital cost allowance

pool remains neutral to the originator. The proceeds

received are treated as prepaid rent. Although the pre-

payment is included in income, a reasonable reserve can

be claimed by the originator with respect to rents for

which rent has been paid in advance.

Box 1: A typical sale-sale-leasebackt r a n s a c t i o n

Lessor Trust

Equipment

$ Payment

Equipment and leases

$ Payment

Master lease

Notes

$

CashRental prepayment

Investor

Securitization: Canada

www.internationaltaxreview.com86

EXAMPLE II: CONCURRENT LEASESTRUCTURE

A second type of securitization structure (shown in Box

2), known as a ‘concurrent lease’ structure, recently

evolved in the Canadian market. This structure has

been marketed as a simpler alternative to the sale-sale-

leaseback.

The typical steps to a concurrent lease structure are

as follows:

● A special purpose trust (SPV) is formed. A charity is

the sole beneficial owner of the SPV.

● Lessor/originator enters into a concurrent lease with

the SPV. The originator assigns, transfers and con-

veys to the SPV the existing leases and their related

rights (the leased assets). SPV, now as lessor to the

original leases, obtains a concurrent lease to possess

and use the leased assets pursuant to the terms of the

concurrent lease. Title to the leased assets remains

with originator. The originator retains ownership for

tax purposes. There is flexibility to securitize any

portion of the lease. Note that to comply with com-

mercial law the concurrent lease term must be slightly

shorter that the original lease term. Effectively, a new

lease has been sandwiched between the existing lease

between originator and the lessee.

● The SPV makes a prepayment of rent equal to 92%-

95% of the book value of the leased assets in exchange

for obtaining the right to possess and use the leased

assets.

● The SPV is capitalized with proceeds from the

issuance of notes to Canadian investors.

● The originator uses the prepaid rent proceeds

received to pay down debt and thereby minimize cap-

ital tax.

The concurrent lease also provides a way for the orig-

inator to mitigate tax because the purchase price

received for the rent receivables is structured as a pre-

payment of rent under a head lease, thereby qualifying

the originator to claim a reasonable tax reserve. Like

the sale-sale-leaseback, the originator is permitted to

defer income tax that would otherwise come into play if

the future rent streams were assigned or sold for cash.

This structure is similar to the sale-sale-leaseback in that

it also relies on a prepayment of rent to provide origina-

tor with funds to pay down debt that would otherwise

attract capital tax.

FUTURE DIRECTION

Recently, Revenue Canada verbally indicated that pre-

paid rent received by the lessor should be included in

taxable capital for LCT purposes. Tax practitioners are

comfortable that LCT would not apply to prepaid rent

and Revenue Canada’s position would not be sustained

in a court of law, provided the prepaid rent is not

included in the lessor’s balance sheet (because of GAAP

conformity), and as long as there is no reference to the

amount of the prepayment netted in the lessor’s balance

sheet referred to in the notes to the financial statements.

The Canadian province of Ontario has recently taken

the position for one taxpayer that the prepaid amounts

are not considered rent in law, but in the nature of a

loan, citing a 1961 House of Lords decision that consid-

ered the nature of "rent" as support for this position.

The court cited a principle in landlord and tenant law

that an amount can only be considered rent when it is

due. Accordingly, Ontario is taking the position that an

advance payment of rent relating to periods where the

rent was not due is considered to be a loan or advance to

the landlord and not rent. It remains to be seen

whether or not this case would be considered relevant

and whether Ontario would prevail.

In view of the developments above, oddly enough, a

partnership structure was developed in the late 1980s

that does not rely on a prepayment to solve the capital

tax issue. The appeal of this structure is that partnership

capital is not included in taxable capital and trusts and

tax-exempt beneficiaries of trusts do not pay capital tax.

The structure shown in Box 3 is the alternative securiti-

Box 2: Concurrent lease structure

Lessor

Lessor

Lessee Investor

Lessee

Before

After

Head lease

Prepayment

Concurrent lease

Cash

Pay

down

debt

Trust

(SPT)

Box 3: Alternative securitizationa r r a n g e m e n t

LeascoA units plus a

noteCash

Pay

down debt

Trust

(SPT)

Partnership

CharityTrustee

CashInvestors

Notes

B units

Sell

assets

Securitization: Canada

87A special supplement to International Tax Review June 2000

zation arrangement:

● A trustee independent of the originator forms a trust

(the trust) that would have a charity as its sole benefi-

ciary. The charity’s capital contribution would be

nominal and it would receive an annual income of

perhaps $5,000 and the capacity to have its capital

returned.

● The originator would form a partnership with a

wholly-owned subsidiary to carry on a leasing busi-

ness. Part of the leasing business would include col-

lecting accounts receivable. The originator would

subscribe to A units of the partnership as considera-

tion for the contribution or rollover of leasing assets

using rollover provisions.

● The trust would issue notes to involve and use the

proceeds to subscribe to B units of the partnership.

● The partnership would use cash from the B units to

pay notes owing to the originator. The partnership

would also issue A units for the value of assets con-

tributed in excess of their cost.

● The originator would pay down debt (otherwise sub-

ject to capital tax) with the payment on the note from

the partnership.

There are certain other aspects to the transaction

above that allow the participants to achieve the desired

tax treatment. It appears that the original ‘mousetrap’

(the partnership structure) may be the best alternative

of all, at least as far as the capital tax is concerned,

should the taxation authorities sustain their position.

www.internationaltaxreview.com88

The initial step in the development

of the French asset securitization

market was taken with the passing of

the t i t r i s a t i o n law of December 23

1988 and the accompanying decrees

and regulations of early and mid-

1989. On October 9 1997 the French

prime minister and the minister for

economy, finance and industry pro-

mulgated decrees which liberalized

the process of securitization of

receivables to a dedicated mutual

fund (fonds commun de créances o r

FCC). A June 25 1999 law on savings

and financial security has completed

the French regime.

The French securitization market

has steadily grown since 1989

(Ffr671 million (US$91 million) of

securitized receivables in 1989 ver-

sus Ffr203,717 million in 1997).

Since 1998, new SPVs using securiti-

zation techniques have been set up

by financial institutions for the fund-

ing of French groups. For instance,

securitization is now used in both

real estate and factoring areas.

EXAMPLE: RECEIVABL ES

Future receivables may be securi-

tized through an FCC to the extent

they arise under a contractual

agreement already entered into at

the time of transfer. For instance, it

is possible to securitize future rents

arising under leasing contracts as

well as future receivables of a prede-

termined amount when the receiv-

ables are securitized.

In addition, an FCC can be used

to securitize receivables held in dif-

ferent currencies. An FCC can also

enter into currency swaps and hedg-

ing agreements. Because an FCC

can issue and re-issue units in differ-

ent currencies and for different

maturities, it may benefit from the

funding flexibility offered by a

multi-currency debt issuance pro-

g r a m m e .

L EG AL AND REGULAT ORYFRAME W ORK

The creation and operation of an

FCC requires the participation of: (i)

investors; (ii) a financial institution

where the funds will be deposited;

(iii) a management company, the

role of which is to conduct the

investment policy of the FCC.

Securitization transactions

through FCCs are governed by a

specific legal and regulatory frame-

work in France. Under French law,

an FCC is regarded as involving

joint ownership of securities and not

as a legal entity. Its activities must

consist exclusively of the co-owner-

ship of receivables and not of other

types of securities (ie shares may not

France

Securitization: Fr a n c e

89A special supplement to International Tax Review June 2000

be held). The transfer mechanism provided for in the

securitization law is inspired by the Loi Dailly mecha-

nism. Title to the receivables is transferred by the exe-

cution and dating of a b o r d e r e a u.

Following changes in the legal regime applicable to

FCCs, an FCC can acquire receivables not only from a

financial institution but also from a commercial entity.

However, only certain receivables can be transferred

to an FCC (for example, no receivable subject to litiga-

tion may be transferred). The fund is now also enti-

tled to transfer receivables to a third party under

certain circumstances. It is not impossible for an FCC

to hold a single receivable.

An interest in an FCC qualifies as a security (v a l e u r

m o b i l i è r e) for French legal purposes and is transfer-

able. The FCC can issue different tranches and classes

of units secured by varying pools of assets.

Under certain circumstances, an FCC now has the

chance to acquire additional receivables after its set-

ting-up and to proceed to subsequent share capital

increases. The redemption of the capital of the fund

during its life must be addressed prior to its setting-

up.

Under certain circumstances, FCCs are now

allowed to borrow funds.

TAXATION

The transfer of receivables may generate a gain or a

loss for the originator, corresponding to the differ-

ence between the nominal value of transferred receiv-

ables and their selling price. Such a gain/loss is subject

to corporate income tax at the standard rate during

the fiscal year in which the transfer is effective. As far

as VAT is concerned for the originator, both the

potential profit derived and the income arising from

the payment of the receivables are tax-exempt. An

election to tax for VAT purposes is not available.

As a co-ownership of receivables with no legal per-

sonality, an FCC is a look through entity and is not

subject to corporate income tax.

From the perspective of the investor, any income (ie

unit income, capital gains) derived by a corporation

through an FCC is subject to corporate income tax at

the standard rate. Pursuant to the French Tax

Authorities’ guidelines, FCC units held by corpora-

tions fall within the scope of the mark-to-market rule.

However, this is debatable since FCC units are not

explicitly mentioned in the related French tax law

provisions. Foreign investors are not subject to

French corporate income tax but may suffer a 15%

withholding tax on income derived from the FCC

units which may be reduced or removed by relevant

double tax treaties.

A CCOUNTING

The French accounting authorities have issued a

guideline relating to the accounting rules applicable

to FCCs, including the accounting treatment of

receivables and units, the financial statements to be

issued and other requested information (number and

value of the units).

www.internationaltaxreview.com90

The ABS market in Germany has

grown steadily since 1995, especially

in the last two years, although it is

not as large as the US market. There

are securitizations of housing loans,

credit card receivables and con-

sumer loans. Two well know securi-

tizations are the Haus 1998-1

project (volume Dm1.4 billion) and

the CORE 1998-1 project (volume

Dm4.3 billion). Both were handled

by Deutsche Bank and set a bench-

mark for German securitization.

The Haus 1998-1 project provided

for the sale of a pool of residential

mortgages to an SPC in Jersey. The

CORE 1998-1 transaction involved

the securitization of 5,300 loan

receivables from German mid-size

companies.

In the spring of 1997 the German

Bank Regulatory Office (B u n d e s a u f -

sichts-amt fuer das Kreditwesen –

BAKred) published a guideline

allowing relief from capital ade-

quacy requirements for banks if cer-

tain criteria are met. Since that time,

not only corporations but also banks

have securitized various assets.

In the past, traditional ABS trans-

actions were based mainly on mort-

gage loans (residential and

commercial), trade receivables, lease

receivables and customer loans. All

kinds of assets can be securitized,

provided the assets are separable,

transferable, pledgeable and free of

objections. Further, a database com-

prising the failure rate, the default

and the prepayment of the last three

to five years should exist. In view of

such conditions an efficient EDP sys-

tem is required to effect an ABS

t r a n s a c t i o n .

L EG AL AND REGULAT ORYFRAME W ORK

From an insolvency, tax and

accounting perspective (see below) it

is important that the transfer of

assets is characterized as a true sale

and not as a secured loan. The new

German Insolvency Act took effect

on January 1 1999. Since this date

the difference between a true sale

and a secured loan has become more

important. If the asset transferred is

considered a secured loan by a

court, the SPV has to contribute a

lump sum of 9% of the transferred

assets to the insolvency estate. Addi-

tionally, the insolvency representa-

tive is entitled to liquidate certain

assets. A possible dispute with the

insolvency representative over

whether a transaction is a true sale

or a secured loan would be an obsta-

cle to investors wishing to partici-

pate in an ABS transaction. In

contrast to the secured loan, the

true sale will be treated like a cash

transaction, ie the SPV can claim

Germany

Securitization: Germany

91A special supplement to International Tax Review June 2000

100% of the assets. To avoid insolvency, the SPV’s

economic activities are restricted to the acquisition of

the assets and the issuance of the securities. However,

participation in other securitizations may be allowed.

The rules regarding the characterization of a true

sale or a secured loan in ABS transactions are not cod-

ified, nor does any court assert jurisdiction over these

types of transactions. As ABS transactions have a cer-

tain similarity with factoring, it can be inferred that

the judgments concerning factoring can be used to

answer the question of whether a given transaction is a

true sale or a secured loan.

The German Federal Supreme Court stated that a

true sale occurs if:

● the originator can keep the appropriate purchase

price definitively;

● the purchaser (factor) has no recourse against the

originator in the case of a receivables default; and

● the originator has no credit risk after the transfer of

the assets.

Consequently, the courts are likely to classify the

sale as a secured loan if one of the above criteria is not

fulfilled. The German Supreme Tax Court follows the

precedent of the Federal Supreme Court in cases of

factoring. In May 1999, the Supreme Tax Court

decided that a sale must be considered a secured loan

because in that case the sale was secured by the origi-

nator’s real estate.

TAXATION

The tax aspects important to ABS transactions in Ger-

many involve VAT, trade tax and international tax

i s s u e s .

For VAT, the tax position of the originator has to be

distinguished from the tax position of the SPV.

From the perspective of the originator, a sale of the

assets is tax free if the SPV is domiciled in Germany or

in an EU country. Consequently, related input VAT is

not creditable at the level of the originator. The input

VAT credit with regard to general (overhead) services

received is impaired. If the SPV is located in a non-

EU country, the asset transfer is non-taxable. Related

input VAT remains creditable. In addition, debt col-

lecting (usually performed by the originator) will be

taxable in the case of a German or EU-based SPV and

will be non-taxable in the case of an SPV domiciled in

a non-EU country. At the present time, there is no

restriction to an input VAT credit by the originator.

