Registered banks and residential mortgage-backed securities special purpose vehicles

Sections HR 9, HR 10 and YA 1 of the Income Tax Act 2007

The residential mortgage-backed securities (RMBS) scheme established by the Reserve Bank of New Zealand (RBNZ) in 2008 requires registered banks to set up a bankruptcy remote third party (SPV), which can be either a company or a trust. All the major banks have set up RMBS structures, and some may have drawn down RBNZ monies.

Broadly, the RBNZ will provide additional liquidity support for a bank provided the bank offers collateral securitised AAA rated residential mortgages as securities. As part of the security arrangements for this funding, the RBNZ requires these mortgages be held by a SPV.

There are potential tax consequences arising from establishing and using the RMBS as collateral to secure a medium-term finance facility from the RBNZ.

The government has determined that taxation consequences should not impact adversely on the RBNZ measures designed to ensure the stability of the financial system.

Consequently, new sections HR 9 and HR 10 have been inserted into the Income Tax Act 2007 by Supplementary Order paper to the bill to produce a tax outcome for the banks and the SPVs which achieves the government's objective.

Key features

The amendments:

• insert a new definition of a residential mortgage-backed securities special purpose vehicle (RMBS SPV);
• set out the tax consequences following the establishment of an RMBS SPV;
• set out the tax consequences of an RMBS SPV ceasing to qualify, other than on an unwind; and
• set out the tax consequences of the unwind of an RMBS SPV.

Application date

The RMBS amendments apply for the 2008-09 and later income years.

Detailed analysis

A RMBS SPV is defined in section YA 1 of the Income Tax Act 2007 as.

• a company or a trust that derives no exempt income;
• which holds interests in New Zealand residential mortgages or loans secured by such mortgages that are treated for financial reporting as being held by the registered bank;
• has all its funding from the RMBS it issues, apart from incidental funding amounts; and
• the RMBS it has issued must be either held by the registered bank with the intention of participating in the RBNZ's domestic liquidity operations; held by RBNZ and accepted into its domestic liquidity operations; or transferred by RBNZ, after being accepted into its domestic liquidity operations, to a person resident in New Zealand or a person not resident in New Zealand but unassociated with the registered bank.

Tax consequences where RMBS SPV exists

Once the existence of a RMBS SPV has been established as set out above, the following tax consequences apply:

• The registered bank is treated as carrying on the activities that the SPV carries on, and having a status, intention and purpose of the SPV, and the SPV is treated as not carrying those activities, and not having that status, intention and purpose.
• The registered bank is treated as holding all property that the SPV holds, and the SPV is treated as not holding it.
• The registered bank is treated as being party to any arrangement which the SPV is party to, and the SPV is treated as not being party to that arrangement.
• The registered bank is treated as doing a thing and being entitled to a thing that the SPV does or is entitled to do, and the SPV is treated as not doing that thing or being entitled to that thing.

The tax effect of these provisions is that the registered bank is treated as doing everything that the SPV does while it remains a qualifying SPV, and the SPV is treated as not doing those things while it is a qualifying SPV.

Practically, this will mean that transactions between the registered bank and the SPV will have no tax consequences for either party while the SPV remains a qualifying SPV. Also, all transactions with third parties by the registered bank and the SPV will be included in the registered bank's tax return while the SPV remains a qualifying SPV.

It also means the RMBS SPV will not be required to obtain an IRD number or file income tax and GST returns while it continues to qualify.

Tax consequences when RMBS SPVS cease to qualify

When a RMBS SPV ceases to qualify in terms of the definition above and other than being unwound (as defined below), the following consequences apply:

• The registered bank is treated as having disposed of the property it was treated as holding as above. It is treated as disposing of the property immediately before the SPV ceases to qualify.
• The RMBS trust/company is treated as acquiring the property referred to in the preceding bullet point immediately after it fails to qualify as a SPV.
• The registered bank is treated as not being a party to an arrangement it was treated as being a party to in relation to the SPV immediately before the SPV ceases to qualify.
• The vehicle is treated as being a party to the arrangement immediately after the SPV ceases to qualify.

Where property or an arrangement is disposed of/acquired for tax purposes in terms of the above deeming provisions it is done so at market value.

Unwind of RMBS SPV

The unwind of a RMBS SPV for tax purposes is defined as being the process of:

• cancellation of the RMBS issued by the SPV and held by the registered bank or the RBNZ;
• transfer of the interests in residential mortgages and loans secured by residential mortgages held by the SPV to the registered bank; and
• termination of the company or trust, by liquidation or otherwise.

Further developments

The definition of a RMBS SPV includes the requirement that the mortgages and loans secured by mortgages held by the SPV are treated for financial reporting purposes by the registered bank as being held by the registered bank.

The strict reading of this requirement is that the relevant financial arrangements are reported in the legal entity financial statements of the registered bank. It has been brought to officials' attention that, while this applies in some cases, there are other cases when the relevant financial arrangements are treated as held by the registered bank only in the consolidated financial statements prepared by the registered bank.

The policy intent is that the amendments apply in the latter case, when the relevant financial arrangements are treated as held by the registered bank in the consolidated financial statements prepared by the registered bank where they are not also included in the legal entity financial statements of the registered bank.

It seems likely that further amendments will be recommended.