Financial institution special purpose vehicles

The Taxation (International Taxation, Life Insurance, and Remedial Matters) Act 2009 inserted sections HR 9 and HR 10 into the Income Tax Act 2007 to deal with the tax treatment of registered banks' residential mortgage backed securities (RMBS) special purpose vehicles (SPVs) (see Tax Information Bulletin Vol. 21, No. 8, October/November 2009, pages 131-132). Those rules removed the tax impediments to banks using the Reserve Bank's (RBNZ) RMBS liquidity facility.

Key features

In March 2010 the RBNZ introduced a new bank liquidity policy, which includes measures to require banks and certain finance companies (lenders) to lengthen the term of their funding to better match their lending terms. One of the strategies proposed by lenders to achieve this, at the lowest cost, is by issuing debt which is guaranteed by bankruptcy remote SPVs. They are commonly called covered bond programmes (CBPs). The structure of the establishment of the CBP-SPVs by the lenders is economically very similar to the RMBS-SPVs.

Establishing and operating the SPVs would have caused unwarranted tax volatility for the lenders and the government, and the major purpose of these amendments is to remove this volatility. Lenders have to set up the CBP-SPVs (typically companies or trusts), which they control but do not own. The lender then transfers parcels of financial assets to this vehicle. When fixed rate financial assets are transferred to the SPVs there would have been either a tax gain or loss on transfer (which could be substantial) without these amendments.

To provide the same tax outcome for the establishment and operation of CBP-SPVs as that achieved last year for the RMBS, the 2009 legislation for RMBS has been modified and extended to include CBP-SPVs. This has been achieved by making the provisions as generic as possible to include both these situations. The following specific amendments have been made.

Detailed analysis

Section HR 9

All references in the headings and section to "RMBS" and "RMBS special purpose vehicle" have been replaced with "financial institution" and "financial institution special purpose vehicle" respectively. This is to recognise that the provisions are now applied generically to a "financial institution" and a "financial institution special purpose vehicle" (FI-SPV) as defined in Section YA1 and that they apply to both RMBS and CBP-SPVs. The new definitions have been inserted into section YA1 and the definition of "RMBS special purpose vehicle" has been repealed. The application of the operative provisions of section HR 9 has not changed from that outlined in Tax Information Bulletin Vol. 21, No. 8, October/November 2009, page 131, as follows.

Once the existence of an FI-SPV has been established as set out above, the following tax consequences apply:

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

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

Practically, this will mean that transactions between the financial institution and the FI-SPV will have no tax consequences for either party while the FI-SPV remains a qualifying FI-SPV.

Also, all transactions with third parties by the financial institution and the FI-SPV will be included in the financial institution's tax return while the FI-SPV remains a qualifying FI-SPV.

It also means the FI-SPV will not be required to obtain an IRD number or file income tax and GST returns while it continues to qualify.</<h4>Section HR 9B

Section HR 9B

New section HR 9B has been inserted into the Act to clarify what property of the financial institution can be attached, charged, disposed of or otherwise used ("attach/ed") in the payment of its tax debt while the FI-SPV continues to qualify as an FI-SPV. Subsection (a) applies to the tax debt of the financial institution which is not for income tax or provisional tax, and would have been the FI-SPV's tax debt if HR 9 did not apply to treat the financial institution as doing everything that the FI-SPV does while it remains a qualifying FI-SPV.

As well, the property to be attached must have been able to be attached in the absence of section HR 9 ie if the FI-SPV was a separate entity.

For example, if the FI-SPV had failed to deduct and pay an amount of NRWT from interest it had paid and that amount remained due to Inland Revenue, the FI-SPV's property could be attached by Inland Revenue at any time while it is a qualifying FI-SPV to recover that debt.

Subsection (b) preserves Inland Revenue's ability to attach the property of the FI-SPV while it is a qualifying SPV for tax debts of the financial institution if Inland Revenue would have otherwise under law been able to attach the property of the FI-SPV as a completely separate entity from the financial institution (if HR 9 did not exist). In some rare instances Inland Revenue has the ability to attach the property of taxpayers for the tax debts of other taxpayers, and the policy is that those rights are maintained here as if the financial institution and the FI-SPV were separate taxpayers. An example of this situation in a general context is if taxpayer A owes Inland Revenue a tax debt and Inland Revenue is aware that taxpayer B owes taxpayer A some money. Inland Revenue has the ability to direct taxpayer B to pay Inland Revenue the money it owes taxpayer A in payment of taxpayer A's tax debt. If taxpayer B refuses to pay the money to Inland Revenue, Inland Revenue can then attach property of taxpayer B to recover the money owed to taxpayer A (and Inland Revenue). This provision applies here as if the financial institution and the FI-SPV are always separate persons.