For the SPV, the acquisition of receivables is not

considered a business activity under German VAT

law. Consequently, there is no input VAT credit for

the SPV. Any VAT charged by the originator on ser-

vice fees for debt collecting would not be recoverable.

As a result of the VAT application, the SPV should

be domiciled in a non-EU country. The same conclu-

sion is reached under an analysis of the trade tax

implications of a securitization financing transaction.

Trade tax considerations are of particular significance

because the funds raised from a sale of assets can be

used to settle the originator’s long-term debt. If so,

long-term debt interest, which increases trade tax, can

be avoided. On the other hand, the interest is gener-

ally a deductible expense, which decreases the trade

tax base. By settlement of the debts the interest

expense ceases, resulting in the loss of the interest

expense deduction.

On the other side of the coin the bonds issued by

the SPV would be treated as long-term debt. Conse-

quently, if the SPV was located in Germany, 50% of

the interest paid on such bonds would not be

deductible. Hence, due to aspects of the trade tax

rules, the SPV is better if domiciled abroad. However,

long-term debt is generally an issue for non-banks

only. Banking organizations benefit from a special

provision in German tax law that allows long-term

debt to be disregarded if certain fixed assets do not

exceed the bank’s.

Given that the trade tax and VAT considerations at

the planning stage suggest the SPV should be estab-

lished outside Germany, it is important that the actual

implementation supports this result. Relevant inter-

national and domestic tax considerations that flow

from this include:

● If the SPV’s place of management is actually in Ger-

many, the SPV will become taxable in Germany.

Hence, any management decisions should there-

fore be made (and documented) abroad. Other

than debt collecting, no further administrative or

management tasks should be transferred to the

o r i g i n a t o r .

● If no sound business reasons can be presented for

the establishment of the SPV, the German tax

authorities might apply German CFC rules, ie for

German tax purposes they might look through the

SPV. This would be a problem only to the extent

that the originator has a stake in the SPV.

● Further, it could become questionable if the origi-

nator is a dependent agent of the SPV if the origi-

nator is in charge of the debt collecting insofar as

the SPV becomes subject to limited taxation in Ger-

many. However, the originator should normally

not depend on the SPV. The method of debt col-

lecting is usually not governed by the SPV.

● In the case of an MBS there is the risk that the SPV

could become subject to a limited taxation in Ger-

many due to interest paid on assets secured by Ger-

man real estate. However, in the case of an MBS the

mortgage lien is generally not transferred to the

SPV but a trustee receives the authority to cause

such transfer upon a certain trigger event (eg

decrease of the originator´s rating) there is in effect

a transfer of the mortgage lien.

A CCOUNTING

Securitization: Germany

www.internationaltaxreview.com92

Both the German commercial law rules and the US

GAAP rules must typically be observed where German

groups are allowed consolidated group accounting

under US GAAP rules. The German rules are consid-

ered for purposes of the single entity balance sheet

whereas US rules govern the consolidated group bal-

ance sheet. Both must be reconciled if ABS transac-

tions are to receive similar treatment.

There is no codification or jurisdiction regarding

ABS in German commercial law. General rules on the

transfer of receivables must be applied. Such general

rules are governed by the risk and rewards approach

requiring that the economic ownership of the assets be

transferred to get off-balance sheet treatment. An

effective transfer of receivables requires:

● an actual (true) sale against consideration, ie the

credit risk must be transferred from the originator

to the acquirer;

● the consideration to be arm’s-length, ie the credit

risk must not remain with the originator following

an extraordinary discount; and

● the originator must not assume the credit risk on

individual credit enhancements (only general

enhancements regarding the pool of receivables

may be granted).

Finally, there is a conflicting interest between the

intention to ensure a true sale by transfer of the ulti-

mate credit risk on the one hand, and, on the other

hand, to leave credit risk with the originator in order

to achieve a good rating on the securities issued.

The important difference between the German and

US rules is that under US rules a loss of effective con-

trol is possible (true sale under US rules), even if the

credit risk remains with the originator (no true sale

under German rules). Therefore, it is important to

keep both sets of accounting rules in mind.

A special supplement to International Tax Review June 2000 93

A legal framework for securitization

was introduced in Italy only in 1999

and this finally filled a regulatory gap

that had hindered the widespread use

of such transactions in Italy. The

potential for growth in the securitiza-

tion market is now substantial. In

fact, until this law was passed, several

legal and tax issues made securitiza-

tion quite a burdensome task to be

carried out domestically. Therefore,

most securitizations were carried out

through non-resident issuers.

Italy represents a unique example

in Europe due to the impressive size

of its non-performing market. The

Bank of Italy has estimated that the

potential securitization market rep-

resented by non-performing loans,

just within the banking system, is

approximately L200,000 billion

(US$90 billion). The potential mar-

ket for trade receivables is estimated

to be in excess of L50,000 billion.

According to major rating agencies,

the official figures of the market size

should be adjusted to take into

account a number of private deals

arranged through multi-originator

vehicles or private placements.

Many deals involving non-per-

forming assets were in process at the

beginning of the year 2000.

REGULATORY AND LEGALFRAMEWORKThe basic securitization structure in

Italy is available by virtue of recently

enacted law (Law No. 130/1999

enacted April 30 1999). Although the

requirements of this law are numer-

ous, salient aspects are discussed fur-

ther below.

The new law specifically allows for

the use of pass-through securitization

using a conduit SPV (although the

same advantages (mainly tax and reg-

ulatory) offered to this legislatively

created vehicle are also available

through an investment fund or by

means of a sub-participation agree-

ment). Article 1 of this law sets the

scope of its application: The provision

hereto applies to securitization trans-

actions carried out through the

assignment against cash of cash

receivables, whether existing or

future, which, in case of miscella-

neous credit receivables, are recog-

nizable in their aggregate amount.

The new law merely gives general

guidelines on securitization and, with

regard to the regulation of specific

cases, merely refers to the regulations

provided by Legislative Decree No.

385/1993 (Italian Banking Code) and

Legislative Decree No. 58/1998 (the

so-called Draghi Law). It does not

provide a definition of the profile of

the originator. This allows wide-

Italy

Securitization: Italy

www.internationaltaxreview.com

spread use of securitization not only by the banks or

financial institutions in general, but also by other com-

panies such as those entities operating in the manufac-

turing industry or any other industries.

In order to ensure application, the securitization

vehicle must be a corporation that meets certain spe-

cific requirements. In addition, the amounts paid by

the obligors must be exclusively secured to the fulfill-

ment of the obligation associated with securities

issued for securitization purposes, as well as to the

payment of transaction expenses. It is furthermore

provided that the requirements of good name and

professionalism must be met by the parties involved,

as well as the requirements of good name and profes-

sionalism of the companies representatives. Addi-

tional rules apply where the securitization vehicle and

the entity issuing the securitization securities (typi-

cally bonds) to investors are not the same party.

As a way of protecting the investors who purchase

bonds issued by the SPV (or by the issuing company, if

different), the law provides for a separation of the

assets assigned by means of a securitization from all

the other assets owned by the issuer. Specifically, the

law states that receivables involved in each transaction

are deemed at all effects as a property different from

the companies’ equity and different from that

involved in the other transactions. Executions on each

property are not allowed other than by the holders of

the bonds issued to finance the acquisition of same.

The SPV, or the issuer if different, must draw up a

prospectus in accordance with the stock exchange

commission (CONSOB) regulations. In the case of

securities offered to non-institutional investors, the

prospectus must state, among other items prescribed

by both the new securitization law and other applica-

ble laws, that the transaction is subject to worthiness

evaluation by third party rating companies.

The securities issued to investors are regarded as

financial instruments and are subject to the Italian

Banking Code. Under this code, the transfer of assets

to the SPV is governed by the following provisions:

● the SPV must give notice of the sale by way of a pub-

lication in the Official Gazette, without prejudice to

other additional forms of advertising provided for

by the Bank of Italy;

● benefits and guarantees of any kind provided by

whomever or anyway existing in favour of the origi-

nator maintain their validity and rank ahead of

claims of the securitization vehicle, without need of

any particular formality or registration.

When these conditions are met, the transfer is valid

without the need for individual notice to each obligor.

Hence, provided that the above procedural

requirements are met, the securitization programme

will be taxed in accordance with the specific provisions

of the new law.

TAXATIONFor income tax purposes, securities issued for securiti-

zation purposes are subject to the same tax regime pro-

vided for bonds and other similar securities issued by

listed corporations. As a consequence for securities with

maturity of at least 18 months (the most likely scenario),

the relevant cash flows:

● are not subject to any withholding at source if col-

lected by the so called lordisti (ie resident entities eli-

gible for gross coupon taxation). This includes

non-residents who benefit from the application of tax

treaties that allow the exchange of information.

● are subject to a substitute tax at 12.5% (levied by

financial intermediaries) if collected by the so-called

nettisti (ie individuals and other entities taxable on a

net coupon basis). This includes non-treaty and

blacklisted country residents.

On the proceeds of securities with maturity shorter

than 18 months, a 27% withholding tax on interest is

levied which is a final tax for individuals not carrying

out a business activity or is an advance tax for entrepre-

neurs, corporations and other commercial entities tax-

able in Italy.

A securitization transaction may take advantage of

the special regime of tax relief provided by Pres Decree

601/73 in all cases where the receivables transferred are

associated with medium and long-term transactions or

with special credit operations. Under this regime, a sub-

stitute tax applies at 0.25% of the amounts paid, in lieu

of the entire ordinary set of deed taxes (including regis-

tration tax, stamp-duty, mortgage, cadastral and gov-

ernment concession taxes).

Finally, where a portfolio of credit receivables is

transferred to the securitization vehicle, regulations in

force characterize the transfer as a VAT-relevant trans-

action. However, the VAT is taxable at a 0% rate. In

addition, the transfer is subject to the fixed stamp duty

amount (L250,000) if filed with the local registration

office. Bonds issued within a securitization transaction

are also subject to the ordinary stock transfer tax (rates

vary between 0.09% and 0.16%) unless issued with the

intent to be listed on the stock exchange (in which case

they are exempt).

ACCOUNTING AND TEMPORARY REGIME

Generally, as a consequence of the transfer of the receiv-

ables, the originator must not retain in its records the

value of the assets transferred unless risk on those assets

is also retained. If no guarantee or collateral is granted

to the securitization vehicle and the price is to be paid by

the same over a period in excess of one year, the receiv-

able from the securitization vehicle must be booked at its

discounted value based on the average market rate at

the time of transfer. If, on the other hand, the origina-

tor retains a degree of risk on the transferred assets,

then these must show on the books of the originator and

94

Securitization: Italy

95

may therefore not be substituted by the receivable from

the SPV. In case of retention of only part of the risk, the

accounting must be modified according to the extent of

the risk borne by the originator.

From the SPV or the issuer's point of view, the assets

received may not be booked at a value higher than the

price actually paid for the transfer.

The new law provides transition relief in order to

avoid an excessive impact on the profits & loss account

from securitization transactions. A special temporary

regime applies with regard to deeds of transfer carried

out within the first two years of enactment of the law. In

particular, the law allows companies to set up directly a

net worth reserve by reallocating existing net capital

reserves, for amounts corresponding to:

● losses from the sale of the assets;

● losses on securitization collateral;

● provisions set against collateral granted to the SPV.

In the above cases, losses and provisions must be

booked in five equal installments in the P&L account of

the year in which the transfer has taken place and in the

following four years. In the notes to the financial state-

ments a specific section must be included describing the

book consequences of the securitization and the impact

caused to the P&L account as a result of this capacity to

defer accounting of the losses. The possible allocation

of the loss is also relevant for tax purposes because the

deduction relies on the accounting treatment in the

P&L for the period. For tax purposes, the decreases in

value are relevant in the determination of the business

income of those fiscal years in which they are entered in

the profit and loss account.

Two years after the enactment of the law, the transi-

tional regime will cease and the accounting and fiscal

system of securitization operations will adopt the ordi-

nary rules: losses will have to be accounted on an

accrual basis and deducted with the same limitations

and restrictions that normally apply for deduction of

each negative item involved.

A special supplement to International Tax Review June 2000

www.internationaltaxreview.com96

Securitization is a relatively new

instrument for the Mexican finan-

cial market. Legal and tax regula-

tions for this type of transaction do

not yet exist. Although securitiza-

tions are not yet used in the Mexican

financial market as a typical means

for raising funds from Mexican

investors, many Mexican companies

use this for financing through for-

eign markets to raise funds.

It is important to note that securi-

tization has a great potential in Mex-

ico. Many banks and commercial

enterprises have substantial

accounts receivable assets in respect

of credit cards, automotive financ-

ing to Mexican consumers; mort-

gages, leases, and participation in

time-share condominiums. Securiti-

zation offers a flexible and plausible

method to monetize these assets, the

most likely investors at this time

being foreign investment institu-

tions (ie the securitization vehicles

would be best placed to issue certifi-

cates or notes abroad).

Since the market is in its infancy

and there are no related regula-

tions, these types of transactions do

not occur frequently in Mexico.

Mexican banks and corporations

perform these transactions abroad.

Certain illustrative examples devel-

oped by these participants are

shown below.

EXAMPLE I: FUTURERECEIVABLES IN US DOLLARS

Securitizations have been carried out

through different vehicles such as

trusts, through which future credit

rights related to the types of receiv-

ables previously mentioned are

assigned for the purposes of issuing

certificates.

