With risk-related securitisations beginning to make their mark in Dublin, PJ Henehan considers their tax implications.
Ten years ago, the Finance Act first introduced legislation concerning the tax treatment of securitisation transactions. This start was, however, hardly auspicious; the original legislation was very narrow in focus and limited the development of the securitisation market to within the International Financial Services Centre (IFSC). Subsequent Finance Acts in 1996 and 1999 have substantially broadened the legislation, which now seeks to provide a tax neutral environment for a wide variety of securitisation transactions in Ireland including risk-related transactions.
To date, around 100 securitisation transactions have been completed in Ireland but very few have involved the securitisation of insurance risk. Indeed, there may well have been a perception in the catastrophe risk market that it was not possible to undertake an insurance risk securitisation in Ireland as the definition of ‘financial assets' in the legislation does not specifically mention reinsurance contracts. Detailed negotiations and discussions with the Irish Revenue resulted in it agreeing that a reinsurance contract can be regarded as a ‘financial asset'. This breakthrough to the establishment of the first two risk-linked securitisation special purpose vehicles (SPVs) in Ireland last year. Ireland v other locations
Tax havens are the traditional location of securitisation SPVs and as Ireland is not a tax haven, a number of tax issues need to be considered before setting up an SPV in the country. These include:
Nominally, a 25% corporation tax rate applies to the profits of a reinsurance SPV resident in Ireland as these structures are not permissible within the IFSC tax regime, where the rate is 10%. However, in calculating the taxable profits of an SPV, expenses incurred wholly and exclusively for the purposes of the SPV's trade which are revenue and not capital in nature, including interest paid by the SPV to the noteholders, should be deductible for Irish corporation tax purposes. Furthermore, interest paid on ‘residual value' notes, where these do not exceed 25% of the total value of notes issued, is also deductible in computing taxable profits of the SPV. Therefore, an effective tax neutral position can be achieved in Ireland, putting the country on an equal footing with what can be achieved in a tax haven.
Withholding tax on interest payments to noteholders
Interest paid by a reinsurance SPV in the ordinary course of its trade or business to a company resident in another member state of the EU or a territory with which Ireland has a double taxation agreement (‘relevant territory') is not subject to withholding tax in Ireland. However, interest payments to residents of non-treaty and non-EU countries or to persons whose usual place of abode is in Ireland will be subject to withholding tax at the standard rate of income tax (20% from 6 April 2001) unless, in the case of non-Irish residents, the SPV issues quoted eurobonds which are bonds held in bearer form. In practice and with some forward planning, withholding tax has not been a major issue for reinsurance-related securitisation transactions undertaken to date in Ireland.
Irish capital duty at the rate of 1% arises on the value of shares issued in an SPV if the SPV is a limited liability company. However, this cost can be reduced by funding the SPV by means of share capital and capital contribution (on which capital duty liability does not arise). In fact, if the minimum amount is put in by way of share capital with the balance by way of capital contribution, the capital duty cost is only around ¤400.
In general, stamp duty should not be chargeable on the issue or transfer of notes issued by an SPV as long as the money raised from the notes is used in the course of the SPV's business. Again, experience would indicate that stamp duty on the issue or transfer of notes should not arise in practice.
The issue of notes and the reinsurance arrangements regarding the risks to be securitised should be exempt from VAT in Ireland. While the activities of the SPV will be regarded as VAT-exempt reinsurance services and the SPV will not be required to charge VAT to the ceding insurer, it generally means that VAT incurred by the SPV on expenses such as professional fees may not be recovered. However, with careful planning it is possible to minimise irrecoverable VAT.
Tax issues for investors
There are a number of tax issues for equity investors and noteholders which have to be dealt with but again, in practice, few of them impact to a significant degree and rarely present a problem which cannot be solved.
Remuneration of equity investors
There are a number of effective methods of extracting profits from an SPV, each with its own particular tax issues. However, remuneration of equity investors normally takes the form of a dividend or other distribution and may be subject to Irish dividend withholding tax (DWT) at the standard rate of income tax unless exemption from DWT is available and appropriate documentation is in place before the distribution is paid. Exemption from DWT is available in respect of distributions made by an Irish resident company to a shareholder which is:
an Irish resident company, pension fund, collective investment undertaking or charity;
not a company and is tax resident in a relevant territory and is not resident or ordinarily resident in Ireland;
a company which is resident in a non-treaty country outside the EU where the company is ultimately controlled by shareholders resident in a relevant territory;
a company which is tax resident in a relevant territory and is not under the control of Irish residents; and
a company which is not resident in Ireland, the principal class of the shares of which, or a company of which it is a 75% subsidiary, or where the company is wholly owned by two or more companies, of each of those companies, are traded on a recognised stock exchange in a relevant territory or such other stock exchange as may be approved by the Irish Minister for Finance.
Interest received by noteholders
A noteholder which is a company resident in a relevant territory should not be liable to Irish income tax on the receipt of interest from an SPV. A noteholder resident in a relevant territory which is not a company should also not be liable to Irish income tax on the receipt of interest from an SPV, where that interest is paid on quoted eurobonds. However, where these conditions are not met, then technically the noteholder is liable to Irish income tax on that interest income. Most noteholders are likely to be corporate entities and therefore an Irish income tax exposure, in practice, is unlikely.
Capital gains tax
Any gain on the disposal (including redemption) of shares or notes in an SPV may be subject to Irish capital gains tax or Irish corporation tax on chargeable gains, where the shareholder or noteholder disposing of the shares is resident in Ireland. The current rate of capital gains tax in Ireland is 20%. A shareholder or noteholder which is neither resident nor ordinarily resident in Ireland is not subject to capital gains tax on the disposal of shares or notes in the SPV unless in the case of shares, they are unquoted and derive their value from specified Irish assets including Irish land and buildings, mineral rights and exploration or exploitation rights on the Irish continental shelf or in the case of shares or notes they form part of the assets of a trade carried on in the country through a branch or agency. In practice, an Irish capital gains tax exposure arises only for Irish resident shareholders or noteholders.
Capital acquisitions tax
Under current law, a gift or bequest of shares or notes may be subject to gift or inheritance tax where the shareholder or noteholder is resident or ordinarily resident in Ireland or where the beneficiary is resident or ordinarily resident in Ireland, or where the property of the gift or inheritance is located in Ireland at the date of the gift or inheritance. The shares or notes issued by an SPV would be regarded as Irish located property, so Irish capital acquisitions tax issues may arise for shareholders or noteholders. As most noteholders will be corporate entities, this tax is irrelevant in practice.
Although a number of tax issues must be considered when doing a securitisation transaction through Ireland, these issues generally can be resolved to the promoters' satisfaction. This, together with the inherent advantages Ireland has as a well-regulated jurisdiction in a European location, with a wide-ranging treaty network and high professional service standards, should ensure that the country can compete successfully for this business going forward. The growing trend of bringing business onshore, where possible, should also benefit Ireland. Bermuda and the Caymans watch out!