By Vinod Kothari,

Microfinance Focus, April 08, 2013: The Indian Securitisation Foundation has sought rollback of proposals on securitisation in Budget 2013. The securitisation industry has sought a pass-through status for securitisation vehicles, whereas Budget 2013 imposed a tax on distribution of tax by such vehicles.

Indian Securitisation Foundation (ISF) is body representing securitisation industry in India, consisting of banks, non-banking finance companies, micro finance institutions, and other stakeholders.

ISF contends that on behalf of the Foundation, consultants KPMG and Vinod Kothari Consultants had moved a proposal on Dec 31, 2012 seeking pass-through status for securitisation vehicles. The proposal was, apparently, accepted as the Finance Minister in his Budget Speech did make a mention of pass through status. However, the fine print of the Budget dealt a blow to the securitisation industry as it imposed a distribution tax, of 25% -30%  on distribution of incomes by the securitisation vehicles. Being a tax on gross incomes, the distribution tax is completely unjustified, and will kill the securitisation industry in the country.

Vinod Kothari, Director Designate of the Foundation explains the position thus: “Securitisation transactions are essentially financial transactions, where funding is raised through special purpose vehicles (SPVs). A securitisation SPV is a dormant, passive conduit which simply provides a legal façade to the transaction to make it qualify the true sale test. Some tax officers, around March 2012, attempted to tax SPVs. To remove unclarity on the issue, we made a representation to the Finance Ministry to provide a pass through status to securitisation vehicles. Clearly, what has been done in the Budget is to promote securitisation – however, the actual drafting of the provisions has resulted into a distribution tax. The distribution tax, being on gross income, completely disregards the actual income of the investor, and may, depending on the refinancing used by the investor, may be even higher than the net profits of the investor. If the investor has losses in the net, the distribution tax still disregards the same.”

Securitisation, in India, is partly used by banks to meet their priority-sector lending requirements. Banks which are unable to originator qualifying priority sector loans by themselves acquire the same from others by way of securitisation. Hence, securitisation is essential to the idea of financial inclusion. In addition, securitisation is also essential to promote housing finance markets. Housing finance, in line with the international practices, is funded substantially by way of securitisation. Infrastructure operators in India also use securitisation as a device of take out financing.

An executive summary of the Representation is enclosed.

 

Executive Summary of the representation

 

Our representation is in the wake of the proposals in the Finance Bill, 2013 relating to securitisation tax.   Our recommendations have been summarized in the covering letter and we have also included a detailed technical points and rationale in the document “Detailed post-Budget representation on securitization tax”.

 

However, for convenience and ease of reading, we give below a bulleted summary of this representation:

 

i.            The Budget, 2013 proposals on securitisation tax were not a product of Revenue’s finding on any tax leakage – in fact, the proposals were largely inspired by the representations made by the securitisation industry and certain regulators.

 

ii.            The sole purpose of the pre-Budget representation was to clarify the unclarity created by some tax proceedings in the matter of certain securitisation SPVs (trustees), seeking to threaten a market that was otherwise growing after the RBI guidelines of 2012.

 

iii.            There were no findings of any revenue leakage at all – as the same could not have been the case, as most of the investments in securitsed instruments comes from banks, insurance companies and mutual funds, all of whom are well regulated.

 

iv.            The overall tone of the Finance Minister in the Budget speech was to promote securitisation – the FM allowed pension funds to invest in securitized debt instruments, and also mentioned that he intends to facilitate securitization.

 

v.            However, it seems that in actual drafting of the tax provisions, securitisation SPVs were equated with mutual funds.  While mutual funds are real life entities engaged in collective investment business on a regular basis, securitisation SPVs are passive conduits dedicated to a particular transaction, and are completely non-substantive, as they do not actually receive or pay any incomes/expenses at all.  Securitisation SPVs are pass through vehicles: they automatically keep redistributing all that is collected in the name of the SPV to investors. The income in a securitisation pool is only technically the income of the SPV; substantively, the income belongs to the investors as the SPV is merely a non-discretionary, fully automated, fully passive fiduciary.

 

vi.            Hence, while a complete pass through treatment of the SPV is well agreed upon, the Budget proposals bring a distribution tax on securitisation cashflows, which is a body blow to securitisation investors.

 

vii.            While mutual funds investing in securitisation vehicles will be free from the distribution tax, we cannot miss the point that professed objective of the country is to develop the fixed income securities market, and therefore, to bring more investors into securitized debt instruments. As in most other countries, securitized debt instruments provide an effective alternative form of fixed income security in the capital market. India cannot afford to kill securitisation market, as that would have far reaching implications on the whole concept of priority sector lending, which is the very backbone of the idea of financial inclusion in the country.

 

viii.            The so-called distribution tax is a tax on gross incomes – the investors in securitized instruments are all leveraged entities, who have their own expenses, primarily interest. The net income of such investors is only a small fraction of the gross income received by such entity. Clearly enough, if an investor in securitisation has to pay tax on gross incomes, not only is the tax offensive, it is also outright inequitable, as it fails to take into consideration the leverage of entities. At the same time, a tax based on gross income ignores the profits or losses of the investor, and becomes particularly inequitable in case of losses.

 

ix.            The right model to treat securitisation SPVs is sec 115U in case of venture capital funds. As in case of VCFs, the income is taxed in the hands of the investors, whether the same is distributed or not. At the same time, the vehicle itself is tax free.

 

x.            The proposed sections 115TA to 115TC impose tax on distributions – thereby, they may actually feed wrong practices whereby income may get accumulated rather than distributed. Given the passive nature of securitisation SPVs, if, for tax reasons, SPVs start accumulating and reinvesting income, the whole nature of “special purpose” vehicles will get distorted, and vehicle will get into the realm of operating entities rather than special purpose entities.

 

xi.            Equating SPVs with operating collective investment devices such as mutual funds is clearly based on misplaced understanding of the nature of SPVs. Hence, a clean pass through is the only way that would promote securitisation.

 

xii.            If a provision equivalent of sec. 115U is applied in case of securitisation, there is no duplication of taxes; at the same time, there is no apprehension of revenue leakage since most of the investors are regulated entities. Even if there are unregulated investors, their particulars may be declared by the trustee – which serves to create a trail. It is unlikely that an investor investing in such instruments will be able to escape the tax net.

 

xiii.            A clean pass-through structure is in line with international best practices. Many countries, to our knowledge, have created special tax provisions for securitization – these provisions effectively provide a pass through treatment to qualifying securitisation transactions.