The Income Tax Law establishes

that income in credit, obtained by a

non-resident through the acquisition

of a credit right of any kind, whether

present, future or contingent, that is

sold by a resident in Mexico, will be

subject to a withholding tax rate of

10%. The income will be determined,

generally, by subtracting the contrac-

tual price from the face value of the

credit right. The law mentions that

the withholding takes place when the

accounts are considered sold. This

issue is important in the case of selling

future receivables. In that case, the

specific situation must be analyzed to

determine if the particular transac-

tion raises the issue. If the issue is

raised, it is necessary to obtain a rul-

ing from the Mexican tax authorities

allowing the withholding during the

period of the financing.

Mexico

Securitization: Mexico

97A special supplement to International Tax Review June 2000

EXAMPLE II: ACQUISITION OF BAD CREDITSFROM A CREDIT INSTITUTIONSome foreign companies incorporate subsidiaries in

Mexico in order to purchase bad loans from Mexican

Banks at very reduced prices. In December 1999, the

Ministry of Finance published certain rules for Mexican

companies that acquire bad credits from a credit institu-

tion, stating that the amount of the loan that has actually

been collected is considered as income. Companies that

acquire bad credit will be allowed to deduct the amount

paid for the credit rights over a three year period.

FUTURE DIRECTIONS

The recent liberalization of the Mexican financial sys-

tem and the fact that the market is expanding have

made it necessary to modernize the Mexican tax system.

In response, the Mexican tax authorities have followed

the policy of internationalizing their tax relations by

signing tax treaties with several countries and by follow-

ing the OECD model as an instrument of negotiation.

For example, the withholding rate for certain kinds

of interest (paid to foreign banks) earned by residents of

countries with which Mexico has concluded a tax treaty

can be as low as 4.9%. These preferential rates will be

abolished in June 2000, though the tax authorities are

already trying to negotiate to continue them for the sec-

ond semester of the year. (In the case of US Banks, the

4.9% withholding rate will continue to apply according

to the tax treaty signed with the US).

Also, a Mexican Derivative Market (MexDer) was cre-

ated and has been granted the status of a recognized

market. This has simplified the administration of risk

business and investors, and made possible the diversifi-

cation of speculative instruments.

International financial markets have grown very

quickly in the past few years; many new instruments and

types of transactions have appeared as a response to the

need for diversifying risks, gaining higher yields, and

enjoying tax benefits. In order for the Mexican financial

market to be competitive among the emerging markets,

Mexico is embarking on legislative reforms in response

to the application of new schedules of financing that

exist in the international financial markets.

The reforms have already paid dividends. On March

7 2000, Moody’s raised the country’s credit rating to

investment grade for the first time. Now the govern-

ment and many private Mexican corporations will have

access to a wider range of financing at lower rates. The

new rating also clears the way for many foreign funds to

buy Mexican bonds, which they were forbidden to do in

the absence of investment grade status. As a result,

securitization may become a more recognized financing

technique in Mexico.

www.internationaltaxreview.com98

The first securitization programme was

introduced to the Dutch market in

1996. A so-called residential mortgage

securitization, it formed the hesitant

start of securitization in the Nether-

lands. The unconfirmed regulatory sta-

tus of securitization up to 1997 and the

availability of competitive on-balance-

sheet funding played an important role

in slowing the market. However, with

the publication by the Dutch Central

Bank of a memorandum outlining

draft guidelines for the regulatory

treatment of securitizations in Septem-

ber 1997, securitizations have made a

flying start.

This flying start may only be partly

explained by the publication of the

Central Bank memorandum. As

increased capital constraints for fin a n-

cial institutions are being adopted by

regulatory authorities, securitization

proves to be a useful instrument for

freeing up capital, enabling the fin a n-

cial institutions to venture into other

p r o fitable business. The financial insti-

tutions acknowledge this aspect of secu-

ritization and deem it especially

important, as they consider the increase

in funding costs that may result from

the continuing pressure on the avail-

ability of savings deposits. The fin a n c i a l

institutions recognize that securitiza-

tion is an important tool for maximizing

shareholder value.

Another relevant factor which

explains the increased activity in the

Dutch securitization market is the pre-

vailing competition for further market

share among financial institutions and

their wish to offer a wide range of prod-

ucts to their clients. This will press such

financial institutions to look for cheaper

and additional funding sources beyond

their traditional debt instruments,

which leads such institutions to the

securitization instrument.

To date, securitization programmes

amounting to tens of billions of Dutch

guilders have been placed in the Dutch

market. These programmes were

mainly backed by mortgages or senior

loans and originated from major Dutch

financial institutions such as ABN

AMRO and Rabobank. However, more

exotic securitization programmes are

being introduced as well, an example of

which is the introduction of LABS, a

securitization instrument issued by

Bank Labouchere which is backed by a

stock lease portfolio.

As the securitization market matures,

relatively fewer mortgage-backed pro-

grammes are expected to be intro-

duced, as the market familiarizes itself

with the securitization instrument and

develops more advanced programmes.

This development, which may well be

i n fluenced by Anglo-Saxon investment

bankers, will further direct the Dutch

securitization market to full maturity,

comparable to the current US and UK

markets.

TheNetherlands

Securitization: The Netherlands

99A special supplement to International Tax Review June 2000

EXAMPLE: LEA SE RECEIVABL ES

In 1998, a Dutch bank introduced a securitization pro-

gramme in which a lease receivables portfolio owned by a

subsidiary (the originator) of the bank was securitized. The

originator sold US$200 million worth of lease receivables

to a Dutch SPV, which financed this through the issue of

debt securities in the market. The SPV used the income

earned on the lease portfolio to pay interest to the holder of

the debt securities. To accommodate fluctuations in the

income from the lease contracts, the purchase price of the

portfolio (net present value) was determined by taking into

account a certain expected minimum return. To the extent

that the actual return on the lease portfolio would exceed

this minimum return, an earn-out mechanism would

ensure that this excess was paid over by the SPV to the orig-

inator as a deferred purchase price for the lease portfolio.

This earn-out provision combined with a pledge on the

lease portfolio, ensured the AAA credit rating for the SPV.

The shares of the SPV were held by a Dutch administrative

foundation (Stichting Administratiekantoor), which had

issued share certificates to the originator. This structure is

illustrated in Box 1.

L EG AL AND REGULAT ORY FRAME W ORK

Since 1997, an SPV in a typical securitization transaction

no longer requires a banking licence to raise funds from

the public. The introduction of this exemption has taken

away a regulatory barrier to development of the Dutch

market for ABS. This action proves that the Dutch Central

Bank authorities are willing to adjust their rules for evolv-

ing markets, rather than forcing markets to operate within

boundaries that do not recognize new and innovative

financing techniques.

However, technical difficulties do remain. For example,

under Dutch law, in order for a receivable to be validly

assigned (from the originator to the SPV), the obligor

needs to be informed of the cession. If no notific a t i o n

occurs, the ownership of the receivables will remain with

the originator and in the case of bankruptcy of the origina-

tor, this would result in the holders of securities issued by

the SPV not having access to the underlying assets of the

transaction. Securities holders will therefore typically

require that a legally valid transfer of the assets (true sale)

from the originator to the SPV has occurred.

However, companies often have a commercial prefer-

ence for avoiding notifying their obligors of a transfer or

securitization. Instead, they invoke one of the alternatives

that exist to by-pass the notification requirement:

● To effectuate the cession under foreign law. In 1997, the

Dutch Supreme Court ruled that the assignment of

receivables in international transactions are governed

by the same law as that governing the relationship

between the SPV and the originator. Hence, parties are,

to some extent, free to elect the jurisdiction governing

an international transaction, and may therefore choose

a jurisdiction that does not impose a comparable notifi-

cation requirement. It is uncertain, though, whether

such choice of jurisdiction would always be respected in

a Dutch domestic transaction where only the SPV is

domiciled abroad, or whether a foreign court would

accept the validity of the transfer if Dutch rules are not

observed. In a purely domestic context, Dutch rules will

always prevail.

● To use dissolution, whereby the receivables are split off

into a separate entity (SPV2), followed by a sale of the

shares in SPV2 to SPV and a merger between SPV and

SPV2. This will however raise other legal complications

and may provide for less flexibility.

● Other options include the establishment of a right of

usufruct on the proceeds of the receivables for the bene-

fit of the SPV (rather than an actual transfer), or a sce-

nario where the SPV assumes liability for payment of the

receivables, repays the debts to the originator and thus

obtains a right of recourse to the debtors.

In practice, another solution is to sell the receivable to

the SPV without informing the debtors. Only in certain

events of default would notification to debtors be made. To

provide the SPV’s securities holders with a greater degree

of security, a so-called silent pledge on the receivables (not

requiring notification to debtors prior to execution) may

be granted by the originator to a security trustee founda-

tion for the benefit of the SPV’s securities holders, and/or

to the SPV. Although this set-up has certain legal draw-

backs compared to a valid transfer of the receivables, the

credit rating agencies have accepted this alternative in past

transactions.

TAXATION

Securitization is not specifically addressed in Dutch tax law

or in case law. Securitization transactions, however, may be

assessed for Dutch tax purposes by using two general con-

cepts, which are both described below.

The first criteria is sound business practice. Dutch lim-

ited liability companies (naamloze vennootschap and besloten

v e n n o o t s c h a p) are deemed to carry out their business with all

their assets and liabilities. This implies that all income and

gains earned by such companies will be subject to corpora-

Box 1: Lease receivables

SPV

Originator

Lease

income

Sale lease

receivablesIssue

securities

Interest &

principalShares

Lease

income

Share

certificatesInvestors

Foundation

Lessees

Securitization: The Netherlands

www.internationaltaxreview.com100

tion tax, unless the

income is in fact a capital

contribution. The annual

taxable profits of Dutch

resident companies are

determined in accor-

dance with sound busi-

ness practice. This

concept, which has been

developed mainly

through case law, is based

on Dutch GAAP, but con-

tains certain adjustments

for taxes. Sound business

practice is governed by

three principles:

● ‘Prudence’ prevents a

taxpayer from overes-

timating the worth of

his business; no profit

recognition is allowed until the profit is reasonably cer-

tain, while unrealized losses may be deducted immedi-

ately.

● ‘Realism’ requires that income be reported in the year it

is earned; a taxpayer’s annual profit can be determined

only by events relating to that year. This principle

requires a certain degree of economic reality.

● ‘Simplicity’ is a system that is theoretically correct but

d i f ficult or impossible to apply in practice and that may

not qualify as sound business practice.

Of the three principles, the principle of realism is the

most important.

Assets and liabilities should be reflected in the taxpayer’s

tax accounts for their value determined in accordance with

sound business practice. The question of whether to capi-

talize or enter an item as liability must also be answered by

using sound business practice.

Apart from the concept of sound business practice

described above, the treatment of the securitization trans-

actions also depends on case law developed in the area of

asset ownership. Dutch case law holds that, in general, an

asset is owned by the person who has legal title to such an

asset unless the entire economic ownership of the asset has

been transferred to another person. For this purpose secu-

ritization transactions in the Netherlands should be sepa-

rated into those where the legal title to the underlying

assets is transferred and those where some or all of the eco-

nomic rights of the assets are transferred.

If the legal title is transferred then the asset is generally

considered sold by the originator. Whatever book gain or

loss is realized on the alienation of such an asset has to be

taken into the taxable result of the originator under the

realism principle. A transfer of legal title, however, does

not necessarily have to result in a sale of the asset for tax

purposes. If the originator retains the economic ownership

of the assets, for tax purposes, the originator will be viewed

as having obtained a loan against collateral security and the

agreed purchase price must be accounted for by the origi-

nator as a loan. This distinction means that many transac-

tions will be structured as transfers of partial economic

ownership because of the legal hurdles involved with

ensuring a transfer of legal title. This combines the best of

all worlds as:

● the assets are taken off balance sheet for NL GAAP;

w h i l e

● the asset can be used for secured financing; and

● the assets remain on the balance sheet for tax purposes,

no taxable gain is realized, the benefit of reduced cost

financing is spread over time for corporation tax pur-

p o s e s .

The tax treatment of the SPV also depends on this dis-

tinction between sale and secured loan. If the SPV is a

Dutch NV or BV, it will be regarded as a Dutch tax resident

by virtue of its being incorporated under Dutch corporate

law. As such it will be subject to tax in the Netherlands on its

worldwide income. The tax consequences will depend on

the chosen structure of the SPV. If the SPV should be

regarded as having become the tax owner of the underly-

ing assets through the securitization, the SPV will derive

taxable income at the time of maturity of the receivables (if

these are the assets securitized and assuming that the

receivables are short-term and non-interest-bearing, eg

consumer receivables). The profit is calculated as the dif-

ference between the nominal amount of the receivables

and the original purchase price paid by the SPV. If the SPV

did not acquire full economic (tax) ownership of the assets,

it is considered as having been loaned to the originator

against collateral security. Taxable income is determined

by the amount of accrued interest.

The Netherlands does not levy a general withholding

tax on interest payments. The only relevant withholding

tax would be dividend withholding tax, which is levied on

dividends paid by a Dutch resident company to its share-

holders. Dividend withholding tax may also be due in the

case of profit-dependent interest payments. In the absence

of dividend payments to the investors or of profit - d e p e n-

dent interest, there should be no Dutch withholding on

payments from the SPV to the investors holding securities

issued by the SPV.

If the SPV is not incorporated in the Netherlands (and

management does not reside in the Netherlands), it will

only become subject to Dutch corporation tax if it can be

said to have derived income from a Dutch taxable source

(as it will not be resident). In the absence of a Dutch perma-

nent establishment, which would be typical in a securitiza-

tion transaction, a Dutch tax liability should not arise.