Section HR 10

All references in the heading and the section to "RMBS" and "registered bank" have been replaced with "financial institution". These changes reflect that the deleted words were relevant when the legislation applied to RMBS-SPVs only and the new words are relevant to it applying to RMBS and CBP-SPVs.

Subsection (4) has been replaced to reflect that the relevant SPV being unwound is either a RMBS-SPV or a CBP-SPV. The latter would involve the cancellation on unwind of guarantees it had issued.

Section YA 1

The definition of "RMBS special purpose vehicle" has been repealed effective from the date of Royal assent (7 September 2010). A new definition of "financial institution special purpose vehicle (FI-SPV)" has been inserted, also effective 7 September 2010. An FI-SPV is defined as a company or a trust that:

1. Derives no exempt income; and
   This criterion is the same as that which applied to a RMBS SPV.
2. Has all of its financial arrangements that are its assets treated as a financial institution's financial arrangements for financial reporting purposes, but ignoring any current account balance that is incidental to the company's or trustees sole purpose described in paragraph (e); and
   
   This criterion has been changed from that which applied for RMBS-SPVs in two respects. The first is that the FI-SPV's financial arrangements assets are treated as the financial institution's assets for financial reporting purposes. The RMBS-SPV definition referred only to interests in New Zealand - originated residential mortgages, or loans secured by those mortgages. The new definition caters for FI-SPVs, which may be able to hold a wider range of financial arrangements as assets. Secondly, it excludes an asset which is a current account balance (say held with a bank) that is incidental to the company's or trustee's sole purpose described in paragraph (e) and may not be included in the financial institution's financial reporting.
   
   Inland Revenue considers that this provision would cover an asset of an FI-SPV which was (say) the fair value of a swap with the financial institution as the counterparty and which the financial institution would, on a stand-alone basis excluding the FI-SPV, include as a liability in its financial reporting. Including the FI-SPV's assets in the financial institution's financial reporting will mean that the swap asset of the FI-SPV is netted out with the financial institution's swap liability for a net amount of nil to be reported by the financial institution. This would satisfy the terms of this criterion for that swap asset.
3. Receives only funds that are -
   
   1. in respect of financial arrangements described in paragraph (b);
   2. incidental to the company's or trustees' sole purpose described in paragraph (e); and
   The intent of this criterion remains unchanged from that which applied to RMBS-SPVs which referred to funds provided to the RMBS-SPV related to the residential mortgage backed securities it has issued or to financial arrangements incidental to its operations. In both cases the provisions are directed at limiting the funding that the SPVs obtain to that for obtaining the financial arrangements assets it holds which are referred to in paragraph (b) or amounts incidental to its sole purpose, such as an overdraft for working capital purposes. It is expected that the latter amounts will be very minor in terms of the FI-SPV's balance sheet and be for very short periods, that is, not used as core funding of the FI-SPVs.
4. Either -
   
   1. operates to guarantee liabilities of the financial institution or of a company, incorporated in and resident in New Zealand, that is a member of a wholly-owned group of companies which includes the financial institution; or
   2. operates in respect of the company's or trustees' issue of residential mortgage backed securities; and
   This criterion has changed in two significant respects from that which applied under the RMBS-SPV definition. The first is that it caters for the CBP-SPVs operations, being to guarantee the liabilities of a New Zealand resident wholly owned group company. Secondly, it includes the operations of an FI-SPV which issues residential mortgage backed securities and therefore carries on and broadens what the previous definition of a RMBS-SPV allowed for. An FI-SPV which operates to issue residential mortgage backed securities now can issue those securities to any person and those securities can be on-sold by the financial institution to any person. The definition of RMBS-SPV effectively restricted the holding of the securities issued by an RMBS-SPV to either the financial institution; the Reserve Bank; or certain persons the Reserve Bank transferred them to after it had accepted them into its domestic liquidity operations.
5. Has interests in financial arrangements only for the sole purpose of carrying out the company's or trustees' operations described in paragraph (d)(i) or (ii); and
   This provision is new compared to the definition of RMBS-SPV. Its purpose is to limit for tax purposes what qualifying FI-SPVs are permitted to do. It was included in the legislation after consultation with interested taxpayers and given the facilitative nature of the government's policy position on the undesirable tax outcomes which would otherwise apply.
6. Has financial statements that are prepared using IFRSs and are audited.
   
   This is a new provision and was included after consultation with interested taxpayers.

Application date

The changes apply from 1 June 2010.