There’s a risk of non-compliance in Russia when special purpose vehicles (SPVs) – also known as specialised entities – lack knowledge on the definition of charter activities.
There’s a risk of non-compliance in Russia when special purpose vehicles (SPVs) – also known as specialised entities – lack knowledge on the definition of charter activities. To illustrate this, let’s examine a recently-won court case with the Russian tax authority.
A special purpose entity was ruled illegal for not including the amount of accrued interest on the deposit in the non-operating income after a field tax audit conducted by the Russian tax authority. As the authority explained, a company’s interest income accruing on the deposit was not related to any SPV’s charter activity, and that income was not covered by Article 251 of RF Tax Code (TC RF), which established the list of income not taken into account when determining the tax base.
As a result, the entity was liable for a fine; the additional amount of income tax and related penalties were also assessed.
However the issuer did not agree with the conclusion by the tax authorities, and, after an unsuccessful attempt to appeal the resolution to a higher inspection of the Federal Tax Service, the issuer appealed to the arbitration court to invalidate the resolution.
Having considered the application and evaluated the issuer's arguments, the court concluded it definitely had and would have, a positive impact to all subsequent tax audits and resolutions of tax authorities.
Based on the above case, the article of the Charter referred by the tax authorities only reveals the legal capacity of a company while the charter activity of an SPV shall be any activity that the SPV can carry out in connection with the set-up and maintenance of mortgage collateral on mortgage bonds. The list of SPV rights for such activities’ performance is not exhaustive. The court also emphasised that article 251 of TC RF stipulated exemption from taxation of income connected with charter activities, but that was not directly from the charter activities.
Separately, the court noted that the special status of a mortgage agent (MA) and statutorily imposed hereto limitations factually make the MA a legal instrument to carry out a transaction, and had no individual business purpose. All property, that the MA gets, should be subject to the transfer for payment of income to investors and the reimbursement of expenses.
In accordance with resolution on emission, MA created reserves and there was no other way to save the reserves other than to place them on a current or deposit account. Thus, acquisition of income as interest on savings meant the company’s direct execution of obligations on the securitisation transaction conditions. At the same time, the accrued and obtained interest was directed exclusively for payment of coupon income and mortgage agent costs.
The court came to a very important conclusion that the tax authorities actually pushed the limits of its competence when evaluating SPV’s activities for their compliance with the charter and law. The Bank of Russia acted as the regulator of special purpose companies, which adopted a resolution on emission and had no objections to quarterly reports of the Issuer. It confirmed that MA complied with requirements of the Federal Law ‘On Mortgage Securities’ (152-FZ).
Summing up the results, in the course of the described trial proceeding, the following positive practice in respect of securitisation transactions has been developed:
1) Any SPV activity carried out in connection with the formation and maintenance of portfolio shall be exempt from income taxation 2) Assessment of SPV compliance with the requirements of law 152-FZ, including part of its compliance with the Charter and law, shall be beyond the competence of tax authorities.
Repurchasing the portfolio without issuing bonds
A situation may arise when a SPV has been established, a portfolio has been transferred or has been in the process of accumulation, but the emission of bonds on behalf of this specialised entity becomes impossible, or the transaction has been canceled for other reasons. In such a situation it is necessary to arrange for the repurchase of the portfolio to a bank or another specialised entity.
In case of cession, there is a problem to determine a status of such transaction as one carried out in connection with charter activities of the specialised entity, or out of its charter activities. If approaching conservatively and not recognising this transaction as the one carried out within the framework of charter activities of a mortgage agent, then in accordance with RF TC (cl.6 art. 250), income in the form of interest on debt instruments is recognised as income and is included in the tax base when calculating income tax on a common basis. This leads to the assessment and payment of income tax at the rate of 20%, for the period from the date of the portfolio acquisition until its sale.
If approaching less conservatively and recognising this transaction as the one carried out within the framework of charter activities, there will be risks of tax evasion on a large or especially large scale. There is also a question related to the assessment of legality of this scheme: transfer of the portfolio to SPV and, as a consequence, release of funds in the form of interest income from taxation – realisation of the described tax benefit during the period when the portfolio was in SPV's balance - return of the portfolio to the bank or sale to another specialised entity. If regulatory authorities analyse the operation as described above, all companies involved in the described network may face tax and other risks.
Since the legislation does not contain clarifications on this issue, and there is no corresponding tax practice, we addressed it with relevant requests to the Ministry of Finance and to the Bank of Russia.
As a result, the Ministry of Finance refused to provide any comments supposing it is out of their competence, and recommended we send a corresponding request to the Bank of Russia. Having provided the general reference to articles 8 and 14 of 152-FZ, the Central Bank expressed that compensated mortgage-backed receivables alienation by a mortgage agent before or after the formation of mortgage collateral shall be its charter activities.
The described opinion of the Regulator cannot be taken as an assured guide on how to act in similar situations. In similar cases it is wise to analyse any situation independently, and make an appropriate decision while considering the opinions of Regulators, legal and tax advisors.