Where the shares of the SPV qualify as a portfolio invest-

ment and Dutch shareholders own at least 25% of the SPV,

the Dutch parent should annually mark-to-market its

investment in the SPV (and will be taxed on any increase in

value).

Various indirect taxes may also apply to the securitiza-

tion transaction. First, a 6% real estate transfer tax is levied

on the transfer of Dutch real estate, although mortgages

are specifically excluded. A transfer of a mortgage portfolio

to the SPV in connection with MBS transactions would

therefore not trigger the real estate transfer tax, a securiti-

zation of Dutch real estate could result in a real estate trans-

Securitization: The Netherlands

101A special supplement to International Tax Review June 2000

fer tax liability if the originator would thus have trans-

ferred an economic interest in the real estate to the SPV.

Unlike Dutch corporation tax, which requires a full eco-

nomic ownership transfer, real estate transfer tax requires

only the transfer of an economic interest. Second, VAT

may be irrecoverable and constitute an outright cost. In a

securitization transaction, services would in principle be

performed between the originator and the SPV, as well as

between the SPV and the investors. Even if the SPV can be

c l a s s i fied as a business for VAT purposes, it will largely be

engaged in exempt financial services. Input VAT incurred

will normally not be deductible. Irrecoverable VAT may be

incurred from resident and non-resident third party ser-

vice providers (eg rating agencies or law firms).

Although the sale of the receivables to the SPV qualifie s

as a taxable service, this transaction should be exempt from

VAT as a transfer of receivables. This will affect the origina-

tor’s ability to deduct input VAT on incurred expenses.

However, if the exempt services are incidental and are not

performed in the originator’s ordinary course of business,

the originator should still be able to deduct the input VAT,

with the exception of VAT on costs that are directly attrib-

utable to the exempt financial service.

Finally, where the performance of the securitized asset

portfolio has been insured with a (third party) insurance

company, the Dutch insurance premium tax may become

payable at a rate of 7% of the premium. If the insurer is

established outside the Netherlands, it must appoint a fis-

cal representative. If it fails to do so the insurance premium

tax is levied on the insured person.

A CCOUNTING

Dutch GAAP does not provide for specific regulations

regarding the accounting treatment of transactions relat-

ing to securitization programmes. General remarks

require that the economic reality of a set of related transac-

tions must be presented. In addition, an asset or liability

which is presented on the balance sheet, remains on that

balance sheet if a transaction does not result in an impor-

tant change of the economic reality regarding this asset or

liability. Whether such an important change in the eco-

nomic reality will occur must be determined in accordance

with the de facto probability that economic advantages and

risks will exist. Finally, an auditing standard exists that

holds that an asset or liability should no longer be pre-

sented on the balance sheet if the trans-

action results in the transfer of

(almost) all entitlements to eco-

nomic advantages or risks associ-

ated with aforementioned asset

or liability to a third party. It

follows from these auditing

standards that under Dutch

GAAP, off-balance treatment

of a securitization transac-

tion may be achieved only

if all real expected risks of

the assets are transferred

to a third party.

As a result of a proposed

amendment to Dutch GAAP,

off-balance treatment of securiti-

zation transactions may become even more difficult to

obtain in the future. Under this proposed amendment,

based on International Accounting Standards interpreta-

tion SIC-12, consolidation rules for SPVs will be even fur-

ther tightened. If any of the following requirements is met,

consolidation of the SPV becomes mandatory for the origi-

n a t o r :

● the activities of the SPV are de facto undertaken for the

b e n e fit of the originator;

● the originator has control over the SPV;

● the originator is entitled to more than half of the eco-

nomic benefit s ;

● the economic risks of the SPV are in fact more than 50%

allocated to the originator.

Consequently, numerous existing securitization transac-

tions will no longer be treated as off-balance for Dutch

accounting purposes if this new proposed amendment to

Dutch GAAP is adopted.

US GAAP differs from the Dutch treatment. FAS 125

lists a number of requirements that must be met in order to

qualify a securitization transaction as a sale for accounting

purposes. It may be argued that under Dutch GAAP, off-

balance treatment of the securitization transaction is more

d i f ficult to achieve than under US GAAP. Under the pro-

posed amendment of Dutch GAAP, based on IAS interpre-

tation SIC-12, this difference will become even more

apparent. Consolidation of SPVs is always mandatory,

unless such a company is a completely independent third

p a r t y .

www.internationaltaxreview.com102

In New Zealand, as elsewhere in devel-

oped economies, the use of securitiza-

tion as a financing tool has grown

rapidly, particularly during the 1990s.

Given the size of the economy and of

New Zealand’s capital markets, the

securitizations market is small by global

standards, but techniques used in other

countries such as the US and the UK

have been quickly and effectively

adapted to local regulatory conditions.

Residential mortgages, commercial

mortgages, credit card receivables,

equipment leases, local authority

debentures and trade receivables are

among the underlying transactions

whose cash flows have been repackaged

in this manner.

EXAMPLE: RESIDENTIALMORT G A GES

Two of the larger mortgage securitiza-

tions in New Zealand were carried out

for major residential mortgage lenders.

These were relatively typical mortgage

securitization transactions. In both

cases the originators were fin a n c i a l

institutions owning substantial portfo-

lios of mortgage receivables originated

by themselves. The SPV that acquired

the mortgages raised funds for the pur-

chase from the capital markets rather

than directly from the public.

In one of the two cases mentioned

above, the SPV obtained funds through

the issue of fixed rate US dollar

Eurobonds by a foreign subsidiary.

Although residential mortgages in New

Zealand have a low delinquency rate,

the Eurobonds were guaranteed as to

principal and interest by a US-based

monoline financial insurer.

In the other case, funds were raised

from issues of bonds, registered and

promissory notes to investors, and a

floating rate loan facility with a domes-

tic bank. The risk was guaranteed by an

Australian insurer, in this case with

100% coverage rather than the more

usual 10%-20% of losses.

TAXATION

Between 1985 and 1999, most securiti-

zations had income tax consequences

governed by New Zealand’s accrual

regime. The accrual rules are statutory

and affect all financial transactions in

which the economic substance includes

a deferral of monetary and/or non-

monetary consideration flows. Certain

"excepted financial arrangements" are

excluded from these rules, namely

equity instruments, specified arrange-

ments subject to other specific tax

regimes, and exclusions to assist in com-

pliance cost minimization. Certain

hybrid instruments are bifurcated for

tax purposes and are taxed in part as

financial instruments (debt) and in part

as equity. Subject to these limited

New Zealand

Securitization: New Zealand

103A special supplement to International Tax Review June 2000

instruments, and the inclusion of participatory loans and

options to acquire equity instruments within the equity

c l a s s i fication, most hybrid instruments are classified as debt

for tax purposes.

Since 1999, however, legal defeasances and absolute

assignments, each with the effect of terminating the inter-

est of the assignor or defeasor in the underlying subject

matter, have been excluded from the accrual rules, and

accordingly are dealt with under ordinary New Zealand

tax principles. As a result, the accrual rules probably no

longer apply to the transfer of assets to the securitization

vehicle. These rules may apply to the underlying assets

themselves, as between the obligor and the SPV, and to

debt securities issued by the SPV to investors.

New Zealand has not levied stamp duty on the sale of a

chose in action or on interests in residential property since

1988, or on sales of interests in commercial property since

1999. Hence, stamp duty will typically not apply on trans-

fer of assets to the SPV.

The predominant tax approach in New Zealand is to

respect the substance and legal effects of transactions. The

general anti-avoidance rule applies to void the tax effect of

a transaction if the Commissioner of Inland Revenue can

show that "tax avoidance was a more than merely inciden-

tal purpose of the transaction".

New Zealand anti-avoidance rules would not apply

where a securitization is carried out primarily to monetize

assets and to improve balance sheet ratios, and any tax

advantages are merely ancillary to the commercial drivers

for the transaction. If they were to apply, the transaction

might well be regarded as a secured financing rather than

a sale.

Where the originator of the securitized assets is a New

Zealand tax resident, and the SPV is incorporated in New

Zealand, it will normally be subject to New Zealand taxa-

tion unless the provisions of a double tax agreement (DTA)

apply to allocate the taxing jurisdiction to another country.

New Zealand has comprehensive rules for controlled for-

eign companies (CFCs) and foreign investment funds

(FIFs). If the SPV is established in a low tax jurisdiction or

in a non-approved jurisdiction, and has New Zealand con-

trol and ownership, these rules will operate to attribute a

portion of the SPV’s income to the New Zealand resident

holding an interest. Where the SPV is established in an

approved jurisdiction, the CFC and FIF rules do not deem

a t t r i b u t i o n .

New Zealand has interest allocation rules designed to

discourage thin capitalization where a company is con-

trolled by non-residents. If an SPV is controlled by non-

residents, it must comply with these rules. The thin

capitalization rules are based on pro rata allocation rules.

In effect, they require a consolidation of the New Zealand

entities and of the worldwide entities controlled by a non-

resident. The debt-to-asset ratio of the New Zealand enti-

ties is compared to that of the non-resident group’s

worldwide debt-to-asset ratio. If the New Zealand ratio is

less than 110% of the worldwide ratio, the apportionment

rules are not triggered. As a means of reducing compliance

costs, taxpayers are not subject to the thin capitalization

rules if the New Zealand group’s debt is less than 75% of its

assets. An SPV typically funds itself with 100% borrowing

and normally the on-lending concession in the thin capital-

ization rules will relieve it from the interest allocation.

Various compliance issues may arise in relation to oblig-

ations to make withholdings from interest under resident

withholding tax or non-resident withholding tax rules, or

to deduct approved issuer levies charged on borrowings

between unrelated resident borrowers and qualifying non-

resident lenders.

A properly structured securitization will normally be

neutral for the purposes of New Zealand’s goods and ser-

vices tax, although some issues need to be considered care-

fully. The sale of a business as a going concern between

parties registered for GST is zero rated, as is the provision

of financial services. In certain cases, the question arises

whether management and other fees paid to servicers or

third party managers of the SPV may constitute a taxable

s u p p l y .

A CCOUNTING

As noted above, New Zealand does not have any specific

accounting rules dealing with recognition and measure-

ment of securitization. However, FRS33 does require full

disclosure of a reporting entity's involvement in these types

of arrangements so that the readers of the financial state-

ments are able "...to separate the business risk of such activi-

ties from that of its other activities." Which approach to

securitization is applicable – the risk and rewards approach

to securitization required by the UK (in FRS-5), or the

financial statement components approach adopted by the

US (in FAS) – often depends on where the owners of the

New Zealand financial institution are resident; either

approach is acceptable for New Zealand GAAP.

FUTURE DIRECTION

As securitization becomes of greater importance in New

Zealand financial markets, it is likely that detailed tax rules

will be put in place. At the present time, however, such

rules are unlikely to be a legislative priority.

Uncertainty as to the tax outcomes of securitization can

be reduced. The New Zealand tax legislation does provide

for a tax binding ruling process that is administered by a

dedicated division within the Inland Revenue Depart-

ment. Binding rulings are sought in relation to most signif-

icant transactions. However, resource and skill constraints

within the Inland Revenue Department in this area again

lead to lengthy and uncertain delays between application

and issue of binding rulings. Appropriate planning is nec-

essary to ensure that this timing uncertainty does not affect

implementation of the transactions.

www.internationaltaxreview.com104

Securitization is a relatively new

phenomenon in Spain, although the

market has very quickly developed

in terms of volume and sophistica-

tion of MBS transactions. Securitiza-

tion as a financing tool was initiated

in 1992 when the legal framework

for MBS came into force. Securitiza-

tion did not become commonly

accepted as an alternative financing

tool until the 1998 ABS regulation

came into force. This regulation

provides a legal basis for the securi-

tization of many types of financial or

non-financial assets and of certain

future rights. Hence, the historic

focus on MBS may now switch to

other asset classes. However, the

Spanish securitization market,

which is relatively important in vol-

ume, is still unsophisticated in prac-

tice. Although there are new

securitization structures in develop-

ment, the majority of the structures

already completed are based on

mortgage credits and other receiv-

ables and are mainly performed by

financial entities.

In 1996, an atypical securitization

was completed by the Spanish elec-

tricity companies. These companies

securitized certain rights granted by

the government in order to recover

investment costs in the construction

of nuclear power stations that were

permanently abandoned. At pre-

sent, other non-traditional securiti-

zation structures are in progress.

The Spanish electricity companies

are attempting to securitize the com-

pensation rights the Spanish gov-

ernment granted to them in order to

cover the "transition to the compe-

tence costs" (CTC). These costs are

the result of a new regulation that

liberalized the electricity tariffs paid

by the final consumers.

The securitization of certain

future rights is allowed but a specific

authorization from the Ministry of

the Economy is necessary for each

individual case. Only the securitiza-

tion of toll roads and urban dwelling

rentals have been permitted. How-

ever, no transaction based on this

type of right has been finalized.

L EG AL AND REGULAT ORYFRAME W ORK

The securitization process is tightly

controlled in Spain. Securitization

funds are the SPVs through which

the securitization process must be

conducted in Spain. The SPV does

not have a legal personality. The

law provides for two types of securi-

tization funds:

● Fondos de Titulización Hipote-

caria (FTH). These bundle the

mortgage credits transferred by

the originator and are always

closed funds since their assets

Spain

Securitization: Spain

105A special supplement to International Tax Review June 2000

(credits) and liabilities (securities) cannot be modi-

fied.

