The long-awaited amendment regulations updating the tax rules for UK securitisation companies were finally laid before parliament on 07 February 2018, marking an end to a long-running process for updating the UK’s securitisation companies tax rules that has been ongoing since 2015. The securitisation companies tax regulations have been in force since 2007 and apply a simplified UK corporation tax regime to securitisation companies - essentially taxing them only on their small retained cash profit.
The current changes are technical in nature and generally helpful and taxpayer-friendly, in exempting securitisation companies from UK withholding tax on “annual payments” and from secondary liabilities, broadening the scope of warehouse securitisation companies, modernising the scope of “financial assets” that can be used to securitise as well as finally taking the opportunity to update the regulations to reflect the tax law rewrite project of the late noughties which somehow overlooked them. There is nothing here that will set the world on fire, but some helpful technical steps in the right direction.
Confirming no annual payments withholding tax on residual payments
Perhaps the most important change is to put beyond doubt that “annual payments” withholding tax does not apply to residual payments by securitisation companies - ie payments of surplus cash at the bottom of the payment waterfall back to the originator which sold the assets into the securitisation company (or to an assignee/successor) by way of deferred purchase price for the securitised assets, often under a residual certificate carrying the rights to deferred purchase price in readily transferrable form. Such deferred purchase price and/or residual certificate payments have long been considered not to be “annual payments” and hence not subject to that withholding tax regime (on the basis that deferred purchase price for securitised assets cannot be pure income profit, even following an assignment of the right to receive the payment). However, elements of doubt over this analysis have lead many practitioners to seek rulings from HMRC on a transaction by transaction basis to confirm annual payment withholding tax does not apply - creating a frustrating additional moving part in the process for the UK securitisation industry and an unwanted procedural burden for HMRC in granting all the rulings.
The amended regulations helpfully exempt UK securitisation companies from “annual payments” withholding tax altogether - it was considered too difficult to define residual payments exhaustively enough to limit the exemption just to these. As a result, the new regulations do not exempt residual payments from interest withholding tax, but it is normally considered clear-cut enough that residual payments do not constitute interest for UK tax purposes to conclude this without an HMRC ruling. So HMRC rulings on residual payments should soon be a thing of the past.
Exemption from secondary liabilities
The change to the regulations also helpfully confirms that securitisation companies cannot be subject to certain rules imposing secondary liability for UK corporation tax following company purchases. This is helpful and will simplify many securitisation tax opinions - though it is not a game-changer as the market had long since concluded the practical risks were highly remote of secondary liabilities being enforced against securitisation companies.
Warehouse securitisation companies - slight extension of scope
A couple of helpful slight extensions to the scope of warehouse securitisation companies are being introduced. The new regulations make it permissible for a warehouse securitisation company to transfer its assets indirectly to a note-issuing company or asset holding company on a securitisation. This permits structures in which the warehouse company re-sells the assets back to the originator which on-securitises them instead of requiring the securitisation to flow directly from the warehouse company. Also the required purpose of securitising the warehoused assets is being diluted to securitising “all or substantially all of them” - presumably to leave room for situations where a minority of the warehoused assets are not suitable for securitisation.
Definition of “financial asset”
Securitisation companies are limited to securitisations of “financial assets”, defined primarily by reference to “financial assets” for accounting purposes, including derivatives other than those relating to shares or land. The original regulations had been left out of date and potentially ineffective by subsequent changes to accounting standards, particularly in relation to embedded derivatives. The changes to the regulations rewrite the definition of “financial assets” to clarify that the exclusion for derivatives whose underlying subject matter includes land or shares also applies to loan relationships with embedded derivatives relating to shares or land. It is anticipated that HMRC’s current published practice of treating more or less any payment cashflows, if separated from the rights or assets that generated them, as financial assets will continue, so that most forms of receivables can be separated out and securitised.
The amended regulations also provide a helpful relaxation for inadvertent inclusion of embedded derivatives in loan relationships relating to shares or land where the embedded return in relation to the shares or land is insignificantly small in value compared with the return on the loan relationship as a whole. Somewhat surprisingly the explanatory memo accompanying the new regulations mis-describes this change as applying to inadvertent inclusion of small volumes of any non-financial assets, whereas in fact it only applies to inadvertent inclusion of embedded derivatives relating to shares and land within loan relationships specifically.
Commencement and transition
The changes to the UK securitisation companies tax regulations come into force on 28 February 2018 but apply slightly retrospectively to accounting periods beginning on or after 01 January 2018. Hence securitisation companies with calendar year ends apply them from 01 January 2018, and securitisation companies with other year ends apply them from the start of the accounting period that begins in 2018. By way of exception, the changes to the definition of “financial asset” only apply to new capital markets arrangements and do not apply to deals already in place as at 06 February 2018.
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