This article appeared in Finance Magazine

Section 110 of the new Finance Bill will help the Irish securitisation industry play catch-up
The long awaited changes to the taxation regime applicable to Irish securitisation companies are contained in the recently published Finance Bill. These changes should greatly simplify the structuring of securitisations using Irish vehicles and expand the types of products (notably CDOs) that can be issued, writes James Somerville.
Successive Irish Governments have been keen to develop Ireland’s financial services industry, and specific taxation provisions in relation to securitisations have been on the statute books since 1991. The legislation, primarily embodied in section 110 of the Taxes and Consolidation Act, 1997, was most recently amended significantly in 1999. Perhaps, unsurprisingly, given the dynamic and constantly evolving nature of the securitisation markets, Section 110 quickly became dated and lagged behind developments in the securitisation markets. While it has been possible, using complex structuring solutions, to bring more recent securitisation products (must notably synthetic securitisations and CDOs) within the provisions of section 110, this increased the cost and execution risk; putting Ireland at a competitive disadvantage to other jurisdictions.

Representatives of the industry, including A&L Goodbody raised the problems being encountered in practice with the Department of Finance and the Revenue Commissioners. Over the last 12 months there have been ongoing consultations identifying these areas and proposing potential solutions. The product of this work is the revised Section 110 contained in the Finance Bill. While the legislation is still at Bill stage, and does not have the force of law, it is unlikely it will be changed during the course of the legislative process. If it becomes law unchanged, it will be deemed to have retrospective effect back to the date of publication of the Finance Bill, being 6 February, 2003.

Currently, under section 110, provided certain conditions are met, an Irish resident company (referred to here as an ‘SPV’) effecting such a transaction can calculate its profits as if it were carrying on a trade. This enables the company to deduct all expenses, including interest, from its income when calculating its taxable profits. There are also specific bad debt relief provisions and a limited interest re-characterisation override rules. This means that an Irish SPV, as an issuer in a securitisation, can normally be ‘tax neutral’, a fundamental requirement for SPVs in securitisations.

The Finance Bill makes a number of important changes to Section 110, without altering its basic effect. The one change likely to have most impact is the significant expansion of the ability of Section 110 SPVs to pay interest to investors directly related to the profit or income of the SPV. This will enable genuine CDO structures to be effected through Ireland for the first time. Up until now, except in very limited circumstances, payments of such interest would have been re-characterised as a distribution and would not have been deductible by the SPV for tax purposes. As a result, the SPV would make a profit for Irish tax purposes, suffer tax at the rate of 25 per cent and have its tax neutrality compromised. Such a re-characterisation of interest also raises dividend withholding tax issues. While this disapplication of the re-characterisation provision in the Finance Bill is not absolute, it should be available in most situations encountered.

The conditions that must be satisfied for an SPV to qualify for Section 110 treatment have also been simplified. The SPV will be able to directly subscribe for the underlying assets it holds (which it could not do until now); it will only need to meet a minimum valuation requirement of e10 million in respect of assets acquired from all originators (rather than per originator); and this valuation requirement no longer has to be met for a three month period.

There are also some changes to exemptions available from withholding tax which expands the classes of person to whom interest that is not paid on a quoted Eurobond can be paid gross by a Section 110 SPV. Additionally some changes in relation to the ability to claim loss relief and a requirement to notify the Revenue Commissioners of the intention to avail of the benefits of Section 110 will be introduced. Further details are needed on this last change, but we do not expect it to have a material impact.

While most of the changes are to be welcomed there is always room for further improvement. Particular issues which have caused concern, which are not solved by this legislation, include the requirement that to avail of the ‘quoted Eurobond’ exemption from interest withholding tax, interest must be paid on a bearer note. It is still not available for registered notes. The resulting obligation to withhold puts Ireland at a disadvantage when compared to other jurisdictions, in particular the UK, the Netherlands and Luxembourg. This requirement also adversely affects the marketability of notes issued by Irish entities to US investors who normally have a US tax concern if they hold bearer instruments. There is also a continued risk that a noteholder who receives interest on a quoted Eurobond free of withholding tax may have an underlying Irish income tax liability if such interest is considered to have an Irish source and the investor is not resident in an EU country or a country with which Ireland has a double tax treaty.

These perhaps are relatively minor gripes with the legislation. Our overall reaction is to welcome it and its proof of the Irish Government’s continuing proactive approach in promoting Ireland as a jurisdiction of choice for these types of transaction. In his speech to the Dail on the Second Reading of the Bill the Minister for Finance confirmed this in saying:

‘Our capital city has become a significant player in international securitisation transactions and it is important that we continue to compete successfully for this business. In order to achieve this, Irish tax law must keep pace with international developments...By its nature the securitisation business is constantly evolving and producing more sophisticated transactions. [The Finance Bill] updates our tax regime in order to bring more of this high-value business to Ireland.’
James Somerville is senior associate in A&L Goodbody’s Tax Department and Securitisation and Structured Products Unit.
This article appeared in the March 2003 edition of Finance Magazine.