● Fondos de Titulización de Activos (FTA). These

bundle the other assets or future cash flows other

than mortgage credits. They can be closed or open

funds. In the latter case (revolving structures) their

assets and liabilities can be modified (usually for the

transfer of short-term receivables). At least 50% of

these funds must be financed by issuing securities,

by financing loans and by contributions of institu-

tional investors who would collect the outstanding

profits once the fund is liquidated. If less than 50%

of the funds are financed by issuing securities, the

prior authorization of the CNMV is required.

Under the law, the originator is forbidden to guar-

antee the credits that are transferred to the fund.

Once the SPV form is determined, incorporation of

the securitization funds requires prior notification to

the regulatory authorities. The securitization funds

must be incorporated, managed and legally repre-

sented by a CNMV authorized management securiti-

zation entity. The law allows different formulas to be

implemented by the management entity in order to

reduce or eliminate the credit risks of the securitiza-

tion funds (swaps, temporary acquisition of other

securities with a similar or better rating or any other

financial transactions with this purpose, and insur-

ance contracts). The SPV must be formed with mini-

mum share capital of Pta150 million (US$798,000)

fully paid and must file and register incorporation

documents, an asset appraisal report and rating and

liability details.

The regulatory authorities must also authorize an

informative prospectus that is intended for the

investors. It is possible to issue different types of

bonds with varying levels of risk (principal and subor-

dinated bonds). The securities issued by the SPV must

be quoted on an official Spanish secondary securities

market (AIAF), except in the case of securities that are

exclusively designated to institutional investors issued

by the FTAs.

Once these stringent requirements have been met,

the tax consequences flow accordingly.

TAXATION

The assets assigned from the originator to the fund

are exempt from VAT and stamp duties. Hence, no

indirect tax costs arise for either party. Nevertheless,

the Spanish VAT law is not clear about whether or not

the transfer of certain future credits would be exempt

from VAT.

The SPV is subject to the general regime of corpo-

rate income tax, but has an important concession

whereby any proceeds obtained (irrespective of their

source) are not subject to withholding taxes. The

incorporation of the SPV is exempt from stamp

duties. Commissions charged by the management

entities of securitization funds are exempt from VAT.

The taxation of the investors is more involved.

Interest or capital gains obtained by the investors

from securities held in a securitization fund are sub-

ject to personal income tax or corporate income tax.

Interest and capital gains (from post-1998 security

issues) derived by Spanish individuals from the secu-

rities issued are subject to 18% withholding tax which

is treated as a pre-payment of tax. As a general rule,

interest and capital gains derived from the securities

held by Spanish resident corporations are not subject

to withholding taxes, unless the securities are not

quoted on an official Spanish secondary securities

market (ie securities from FTAs exclusively intended

for institutional investors) or the titles are not repre-

sented through account entries. Interest derived by

non-EU residents is subject to withholding tax at the

rate of 25% or the applicable reduced tax treaty rate.

The outstanding profits arising from the liquida-

tion of the securitization fund that are collected by

institutional investors (deriving from their contribu-

tions to the fund) would be taxed according to the

general corporate tax regime for proceeds resulting

from the liquidation of entities.

A CCOUNTING

There are no specific rules regarding the accounting

treatment for the originator of the assets assigned to a

securitization fund. However, a recent ruling issued

by the Spanish Accounting Authorities (ICAC) pro-

vides an opinion on this matter. The ICAC states that

according to the securitization legal regulations, the

assets must be totally and unconditionally transferred

and it is specifically forbidden for the originator to

grant guarantees to the fund in order to ensure the

transaction, otherwise, the originator could not

Securitization: Spain

www.internationaltaxreview.com106

remove the transferred assets from its balance sheet.

The credits are transferred at their nominal value,

but the cash that is received by the originator is usu-

ally reduced by two amounts:

● the financial discount assigned to the transaction;

a n d

● an amount considered to be a deposit in the fund

(at an estimated level) to cover any default in the

credit payments. This amount would be reim-

bursed to the originator once the credits are paid.

According to the accounting ruling issued by the

ICAC, the financial discount associated with the trans-

action is considered an early payment discount to be

registered by the originator as an up-front financial

expense. This expense would be tax deductible for

corporate income tax purposes. However, the origi-

nator should maintain on the balance sheet as a finan-

cial asset the discount amount as a guarantee for

potential defaults. The balance sheet notation should

be covered by an insolvency provision for the same

amount. This insolvency provision is not tax

d e d u c t i b l e .

FUTURE DIRECTION

In the current market, securitization is predomi-

nantly used by financial entities in order to obtain off-

balance financing, reduce their credit risk and

improve their equity requirements for regulatory

purposes. Spanish securitization structures are not

commonly used amongst non-financial entities. How-

ever, in the short term securitization will become

widely used as a financing tool by these non-financial

entities, given that a permitted securitization vehicle

under the Spanish Securitization Law offers the fol-

lowing advantages over other techniques:

● In addition to existing financial assets, certain

future rights (toll roads, urban dwelling rentals,

and others as approved) can be securitized.

● The assets assigned will only be valid against third

parties if they are publicly-certified with a certified

date (which is important in the case that the origi-

nator becomes insolvent). However, the use of a

securitization fund means that this public certifica-

tion should only be required once at the incorpora-

tion of the fund.

● No withholding taxes apply to proceeds obtained

by the SPV. Thus, a securitization structure could

be used in order to avoid withholding taxes on pro-

ceeds that otherwise would be levied (eg interest to

be collected by non-financial entities and royalties

on certain dwelling rentals).

Given these benefits, securitization offers an attrac-

tive financing technique in Spain for all industries and

sectors. Increased securitization activity is expected

to result primarily from an expansion of asset classes.

A special supplement to International Tax Review June 2000 107

Although current law does not pre-

vent securitization of Swedish assets,

it does in most instances render the

securitization process ineffective

and unviable if conducted entirely

in Sweden. Despite this inhibition

on market development, securitiza-

tion is accepted in Sweden as a valu-

able financing tool.

The market in Sweden for securi-

tization is very young but growing

and developing somewhat differ-

ently from the US market. This is

because legal obstacles exist and

assets are far from being homoge-

neous. Consequently, those partici-

pants involved in the Swedish

securitization business have to be

more creative in order to generate

volume. More typical are multi-

jurisdictional deals, which in the

future will be enhanced and facili-

tated by conversion to the Euro.

Real estate companies are an obvi-

ous target for securitization planning

and implementation because they pay

relatively high interest rates on their

loans compared to international levels

and because they are a capital intensive

part of the economy. Other possible

securitization products involve resi-

dential and commercial mortgages.

However up until now only five or six

operators are involved in securitization

in Sweden. In many of the transactions

the SPV has been established in a tax

h a v e n .

In an attempt to simplify securiti-

zation in Sweden, the Ministry of

Finance is considering introducing

new legislation in this area. Accord-

ing to officials within the ministry,

the new rules are under considera-

tion and will probably come into

force on January 1 2001.

TAXATION

There are no specific tax rules

applicable to securitization in Swe-

den but a general anti-avoidance act

applies. The SPV is taxed according

to normal corporate income tax

rules and therefore is also covered

by the anti-avoidance act.

The transfer of the assets to the

SPV must take place according to

the tax rules. Even if an agreement

under civil law is in place, the tax

courts may not accept the agree-

ment for tax purposes. Tax issues

may arise due to the earnings/cash

flows of transferred assets. The

financing of the SPV may give rise to

tax considerations.

If the SPV is domiciled in Swe-

den, ordinary tax rules apply. If,

alternatively, the SPV is established

in a tax haven, it may fall under

Swedish CFC rules. This generally

applies where there is a community

of interests between the originator

and the SPV. There may also be a

Sweden

Securitization: Sweden

www.internationaltaxreview.com

withholding tax problem due to leasing payments

from Sweden to the SPV. These payments may be

regarded as royalties and such payments are truly not

subject to withholding tax, but are taxed as Swedish

source income at the normal corporate rate of 28%.

A CCOUNTING

Financial institutions are facing an increasing require-

ment to maintain capital ratios to match the quantum

of the securities. This highlights the advantages of off-

balance sheet accounting. The core issue with an

impact on both audit and capital matching issues is

therefore whether or not the transfer of assets may be

disclosed as sales. Sweden does not have specific rules

to determine whether a sale has occurred. Typically

reference is made to international standards such as

FAS 125 and IASC standards (discussed in the Aus-

tralian commentary).

In addition, the issue of consolidation must be con-

sidered, as the majority of securitization undertakings

are conducted by using an SPV to acquire the assets

subject to the securitization that finances the acquisi-

tion by issuing debentures, bonds or similar financial

instruments. Where one vehicle has control of

another vehicle, international accounting requires

consolidation of the controlled entities. Swedish civil

law, however, defines the relationship between enti-

ties differently than that of the accounting and audit

regulations. In order to circumvent the situation

where the vendor is viewed as the controlling vehicle

with the subsequent consolidation requirement, many

securitization transactions are being structured so

that the SPV is owned by a trust rather than a com-

pany.

Finally, the treatment and disclosure of on-going

income and expenditure throughout the entire

period of the transaction must be carefully scruti-

nized. The timing and manner in which these items

are disclosed are decisive to the originator when eval-

uating the outcome of a contemplated transaction. In

particular, consideration must be given to the provi-

sion for liabilities relating to possible vendor recourse

undertakings, the treatment of structuring costs

assumed by or imposed on the vendor and valuation

of advances from the vendor to the SPV.

FUTURE DIRECTION

Although current legislation does not prevent securi-

tization of Swedish assets, it does, in most cases, ren-

der the securitization process economically ineffective

if conducted entirely in Sweden. The primary reason

for this result is that, pursuant to the Law of Finance

Activities, the acquisition of accounts receivable by an

SPV is considered to constitute carrying on the busi-

ness of financing. Consequently, the SPV is required

to hold sufficient capital to match the quantum of the

accounts receivable acquired. The capital outlay

requirement is considered to be the most significant

factor preventing widespread use of the securitization

concept in Sweden. Securitization is thus conducted

via SPVs situated outside Sweden.

A memorandum compiled by the Ministry of

Finance purports to offer various suggestions regard-

ing a rewrite of the law in order to simplify the imple-

mentation of securitization in Sweden. The

memorandum recommends exemption from the Law

of Finance Activities for entities conducting one-off or

irregular acquisitions of accounts receivable assets for

the purpose of securitization through a legally recog-

nized SPV. It is postulated that the fundamental

financial interests that are protected do not justify the

application of separate legislation to govern the area

of securitization. Securitization business ventures

must not, however, be financed by raising capital from

the general public.

The area that has attracted most interest from the

regulatory bodies centres on securitization issues

relating to the originator. The focus has primarily

been on financial entities. Initially, the focus was on

the conditions alleviating entities from the require-

ment to match the quantum of the accounts receiv-

able, disclosure of the accounts receivable transferred

and how potential remaining rights and obligations

should be handled. The legislation governing these

issues, namely the Law of Capital Matching and Sub-

stantial Exposure to Credit Institutions and Financial

Instrument Entities and the Law of Credit Institutions

and Financial Instrument Entities, is general and does

not stipulate intricate rules for the treatment of secu-

ritization transactions. The legislation is interpreted

in conjunction with guidelines issued by the Finance

Inspection. The memorandum recommends that the

separate regulation of securitization transactions

would require specific legislation. This is considered

unnecessary, as securitization is considered to fall

within the Finance Inspection’s jurisdiction, thereby

rendering express legislation superfluous. It is, how-

ever, imperative that the existing uncertainty within

this area be eliminated.

The recommendation does not foresee the need to

draft legislation to govern consumers, whose accounts

receivable become the subject of securitization, or the

acquirers of the debentures issued by the special pur-

pose entities. The justification for this position is that

existing law provides sufficient protection.

108

A special supplement to International Tax Review June 2000 109

Although Swiss banks, financial insti-

tutions and other corporates are

beginning to recognize the strengths

of securitization as a financial tool,

there has been very little actual trans-

action experience in Switzerland.

Few securitization transactions have

been completed.

The following commentary looks at

reducing capital cost as a major value

driver of a company by using asset

and project financing instruments.

Instead of financing the whole busi-

ness, groups of assets and projects

with a specific risk structure – differ-

ent from the risk profile of the whole

company - are financed separately.

The investor takes on the specific risk

structure of the assets or the projects

rather than the risks of the entire

company. The financing of the core

business of the company is not influ-

enced by the risks associated with the

assets or projects that are financed

separately on the financial markets.

EXAMPLE I: ASSET-BACKEDSECURITIES

In general, an SPV without commer-

cial activities is established in an off-

shore country. The SPV issues bonds

to investors. The funds received are

transferred to an originator either by

purchasing these assets or by grant-

ing a loan. If the SPV grants a loan,

the payment of interest and the prin-

cipal amount is secured by the

financed assets. The Swiss tax treat-

ment of ABS differs if the SPV pur-

chases the assets and bears the risks of

the assets rather than issuing bonds

that are secured by the assets.

The diagram in Box 1 (overleaf)

illustrates the situation where owner-

ship of the assets is transferred to the

SPV.

If the ownership of the assets is

transferred from the originator to the

foreign SPV, the issue of bonds by the

SPV is not regarded as a Swiss bond

for withholding and stamp tax pur-

poses, provided that:

● the price agreed following the

transfer of the assets is determined

on an arm’s-length basis;

● the assets are removed from the

balance sheet of the originator;

● the risks connected with the assets

transferred to the SPV are borne

entirely by the SPV;

● the SPV has no put option regard-

ing the assets purchased.

