ISF seeks rollback of securitisation tax proposal

Even though the budget exempts securitized vehicles from the ambit of income tax, they will be taxed if they distribute income to stakeholders. This will scare away entities investing in such instruments, which will otherwise broaden the scope of the financial markets in India, particularly fixed income market, feels the Indian Securitisation Foundation

Just when India is seeking to broaden the scope of the fixed income market in India that has remained stagnant for more than a decade, the 2013 Budget proposal to tax income distribution by securitisation, special purpose vehicles (SPVs) could scare away investors who are seeking to invest in a more stable source of revenue and income.

 

Vinod Kothari, director designate of the Indian Securitisation Foundation (ISF), said, “While a complete pass through treatment of the SPV is well agreed upon, the Budget proposals bring a distribution tax on securitisation cash flows, which is a body blow to securitisation investors.”

 

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. “Indeed, the finance minister accepted the proposal but the Budget fine print told a different story! Instead, securitisation vehicles will come under the ambit of taxation vis-à-vis distribution (rather than being tax-free), and thus equating them with collective investment vehicles like mutual funds even though both are structured very differently. This will hurt the securitisation industry,” he said.

 

Mr Kothari added, “Clearly, what has been done in the Budget is to promote securitisation. However, the actual drafting of the provisions has resulted in a distribution tax. The distribution tax, being on gross income, completely disregards the actual income of the investor, and depending on the refinancing used by the investor, may be even higher than the net profit of the investor. If the investor has losses in the net, the distribution tax still disregards the same.” 

 

An SPV vehicle will have to pay as much as 25%-30% tax on income distributed, according to new budget proposals. The fine print of Section 115TA of the Income Tax Act states:“Notwithstanding anything contained in any other provisions of the Act, any amount of income distributed by the securitisation trust to its investors shall be chargeable to tax and such securitisation trust shall be liable to pay additional income-tax on such distributed income at the rate of—(i) twenty-five per cent on income distributed to any person being an individual or a Hindu undivided family; (ii) thirty per cent on income distributed to any other person”. However, it is ironic that mutual funds investing in SPVs will be free of distribution tax as they fall into exempt category of investors.

 

According to ISF, while securitisation trusts will be exempt from income tax, the decision to tax an SPV’s distribution may have unintended consequences. Instead of distributing income to investors and acting as a conduit, the SPV may just accumulate income (since it does not have to pay tax) and, perhaps, put it back into a project or completely elsewhere. Investors, who invested in an SPV by way of shares or debt instruments issued by the SPV, will be simply waiting for their income. There will be zero cashflow for them. When there is zero cashflow for them, they will stay away from SPVs or even fixed markets and seek income elsewhere, the Foundation said in a release.

 

According to the representation paper titled “Detailed post-Budget representation on securitization tax” drafted by ISF, the whole nature of “special purpose vehicles” will get distorted and such vehicles will get into the realm of operating entities rather than special purpose entities. The representation paper seeks to remove the ambiguity and inequity imposed on securitisation vehicles. Instead, ISF contends that securitised vehicles ought to be treated the same way as venture capital (i.e. Section 115TU), in which income is tax in the hands of their investor, regardless of whether it is distributed or not. 

 

The representative paper states: “If a provision equivalent of Section 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.”

 

The representative paper also adds that developing fixed markets is crucial. It states, “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.”

 

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 takeout financing.

 

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