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Securitisation evolves Back  
Securitisation has evolved in recent years as a financial structure. It has changed from being a low-cost low-risk means of raising finance to becoming additionally a potential form of risk sharing. It is likely to be a permanent feature of the financial landscape, despite the current bad press for off balance sheet vehicles. Irish tax law needs to change in response to the changes in securitisation itself.
The original securitisation model was an attempt to bring down the cost of borrowing. The degree of risk to which the lender is exposed is one factor in determining the interest rate on borrowing.
It was found that by taking high-class assets and isolating them from the business which owned them into an SPC, that those lending to the SPC would perceive the risks of lending to be less than if they had lent to the original business. This analysis led to the classic structure in which high-grade assets were put in an SPC and the SPC paid the originator for those assets by issuing notes to various lenders.
The value of assets in the SPC usually exceeded the borrowing, with the differential being represented by finance provided by the originator. That surplus represented by the originator’s finance was designed to provide a buffer against any drop in value of the assets, and usually also absorbed any increase in the value of the assets, by way of additional return on that finance.
A securitisation vehicle structured in that fashion had two critical attributes from a tax viewpoint. Arguably it has investment income rather than trading income, and it was likely to have a substantial interest expense. Part of that interest expense payable to the originator could vary depending on the increase or decrease in the value of the assets of the securitisation vehicle. Whereas interest is generally deductible when incurred for trade purposes, its deductibility in the context of investment income is not at all straightforward. Interest which varies according to the results of the payer is potentially not deductible but treated as a quasi dividend. Interest payments to overseas persons raise withholding tax issues.

Problems solved
All of these problems, deductibility of interest, withholding tax on interest, were originally dealt with by legislation which was confined to the IFSC.
Subsequently, as part of the process of moving to the 12.5 per cent corporation tax rate for financial services nation-wide, section 110 Taxes Consolidation Act 1997 sought to address the problems on a nation-wide basis. It generally did so in a satisfactory manner in so far as the original securitisation model described above was concerned.
It deemed the securitisation vehicle to be carrying on a trade, thus rendering interest generally deductible. It permitted a deduction for interest related to the securitisation vehicle’s results where that interest was on notes held by the originator, and where those notes do not exceed 25 per cent of the total notes in issue. These reliefs were provided only where the securitisation vehicle had at least E12,690,000 of qualifying assets obtained from one originator only.

New forms of securitisation
Section 110 represented a real effort by the Department of Finance to ensure that the Financial Service industry in Ireland could compete for securitisation work worldwide. Unfortunately the rapidly evolving nature of the securitisation market has left the provisions of section 110 behind.
Newer forms of securitisation seek to move risk away from the originator, and to find lenders who are willing to accept increased risk rather than reduced risk.
As a result the loan notes which ‘take the hit’ if the value of the assets in the SPC drops, and which correspondingly take the upside potential on the same assets, may now be held not by the originator of the SPC, but by third party lenders. Section 110 does not provide for a deduction for results related interest on notes not held by the originator.
In the newer model of securitisation it is possible that the assets of the securitisation vehicle may not be provided by the originator at all. They may well be government bonds or other assets purchased by the SPC in the market. The essential function of the assets held by the vehicle would be to provide backing for risk swaps which the vehicle might enter into with the originator.
In other words, certain risks are moved from the originator to the vehicle, and the vehicle uses the borrowed moneys as a form of security for its ability to take those risks. Once again, such a structure is not covered by section 110 since its assets would not be provided by the originator of the vehicle.
The 25 per cent limit on the amount of notes which an originator may hold, and the de minimis value of over E12m are likewise restrictions that do not suit some of the newer models of securitisation vehicles.
As a result of the limitations of section 110, Ireland is finding itself becoming a less attractive location than it previously was for securitisation business. There is a need to look again at section 110.
Witholding taxes
The issue of withholding tax is a wider issue but also important to securitisation business. Ireland imposes withholding tax on interest payments to non-residents where the interest is on borrowings likely to be for more than one year. There are numerous exceptions to the requirement to withhold tax. Further, many double tax agreements apply a zero or reduced rate of withholding tax.
Although Ireland has an extensive range of double tax agreements, it is far from comprehensive. A lender to a securitisation vehicle can be resident anywhere. The securitisation business cannot be effectively carried on if you start with the proposition that you will limit it to lenders from certain countries only.
This problem has to some extent been overcome to date by what is known as ‘the Eurobond’ exemption. Interest on a corporate security held in bearer form and quoted on certain recognised stock exchanges may be made free of Irish withholding tax subject to various conditions. This exemption does not concern itself with where the recipient is resident overseas. It is not linked to double tax agreements etc.
However Eurobonds have the peculiarity that they must be bearer instruments in order to come within the exemption. Not all investors are keen on holding bearer instruments, which is not surprising. For that reason the Eurobond exemption, although widely relied on, is not an ideal form of relief in this critical area.
The truth is that withholding taxes on interest are a shot in the foot for any financial centre. Charging local tax on non-resident interest income is not a sensible business model. That was recognised in the IFSC, where there is a general exemption from withholding tax on interest in most circumstances. However that nettle has not been grasped on a nation-wide basis.

Judgement from minister
The judgement which government must make is whether the loss of revenue from totally abandoning withholding taxes on interest paid by financial institutions, securitisation vehicles etc to non-residents would be more than compensated for by the additional corporation tax on the profits of Irish financial institutions and by the additional payroll taxes and other knock-on revenue effects of Irish financial institutions doing additional business, and growing and taking on more employees.
Superficially, it is easier to make that call when the economy is booming and tax revenues are in surplus. It might appear more difficult when deficits are looming. In reality it is far more important to make the decision in the current climate and to make that decision in favour of employment and profit growth and the taxes that go with it, rather than in favour of sterile withholding taxes.

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