The opportunities and risks on the

assets may be transferred to the SPV

by a sub-participation of the SPV in

the assets. The sub-participation

should be treated like the sale of the

assets to the SPV. However, there is

no safe harbour rule and this strategy

may be best discussed with the tax

authorities before the issuance of this

type of financing vehicle.

Switzerland

Securitization: Switzerland

www.internationaltaxreview.com

Alternatively, the loan may be secured by the assets

and the originator remains the owner of the assets and

bears the risks in connection with the assets. The assets

secure the issuance of the bond by the SPV and provide

the investors with a low-risk investment opportunity.

This is illustrated in Box 2.

If the funds for the issuance of bonds received by the

SPV are transferred to Switzerland, the bond will be

treated as a Swiss bond for Swiss withholding tax and

stamp tax purposes. Hence, it may be better for the

group to use the funds offshore rather than transfer

these back to Switzerland.

EXAMPLE II: CORE MORTGAGE-BACKEDSECURITIES

The rules regarding ABS generally apply to MBS. In

addition, specific rules on mortgage secured loans must

be considered in the case of foreign creditors. Interest

paid on mortgage loans to foreign recipients is subject to

withholding tax (3% direct federal tax as well as can-

tonal and communal taxes, eg 14% in the Canton of

Zurich). Therefore, it is essential that a double tax treaty

between Switzerland and the country of residence of the

SPV eliminate this withholding tax burden on Swiss

mortgage secured loans.

110

Box 1: Ownership of assets transferred tothe SPV

Swiss OpCo

Sale of

assetsBond issue

Investor

SPV

Box 2: Ownership remaining with owner ofa s s e t s

Swiss OpCo

Loan agreement

secured by assets

Bond issue

secured by assets

Investor

SPV

A special supplement to International Tax Review June 2000 111

The UK is Europe’s largest securitiza-

tion market, with issues worth

approximately $26 billion in 1999.

Domestic mortgage loans were the

first asset class securitized in the UK,

and this class remains one of the most

important. The market has subse-

quently expanded significantly to

include, among other things, credit

card receivables, other consumer

loans, lease receivables and whole

business securitizations whereby the

entire future receivables of a com-

pany are securitized.

New asset types and structures con-

tinue to be introduced and the use of

securitization for funding purposes

by major UK banks and financial

institutions is increasing. For exam-

ple, a number of securitizations of

future revenues from operating com-

panies have taken place in the UK.

These include a £230 million securiti-

zation by the Tussauds Group (opera-

tors of visitor attractions and theme

parks) and a £135m securitization by

Wightlink Limited (a domestic ferry

and ports owner and operator). In

both cases the proceeds of the issue

were mainly used to refinance indebt-

edness associated with the acquisition

of the companies. Many other new

asset classes have been, or are being,

developed, including season tickets

and intellectual property such as pub-

lishing royalties. Recently, interest

has grown in securitizations as a risk

transfer mechanism for credit risk

and as a form of reinsurance.

The use of ABCP conduits, estab-

lished by US and, increasingly, UK-

based banks, has become very common

in the UK, with the usual benefits for

originators including cost and speed.

EXAMPLE I: MORT G A GE ANDCREDIT CARD RECEIVABL ES

A typical UK structure of a MBS issue is

illustrated in Box 1 (overleaf).

The issuer in this example is a newly

incorporated orphan SPV, ie it is not

part of the originator’s UK group. The

shares are being held indirectly by a

charitable trust. The bonds are secured

by a fixed charge over the issuer’s bene-

ficial interest in the receivables and

other rights and a floating charge over

the whole of the undertaking and assets

of the issuer not already subject to a

fixed security.

P r o fit extraction from the structure

is more complicated than if the issuer

were part of the originator’s group

since in the absence of this profits can-

not be extracted as dividends. There

are a number of solutions to this prob-

lem, including using deferred consider-

ation or using a receivables trust.

Under the trust structure, the receiv-

ables are paid initially not to the issuer

but to a receivables trustee. The receiv-

ables trustee holds the assets in trust for

UnitedKingdom

Securitization: United Kingdom

www.internationaltaxreview.com

the originator and the issuer, with the issuer given such

amounts as it needs to meet its liabilities and the balance

remaining with the originator. Receivables trusts are tax

transparent provided they are properly constituted.

Similar structures have been used in credit card securiti-

zations in the UK. The recent Barclaycard deal used an

innovative variant on the receivables trust involving fur-

ther issues of notes on the back of new receivables sold to

the same trust.

EXAMPLE II: PROPERTY

The last year has seen a number of large property securiti-

zations in the UK. The largest of these transactions to date

was the securitization of the Broadgate office complex in

London, with £1.54 billion of bonds issued. A simplifie d

version of the transaction structure is as follows:

The property holding companies and the borrower are

both indirect subsidiaries of the originator, British Land

PLC (BL), a British property company. The property

companies are new SPVs, each established to hold a 999

year lease over an individual property. The obligations of

the issuer under the bonds are secured by fixed and flo a t-

ing charges over all the property and assets of the borrower

and each of the property holding companies. The notes

issued by the borrower are in two tranches – secured notes

of £100 million and unsecured notes of £1.44 billion.

The securitization was designed to allow BL to take

on borrowings in excess of those permitted by covenants

in BL’s existing Eurobonds, limiting the amount of

secured debt which the company is able to issue (to £100

million).

Another recent securitization implemented for the

supermarket chain Sainsbury’s, involved splitting the

interest in the property between the freehold – held for

the benefit of the originator or a third party investor –

and a long leasehold granted to the issuer. A further

variant, seen in a number of nursing home securitiza-

tions, involves purchase of an AAA-rated zero coupon

bond by the issuer to defease the principal amount on

the senior bonds.

TAXATION

The UK has no specific tax legislation designed to facilitate

securitization, but the application of general UK tax princi-

ples to securitization transactions is now well understood.

In recent years the UK has moved to taxing companies

more closely by reference to the profits shown in their

accounts and it is crucial for tax advisers and accountancy

experts to work closely together.

O r i g i n a t o r ’s position

For the originator, a crucial question is the treatment of the

disposal to the issuer of the receivables that are to be securi-

tized. In many cases, the disposal will be taxed by reference

to the originator’s accounting treatment. This is the case in

relation to trade debts, for example, and also where the

receivables concerned are loan relationships within the

rules in the Finance Act 1996. In some other cases, a spe-

cial treatment for tax purposes will apply, for example, in

the case of assets held as capital assets (notably, real prop-

erty) and intellectual property rights (where the treatment

can be more complex, depending on the nature of the

assets concerned).

Where the assets concerned are capital assets, most

notably real property, it is possible that a substantial capital

gains tax (CGT) charge can arise when assets are trans-

ferred to the issuer. There are various possible ways to

avoid this charge. Normal tax planning (use of capital

losses, or availability of capital allowances) may eliminate or

reduce the tax charge. The securitization vehicle may be

established as a member of the UK tax group of the origi-

nator. The disposal of a freehold or grant of a lease can

generally therefore be entered into within a UK tax group

112

Box 1: Typical UK structure of an MBS issue

Investors

Issuer

Obligor

Originator

Receivables

trust

Balance of

funds

Interest

or

Principal

and

interest

Principal

and

interest

Bond

proceeds

Proceeds

Sale of loan

portfolio

Principal

and

interest

Box 2: A simplified version of the propertytransaction structure

Investors

Issuer

Propertyholding

companies

Borrower

Inter-

company

loans

Interest

and

principal

Bond

proceedsProceeds

Secured notes

Unsecured

notes

Property company

guarantees

Interest and

principal

Rental income

Fixed charges over

property and rent

Principal

and

interest

Securitization: United Kingdom

113

without adverse CGT implications, although on a short (up

to 50 years) lease there will additionally be a charge to tax as

income on part of any premium.

In the case of other forms of capital assets, such as leased

equipment or intellectual property rights, more elaborate

structures will be needed. For example, in the case of secu-

ritization of equipment leases a structure can be put in

place which, by bifurcating interests in the assets and the

receivables, avoids a clawback of capital (ie depreciation)

a l l o w a n c e s .

One other issue is that care must be taken to ensure the

deductibility of the substantial fees of the issue. Incidental

costs of raising finance may, if properly structured, be

deductible by the issuer under the FA 1996 rules. Account-

ing Standard FRS4 will generally require issue costs, and

thus the tax deductions, to be amortized over the period of

the notes. Alternatively, the originator may be able to claim

at least some expenses as incidental costs of disposal of the

relevant assets and hence claim an immediate deduction as

a trading expense (where the assets concerned enjoy this

treatment) or can claim incidental cost on any chargeable

disposal for CGT purposes.

I n v e s t o r

An investor’s UK tax position will be reasonably straight-

forward. Notes will generally fall within the withholding

tax exemption for quoted Eurobonds. The notes will nor-

mally be loan relationships, and the investor is subject to

UK corporation tax. The only issue which is less than

straightforward is the treatment of losses. This is unlikely

to be contemplated by investors (especially given the good

record of securitizations historically in terms of defaults)

but an exception exists in the case of risk securitizations.

UK investors to date have generally been insurance com-

panies or bond dealers, and the view so far (and it is under-

stood that the Inland Revenue may concur) is that the

accounts treatment for UK insurance companies which

invest in them will also apply for UK tax purposes.

I s s u e r

It is crucial that the issuer be tax transparent. The most

important payments made by the issuer will be principal

and interest on the bonds. For UK tax purposes, interest

will be tax deductible – principal will not be. In determin-

ing the availability of tax deductions, accounting principles

will be applied under the FA 1996 provisions. The receiv-

ables, on the other hand, may well have a different profil e .

Tax mismatches can arise because of differences between

the tax rules for the timing of bad debt relief and the point

at which the issuer is required for rating purposes to recog-

nize a bad debt. A further point to watch is that this timing

mismatch could become permanent due to restrictions on

availability of carry-back for losses if the bad debt is later

recognized for tax purposes. It is important to note that all

UK rental income is subject to UK tax.

A number of reasonably imagina-

tive solutions have been devised.

The simplest is to establish the

issuer offshore in a jurisdiction

that has a more convenient tax

regime (or a tax haven). This is

subject to withholding tax, dis-

cussed below. These issues

are particularly acute in

certain asset classes such as

property, but the use of a

split freehold/leasehold

structure, as mentioned

above, can mitigate the prob-

l e m .

P r o fit extraction is elementary where the structure

involves setting up the issuer as a subsidiary of the origina-

tor. Dividends can then be paid by the subsidiary to the

originator. With other structures, a somewhat similar

result can be obtained if the originator makes a participat-

ing loan to the issuer. Interest on such a loan is not tax

deductible for the issuer, and if the issuer is a UK resident

company it is not taxable for the originator either. If the

loan in question is a subordinated loan it will be possible to

justify a high interest rate. However, unless the originator

is a bank (as defined for UK tax purposes) there can be a

withholding tax disadvantage if the issuer is UK resident.

This can be overcome by structuring the loan in a different

way, for example as a zero coupon bond issued at a dis-

count. Where a subordinated loan is made for this reason

or for credit enhancement, issues also arise concerning the

availability of bad debt relief for the originator if it becomes

clear that the subordinated loan will not be repaid.

These concerns can also be mitigated by careful atten-

tion to the question of fees paid by the issuer. The origina-

tors (and other related parties in the transaction) may well

be providing all kinds of services to the issuer (apart from

administering the assets). It is fruitful to think analytically

about what all the services are in a particular case and to

ensure that the issuer pays a fair fee for all of them. In

appropriate cases, these fees will be tax deductible for the

issuer although complications and possible tax leakage can

arise as regards VAT.

An efficient method for profit extraction is to put in

place a receivables trust, as described above.

Withholding taxes

UK withholding taxes do not apply to certain classes of

receivables, including trade debts (except possibly where

interest is payable on them for late payment), equipment

lease rentals and payments under HP or conditional sale

contracts. However, withholding taxes do apply to items

such as interest (unless the advance was originally made

from a bank if the issuer is within the charge to UK corpo-

ration tax). They also apply to rents payable to an offshore

entity, though for such rents it is usually possible to pay the

gross amount (subject to clearance and to strict compliance

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Securitization: United Kingdom

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with the requirements for submitting income tax returns).

An offshore issuer that carries on a business of holding UK

land must file UK tax returns and is still subject to UK

income tax on its net profits at a rate of 22%.

In cases where UK withholding tax cannot otherwise be

avoided, it has become increasingly common to use an off-

shore entity that claims double tax relief under a double

tax treaty. Favorites include Ireland, the Netherlands and

the US.

Stamp duties

UK stamp duty at a rate of 4.0% applies on transfers of

many UK assets, subject to various exemptions including

an exemption for secured loans. Stamp duty may there-

fore apply to transfers of trade debts, credit card receiv-

ables, freehold and leasehold property and many other

forms of receivables. In a property securitization this can

be of concern, but if sufficient shares (with rights to profit s

available for distribution to equityholders and rights to

assets available for distribution on a winding up) of the

issuer are held by the originator’s group, relief will be avail-

able because the transfer should be an intra-group transac-

tion within Section 42 of the Finance Act 1930.

Other techniques to avoid the duty exist but, as in a secu-

ritization, the possibility of enforcement must always be

considered. The credit rating agencies may well require a

stamp duty reserve to be maintained, or a transfer docu-

ment to be executed and adjudicated for stamp duty pur-

p o s e s .

A CCOUNTING

In the UK, as in the discussion in many of the other juris-

dictions discussed, the main accounting issues arising

relate to the treatment of the assets transferred to the

issuer. Specifically, it is necessary to consider whether the

transfer of the assets allows off-balance sheet treatment for

the originator and whether there is a requirement to con-

solidate the issuer in the financial statements of the origina-

tor.

The main UK accounting guidance relevant to securiti-

zation is Financial Reporting Standard 5 (FRS5), Report-

ing the Substance of Transactions. The central premise of

FRS5 is that the substance and economic reality of an

entity’s transactions should be reported in its fin a n c i a l

statements.

In terms of FRS5, where there is a series of connected

transactions, the overall substance of these transactions as a

whole must be determined and accounted for, rather than

accounting for each individual transaction. This can have

an impact on securitization transactions, with the conse-

quence that the accounting treatment appropriate under

FRS5 will be different from that which would apply if the

transactions of each entity in the securitization structure

were viewed independently. A detailed application note

relating to securitized assets was issued with FRS5 and is

regarded as part of the standard, although it is not exhaus-

tive in nature.

The question of whether or not assets transferred by the

originator and the notes issued by the issuer should appear

on the balance sheet of the originator can be subdivided

into two main issues:

● Has the sale of the assets succeeded in transferring the

risks and rewards of ownership of the assets from the

originator to the issuer?

● Is the issuer a subsidiary or quasi-subsidiary of the origi-

nator? If it is, then the issuer’s accounts will have to be

consolidated with those of the originator with the result

that the assets and liabilities that appear on the issuer’s

balance sheet will appear on the consolidated balance

sheet of the originator.

In terms of FRS5, there are three possibilities in relation

to the required disclosure of the securitization in the origi-

nator’s financial statements:

● Derecognition, where the securitized assets are

regarded as sold and are consequently removed from

the balance sheet. This is appropriate only if all the sig-

n i ficant risks and rewards relating to the debts in ques-

tion have been disposed of.

● Linked presentation, where the proceeds of the note

issue are shown as a deduction from the securitized

assets as a net figure within the assets section of the bal-

ance sheet. This is likely to be appropriate if the origina-

tor has retained significant risks and rewards in relation

to the securitized assets but has limited its downside

exposure to loss to a fixed monetary amount. There

must also be no arrangements under which the origina-

tor can reacquire any of the securitized assets in the

future. These conditions should be applied restrictively.

● Separate presentation, where the gross securitized

assets appear on the asset side of the balance sheet, with

the proceeds of the issue within creditors. This will

apply if neither derecognition or linked presentation is

a p p r o p r i a t e .

114

Securitization: United Kingdom

115

The considerations discussed above will also apply in

determining the appropriate treatment of the securitiza-

tion in the issuer’s accounts. However, it is generally clear

that separate presentation is required.

The second question to be answered is whether the

issuer has to be consolidated by the originator. This will be

the case if the issuer is a subsidiary or quasi-subsidiary of

the issuer. In this context a quasi-subsidiary is defined by

FRS5 as follows:

"A quasi-subsidiary of a reporting entity is a company,

trust, partnership or other vehicle that, though not fulfil-

ing the definition of a subsidiary, is directly or indirectly

controlled by the reporting entity and gives rise to benefit s

for that entity that are in substance no different from those

that would arise were the vehicle a subsidiary."

The key feature of the above definition is control, which

in the context of a quasi-subsidiary means the ability to

direct its financial and operating policies with a view to

gaining economic benefit from its activities. Control is also

indicated by the ability to prevent others from exercising

those policies or from enjoying the benefits of the vehicle’s

net assets.

If the issuer is a quasi-subsidiary it will require consoli-

dation as part of the UK group accounts. Consolidation is

founded on the principle that all the entities under the

control of the reporting entity should be incorporated into

a single set of financial statements. Applying this principle

has the result that the assets, liabilities, profits, losses and

cash flows of any entity that is a quasi-subsidiary should be

included in group financial statements in the same way as

if they were those of a member of the statutory group.

In addition, FRS5 requires that when quasi-subsidiaries

are included in consolidated accounts, the fact of their

inclusion should be disclosed, together with a summary of

their own financial statements within the notes to the

a c c o u n t s .

However, where a quasi-subsidiary holds a single item

(or a single portfolio of similar items) and this arrangement

results in the item being financed in such a way that the

conditions for linked presentation are met, then the quasi-

subsidiary should be included in the group financial state-

ments by using a linked presentation. The quasi-subsidiary

issue does not therefore prevent the use of linked presen-

t a t i o n .

FUTURE DIRECTION

There can be little doubt that the volume and variety of

securitizations will continue to grow in the UK. This will

require an innovative and creative approach from

arrangers and their advisers. At the same time, as the mar-

ket intensifies, tax efficiency will become ever more signifi-

c a n t .

Future tax issues likely to arise in the near future

include stamp duty on the transfer of assets to securitiza-

tion vehicles. The government has declared its intention

to procure closer compliance with stamp duty obligations

and the tax remains an oddity in that it is not directly

enforceable. The UK is out of step here, not merely with

the EU but also with former colonies. It is also probable

that stamp duty rates on asset transfers will increase signifi-

cantly in the coming years.

Perhaps the most intriguing issues for UK securitiza-

tions will be presented by the current moves for tax ‘har-

monization’ within the EU, including the proposed

introduction of a withholding tax. Securitization vehicles

are one of many capital markets structures which would be

seriously affected if the alternative suggested by the UK

government (introducing a reporting requirement in rela-

tion to interest earned by non-residents) is not accepted

although it now appears that the UK view will prevail. It

should also be noted that the EU, among others, has taken

steps to challenge the favourable tax treatment of the

Channel Islands and the Isle of Man, although it is likely to

be some time until this fundamentally political issue is

r e s o l v e d .

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117A special supplement to International Tax Review June 2000

The US is the largest securitization

market in the world and typically

has led the innovation of securitiza-

tion products. Historically, US cor-

porations borrowed funds through

debt from, or securities offerings to,

the public through traditional unre-

lated financial agents (eg banks). In

the last decade, US borrowers have

been using asset securitizations

more and more to raise funds, and

using unrelated financial interme-

diaries mainly as underwriters.

There are essentially three types

of securitization of assets commonly

used in the US to obtain financing

for a business by leveraging its

assets:

● Securitization of financial assets

such as auto loans, mortgages,

trade and insurance receivables.

Often the form used to raise

funds from the ultimate investor,

using these assets as collateral,

will be a security.

● Asset-backed financing. Unlike

the above type of securitization,

the collateral for asset-backed

financing is not necessarily struc-

turally isolated from the credit

and liquidity of the underlying

business, and often includes non-

financial assets.

● Revenue anticipation securities,

such as municipal tax, tobacco

settlement funds and other rev-

enue, and anticipation notes,

lease, royalty, and earned but

amount uncertain receivables.

The actual type of securitization

vehicle used within each of these

three securitization types (or combi-

nation thereof) will depend on the

type of asset securitized. It will also

depend on the goals or benefits

desired by the issuer and/or target

investors (eg to remove assets and

liabilities from the borrower’s bal-

ance sheet, lower after-tax cost of

financing, improve liquidity, maxi-

mize investors’ risk-adjusted after

tax return).

US TAX ISSUES

In addition to the benefits desired

and the broad forms of securitiza-

tion available, it is important also to

consider the following potentially

significant US tax issues when

determining the best securitization

structure to use.

Choice of entity used for thes e c u r i t i z a t i o n

Special purpose trusts (ie grantor or

owner trusts that issue both debt

and equity interests), partnerships,

or corporations (eg for collateral-

ized mortgage obligations), may be

used. The first two are typically

United States

Securitization: United States

www.internationaltaxreview.com118

transparent, in that no tax is imposed either on these

entities, or on transferors to these special purpose

entities. This US tax treatment is preferred, unless

the issuer is tax-neutral. However, unlike partner-

ships and corporations, trusts may be recharacterized

as partnerships or corporations by the Internal Rev-

enue Service.

Investor interest as debt v equity

If an investor’s interest in an SPV is equity, the

investor will be deemed to receive dividends with no

deduction to the SPV, to lower the cost of financing.

(In addition, foreign investors, especially investors

from countries which have an income tax treaty with

the US, are more likely to be subject to US withhold-

ing taxes if the payment is deemed to be a dividend.)

However, a US corporation issuing equity to US cor-

porate investors may obtain a similar benefit. Since

these US investors will only be taxed on 30% of the

dividend, the issuer may reduce the instrument’s

(dividend) rate approximately equal to an interest

deduction benefit.

Sale v collateralized loan treatment fortransfers to SPV

Sales are taxable events, generally requiring gain or

loss recognition (or acceleration of income recogni-

tion, as with the sale of lease receivables). Issuers

generally try to avoid this US tax treatment.

Secured loan treatment, however, may cause

investors to be taxed on interest income accrued but

not yet received, ie original issue discount, on the

excess of the amount payable on maturity over the

issuance price.

Role of SPV

Regardless of whether a transaction is either a sale or

a loan, the issue of whether this sale or the loan is with

the SPE, or alternatively with investors (or interest

holders, ie SPE is only acting as a securitization inter-

mediary), needs to also be addressed in structuring.

US SECURITIZATION VEHICL ES

The discussion herein of US securitization vehicles not

commonly used outside the US reflects the above frame-

work of types of securitizations, and the US tax con-

straints in structuring securitization vehicles of these

t y p e s .

Although most of the securitization vehicles used today

worldwide were first marketed in the US, largely due to

the globalization and integration of financial markets,

describing the countless forms of securitizations used in

the US that are now commonly used in many of the other

countries mentioned in this article (and therefore

described in other countries’ sections) would only serve to

confuse. Therefore, this final section reflects the fact that

securitization is another form of financing with collateral

and almost any asset (or revenue anticipated) may be

securitized for US taxes.

However, markets will reflect the rate appropriate for

the quality (eg risk) of the collateral and credit enhance-

ments thereto. Often, the credit-worthiness of the secu-

rity requires that the issuer sell beneficial interests in a

grantor trust formed to hold these assets, with the

grantor retaining an equity interest (ie capital) in the trust

as credit support to the buyers.

Because the goals, nature of assets and legal and

accounting rules (pursuant to the 1988 Basle Accord, as

amended) for securitizations are similar in all economi-

cally advanced countries, the vehicles used in these coun-

tries will also be significantly similar. However, due to

s p e c i fic factors such as local market perceptions, tax con-

straints, issuer needs, innovation, and sundry differences,

there may be differences. This section of this article

focuses on US differences, especially those due to US tax

c o n c e r n s .

The broad categories of selling interests in assets or

using them as collateral for a loan through pass-through

trusts (eg grantor trusts) and leveraged (eg owner) trusts

or corporations, are well understood by issuers and

investors. Therefore, the pass-through trust structure is

typically used in basic securitization vehicles, while the

leveraged model provides greater flexibility. This is

because the pass-through trust cannot have multiple

classes of beneficial ownerships. As a result, this precludes

the use of fast-pay and slow-pay trust certificates. The

leveraged entity may have multiple classes of ownership

(eg multiple classes of debt and equity) and the power to

vary investments may be retained. However, care must be

taken to ensure that the debt securities sold to investors

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119A special supplement to International Tax Review June 2000

are in fact characterized as debt for US tax purposes.

For example, although auto loans are usually securi-

tized by use of owner trusts (for maximum flexibility to

meet different investors’ objectives), in April 2000, Mel-

lon Bank chose to issue its second grantor trust auto loan

securitization, because of the relatively small amount of

auto loans securitized.

CREDIT CARD TRUST S

Aside from the core worldwide securitization techniques

(as described in other countries’ sections of this article),

the US market has also made use of more sophisticated

securitization vehicles and structures. For example, the

use of a trust borrower structure has been widely used for

repackaging (securitizing or monetizing) credit card

accounts. The credit card trust is different from other

securitization forms, in that its principal balance (of

assets) increases and decreases. Its assets include the

credit card accounts, amounts charged by cardholders

for goods and services as well as cash advances, fin a n c e

charges, and other charges such as annual fees and late

charges. As a cardholder charges additional amounts,

these amounts are automatically transferred to the trust.

Thus, its asset pool constantly increases because of addi-

tional charges, and decreases due to losses, principal col-

lections and other adjustments.

In this structure, the investor certificates represent an

undivided interest in the credit card receivables held by

the trust.

The investors are entitled to receive interest only at a

stated rate on the principal balance of the investor certifi-

cates for a period of time, usually from one to two years.

Thereafter, all or a portion of the principal collected on

the credit card accounts is allocated to pay down the

investor certificates’ principal. Interest is also payable on

the investor certificates during this period. The origina-

tor certificate holder is entitled to the balance of the assets

of the trust.

Recently, home equity loans have used this credit card

type securitization vehicle structure. These loans resem-

ble credit card debt, in that the borrower can draw down

additional credit up to its home equity credit (line) limit.

The non-REMIC home equity loan transaction is struc-

tured so that the home equity loan accounts are trans-

ferred to the trust. If a borrower draws on its home

equity line of credit, the increased principal balance

becomes part of the trust and repayments with respect to

the new balance can be used to retire the investor certifi-

cates.

REAL ESTATE MORT G A GE INVESTMENTCONDUIT (REMIC )

To make it easier for borrowers to securitize their

financial assets, the US Congress created two elective

securitization structures, REMIC (for mortgage loans

held) and FASIT (for mortgages and other loans to

unrelated persons held), that statutorily provide

responses (for REMICs and FASITs) to the above dis-

cussed potential US tax issues, of type of entity, debt

v equity, sale v loan, and role of SPE as a securitiza-

tion (or other) intermediate or as the actual lender

(or buyer).

A REMIC is a US statutorily created securitized

financing classification, for entities or structures that

meet the REMIC requirements discussed below.

REMIC may be used solely for the securitization of

real estate mortgages.

The use of a REMIC might be appropriate when

parties require a more clear and flexible repackaging

of the mortgages, because the four US tax treatment

uncertainties discussed above are statutorily resolved

for REMICs as follows:

● Type of entity for US tax: The US tax treatment of

a REMIC is unaffected by the legal entity form

c h o s e n .

● Debt v equity: whether interests in a REMIC are

debt or equity is determined by statute. All regular

interests in a REMIC are considered debts for US

tax purposes. Although there may be many resid-

ual or owner interests in a REMIC, they must all

have the same terms, ie be one class.

● Sale v loan: Regardless of the method used, the

formation of a REMIC is always treated as a trans-

fer of mortgages to the REMIC, followed by a sale

by the transferor of interests in the REMIC. How-

ever, if the issue price of a regular interest (based

on the fair market value of its contribution to the

REMIC) differs from this interest’s basis (based on

the basis of the property contributed), gain or loss

must be recognized and amortized in a manner

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www.internationaltaxreview.com120

similar to market discount (for gains) and bond

premium (for losses).

● Role of SPE: REMICs act as securitization interme-

diaries.

The financial reporting for REMICs differs from

the above described tax reporting in many respects,

including that the transfer of assets to a REMIC may

be structured either as a sale or as a financing for

G A A P .

Formation requirements

There are seven statutory (tax) requirements to elect

to be a REMIC. The scope of this article does not per-

mit a detailed discussion of each requirement. A sum-

mary is provided below in broad terms:

1. Although generally a trust, a REMIC may be

almost any type of entity, including a segregated pool

of assets.

2. All of the interests in the REMIC must either be

a regular or residual interest. A regular interest is an

interest whose terms are fixed on the start-up date

and is designated as a regular interest. A regular

interest unconditionally entitles the holder to receive

a specified principal amount (as defined by statute).

Interest payable thereon will be either at a fixed rate

or at certain prescribed types of variable rates. A

residual interest is an interest that is not a regular

interest. The interest must have been designated as a

residual interest and issued on the REMIC’s start-up.

It may have zero economic value; ie a residual inter-

est is not required to receive any distributions.

3. The REMIC may have only one class of residual

interest. Within this class, distributions must be

made on a pro-rata basis.

4. By the end of three months after start-up, sub-

stantially all of the REMIC’s assets must consist of

either qualified mortgages or permitted investments.

These terms are specifically defined by statute. Qual-

ified mortgages are: obligations, principally secured

(as defined by statute) by real property, beneficial

interests therein, certain replacement mortgages,

and regular interests in other REMICs, and FASITs

for which at least 95% of their values are from quali-

fied mortgages.

5. The entity must elect to be treated as a REMIC

on its first tax return. The election applies for all sub-

sequent years, unless revoked or terminated.

6. REMIC must have a calendar taxable year.

7. REMICs must have arrangements prohibiting

disqualified organizations (generally government

agencies) from owning a residual interest.

As discussed above, in order to form a REMIC,

assets must be transferred to the REMIC. No gain or

loss is recognized on property transferred to a

REMIC. Instead, any gain or loss of the regular or

residual interest is amortized over the life of the regu-

lar (transferring) interest, or the expected weighted

average life of the (contributing) residual interest.

The REMIC’s basis in these properties is equal to the

total of the issue prices of the residual and regular

i n t e r e s t s .

Taxation of the REMIC

The REMIC is generally not subject to tax and

treated as a transparent entity. However, the REMIC

is subject to a 100% penalty tax on net income from

certain specified prohibited transactions, or on any

contribution to the REMIC after start-up.

The REMIC regular interest holder is taxed as

holding a debt instrument, and income from this debt

must be reported under the accrual method of

accounting regardless of the holder’s actual account-

ing method. Any gain on sale of a regular interest is

treated as ordinary income to the extent of the excess

of the regular interest’s includible gross income as if

the yield on this interest were 110% of the Applicable

Federal Rate, provided by US Treasury (at the begin-

ning of the taxpayer’s holding period) over the

amount that the holder actually reported.

The REMIC residual holder includes in taxable

income its share of the REMIC’s residual income or

loss after interest paid to regular interests and other

expenses. However, the net loss taken into account

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121A special supplement to International Tax Review June 2000

by the residual interest cannot exceed its basis in the

residual interest. Suspended losses are carried for-

ward indefinitely to offset other income from the

R E M I C .

The residual holder is not taxed on distributions to

it, unless they exceed the adjusted basis in its residual

interest. The residual interest’s initial basis is

adjusted up for its portions of REMIC taxable

income, and down for its share of net losses (for dis-

t r i b u t i o n s ) .

TAXABLE MORT G A GE POOL S

Starting in 1992 with the enactment of IRC section

7701(i) (and its 1995 regulations), REMICs effec-

tively became the sole vehicle for issuing multi-class

real estate mortgage-backed securitizations without

two levels of taxes.

These section 7701(i) taxable mortgage pool

(TMP) rules apply both to entities that qualify as

REMICs (but do not so elect) and those that do not

qualify to be a REMIC.

A TMP is defined as any entity, other than a

REMIC, where:

● substantially all of its assets are debt obligations (or

interests therein);

● more than 50% of its assets are real estate mort-

g a g e s ;

● it issues debt with two or more maturity dates; and

● the payment terms on the multiple class debt oblig-

ations bear a relation to payments on the debt

obligations owned by the entity.

Although the TMP and REMIC rules are generally

complementary, due to differences in permitted asset

compositions (eg TMP’s lower minimum real estate

mortgage requirement), entities may qualify as

TMPs, even if they do not qualify to elect to be a

REMIC.

Since a non-REMIC multi-class TMP vehicle is sub-

ject to a corporate level tax on residual income and it

cannot be included in a consolidated Federal income

tax return (ie two levels of taxes), grantor and other

pass-through trusts and CMOs are now generally

only used when the trust has only a single class of

ownership interest or debt, instruments (eg GNMAs).

Although issuers’ preference to avoid creating

residual interests and to be able to offer investors

maturity certainty, and other factors, have kept some

issuers away from using REMICs, the general flexibil-

ity (eg recent issuances with stripped securities, ie

separate sale of principal and interest, and 13

investor classes with different payment structures)

and the tax comfort of REMICs, have made them a

popular form of multi-class mortgage-backed secu-

rity. The two largest participants in the secondary

mortgage markets, FNMA and FREDDIE MAC, espe-

cially expanded the REMIC market.

FINANCIAL ASSET SECURITIZATIONINVESTMENT TRUST (FA SIT )

In an effort to provide the benefits of the REMIC

provisions to the securitization of assets other than

real estate mortgages, Congress created the Financial

Asset Securitization Investment Trust (FASIT).

Unlike REMICs, FASITs are a separate form of tax

entity that, similar to REMICs for mortgage loans,

helped to standardize, for US taxes, the securitization

of asset loans and increased these securitizations’ effi-

c i e n c y .

Also similar to REMICs, the 1996 FASIT legisla-

tion resolved each of the previously discussed poten-

tial tax issues in securitizations, as follows:

● Type of entity: A FASIT may be any type of entity

that has the five characteristics discussed below. In

any case, its income, after interest and other

expenses, is taxable to its residual interest (with a

statutory minimum based on a formula). Unlike

with a REMIC, a FASIT’s balance sheet and

income statement are entirely included in the

residual interest’s financial statements (as if a

b r a n c h ) .

● Debt v equity: Regardless of the legal form chosen,

the regular interests are debt and the residual

interest is equity. Since a FASIT may only have

one US corporate residual interest (or owner, and

not a class of owners, as with REMICs), a regular

interest with equity characteristics, in addition to

those of the residual interest, may disqualify the

F A S I T .

● Sale v loan: On the transfer of property to a

FASIT, regardless if contributed or sold, gain (but

not loss) on the transfer, must be recognized. The

regular interest is debt on which interest is paid

(regardless of the legal form of the interest or dis-

t r i b u t i o n ) .

● Role of special purpose entity: Because of the

immediate gain recognition on transfers of appre-

ciated assets to a FASIT, it would appear that the

transferors are deemed to have sold the assets to

the FASIT and the FASIT uses these assets to bor-

row funds and to service this debt.

The FASIT asset securitization structure provides

off-balance sheet financial statement treatment for

the sponsor of the transaction (ie the owner interest).

Formation requirements

To provide flexibility, FASITs can be organized as

trusts, corporations, partnerships or a segregated

pool of assets, provided that they satisfy certain sub-

stantive requirements. As with a REMIC, specific

statutory criteria must be met to qualify as a FASIT,

as follows:

1. An entity is required to elect FASIT status. The

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www.internationaltaxreview.com122

entity may have previously been a non-FASIT or may

be newly established as a special purpose entity.

2. Substantially all of the assets of the entity, as of

the close of the third month beginning after the day

of its formation and at all times thereafter, are

required to consist of "permitted assets". These assets

i n c l u d e :

● cash or cash equivalents;

● debt obligations having non-contingent interest

payments thereon;

● property acquired in connection with the default

or imminent default of a debt obligation held by a

F A S I T ;

● instruments or contractual rights hedging against

the risks associated with being the obligor on inter-

ests issued by the FASIT (including interest rate or

foreign currency swaps and credit enhancements,

and guarantees);

● regular interests in other FASITs; and

● regular interests in other REMICs.

3. All of the interests in the FASIT are required to

be either regular interests or an ownership (or resid-

ual) interest. An ownership (or residual) interest is

defined as an interest issued by a FASIT that is so des-

ignated and is not a regular interest. A regular inter-

est is an interest that (i) is designated as such; (ii)

unconditionally entitles the holder to receive a speci-

fied principal (or similar) amount; (iii) pays interest

(or similar amounts) based on fixed or variable rates

(discussed in the REMIC regulations), or combina-

tions thereof; (iv) has a stated maturity no longer

than 30 years; (v) has an issue price that does not

exceed 125% of its stated principal amount; and (vi)

does not have a yield to maturity, as of the date of

issuance, that is more than five percentage points

higher than the yield to maturity on outstanding

marketable obligations of the US with a comparable

maturity (ie AFR plus five percentage points).

4. A FASIT must have one and only one ownership

i n t e r e s t .

5. There are also restrictions on possible holders of

FASIT interests. For example, only a domestic C cor-

poration (other than a tax-exempt corporation, a RIC

or a REIT, a REMIC, or a cooperative) may hold the

ownership interest.

Taxation of the FA SIT

As a general rule, a FASIT is treated as a pass-

through entity and not as a trust, partnership, corpo-

ration, or taxable mortgage pool, ie a FASIT is not a

taxable entity as such. However, as with REMICs, a

100% prohibited transaction tax may be imposed on

the holder of the ownership interest (rather than on

the FASIT, as would be the case for REMICs) in cer-

tain circumstances.

FASIT securities, namely regular and ownership

interests, are taxed as follows:

● Holders of regular interests in the FASIT are taxed

in the same manner as holders of any other debt

interest, except that a holder is required to report

its FASIT income on the accrual method of

a c c o u n t i n g .

● A holder of an ownership interest in the FASIT is

required to include all of the assets, liabilities and

items of income, gain, deduction, loss, and credit

of the FASIT in computing its own taxable income.

● Under the FASIT rules, holders of ownership

interests and high-yield regular interests are not

permitted to use their own net operating losses to

offset FASIT income.

FA SIT v REMIC

A FASIT may be used, in lieu of a REMIC, for the

securitization of real estate mortgages. The differ-

ences between the two statutory securitization struc-

tures include:

Securitization: United States

123

● Permitted assets can be added to a FASIT at any

time and new regular interests can be issued at any

time. A prohibited transaction tax applies to con-

tributions to a REMIC after a specified grace

p e r i o d .

● A FASIT can hold an interest rate or currency

swap, whereas a REMIC cannot unless the swap

and debt can be integrated.

● Gain is recognized on contribution of property to a

FASIT. In contrast, with a REMIC, any gain or loss

is recognized either when the regular and residual

interests are sold, or over the life of such interests.

● With a FASIT, a special valuation rule applies to

determine the amount of gain recognized on prop-

erty transfers to a FASIT. No such rule applies to

REMICs.

● For REMICs, disqualified holder rules only apply

to residual interests. For FASITs, such rules apply

to ownership interests and to high-yield interests.

The disqualified holders for FASITs include a

much broader group than for REMICs.

● A FASIT election can be made in the first year or in

any subsequent taxable year of an entity. A REMIC

must so elect in its first taxable year.

● A FASIT can only have one ownership interest. A

REMIC can have any number of residual interests

as long as they all are in one class.

● REMIC taxable income is determined as if it were

an individual. FASIT taxable income is deter-

mined at the sponsor level.

● The real estate collateral for a mortgage loan must

meet technical REMIC requirements as to its value

relative to the mortgage loan’s principal. A FASIT

has no such restriction on any debt it holds.

● A FASIT, unlike a REMIC, may not hold any direct

or indirect loan to related persons.

FUTURE DIRECTION

Without doubt the US securitization market will con-

tinue to develop and continue to perform part of the

role historically provided by financial intermediaries.

This will result not only from the use of existing

structures and asset types, but also from continued

innovations and product development. In particu-

lar, it is anticipated that there will be continued

expansion in terms of asset types and classes securi-

tized, as well as the securitization of anticipated rev-

enues. Global securitization products are expected to

develop in a manner similar to swaps, and the US will

inevitably continue to play a central role in many

global securitization issuances and structurings.

The FASIT restrictions on ownership of residual

and high-yield interests, the immediate gain recogni-

tion, as ordinary income, on transfers to a FASIT,

and the lack of even proposed regulatory guidelines

until recently, has somewhat held back the market for

FASIT use.

A special supplement to International Tax Review June 2000