SECURITIZATION IN LUXEMBOURG AN INNOVATIVE INSTRUMENT

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1 SECURITIZATION IN LUXEMBOURG AN INNOVATIVE INSTRUMENT

2 Information available on this leaflet have the sole purpose of providing general information on the activities of GODFREY-HIGUET. It does not constitute legal advice and does not replace the legal documents duly published. Their reader should not be determined on its basis alone. Only a consulting GODFREY-HIGUET s lawyers can bring a legal opinion on a particular situation GODFREY-HIGUET, Association d avocats

3 Evolving from US banking practices from the end of the 1960 s, securitisation mechanism faces to a bad press since the recent subprime crisis. If it appears nowadays, as a disastrous tool for a certain financial system, this obviousness should however not hide its virtues. Answering to numerous objectives, it was originally revealed as an efficient technique for the solicitation of savings whether public or private. In certain cases, it can even improve the ratios of the transferor by reducing the size of its balance sheet liabilities. The range of assets subject to securitisation was progressively widening, and the practice has in response known a boom in its use. It allows today all the assets to be liquefied, especially those whose yield is uncertain or whose repayment is improbable; in other words, securitisation is a technique aiming at turning risks into securities. Always concerned about the attractiveness of its financial centre, the Grand Duchy of Luxembourg introduced a law dated March 22 nd, 2004 related to securitisation practice (the Law) creating an advantageous tax and legal framework favourable for securitisation companies combining flexibility and protection for investors (1). In a most extensive manner, this law defines the securitisation as being the operation by which a securitisation body may acquire or take on, directly or through the intermediary of another body, the risks linked to debts, other assets, or agreements met by third parties or derived wholly or in part from completed activities carried out by third parties while issuing securities whose value or yield depend on those risks. Taking into account the flexible and comprehensive redaction of the Law, any asset capable of generating revenue is a priori able to be securitised; also, it is possible to securitise only certain assets or risks, either the whole activity of the company or of one of its branches of activity. I. GENERAL PRINCIPLES A The securable risks Under the terms of the Law, all types of risks can be made the subject to securitisation, no matter it is linked to the holding of an asset (security or real estate, tangible or 1

4 intangible), or inherent to the engagement of a third party. The Law therefore does not contain any restriction as to the nature of the rights, risks or assets subjects to securitisation; it also authorises the securitisation of activities having a certain and reasonable intrinsic value, certain and reasonable, as well as the securitisation of activities generating a future income. B The actors A securitisation operation generally involves three parties: - the owner of an asset called 'initiator'; - the securitization body designated by the acronym SPV (Special Purpose Vehicle); - the investor. C The process A combination of rights to which a certain risk is linked is transferred to a SPV created for these purposes, which makes the financial acquisition by the issuing of securities subscribed by an investor. The SPV receives the securitised asset from the initiator and pays a price taking into account the transferred risk, which allows the initiator to refinance and/or to improve his balance sheet. The SPV perceives the income of the securitised asset. These funds are paid back to the investor in the form of interest or dividend payments and finally, in the form of a reimbursement of securities previously issued. The risk linked to the securitised assets is borne by the investors and the performance of the securities issued by the securitisation body depends on this risk. II. THE LEGAL FRAMEWORK A The securitisation vehicle 1. In order to choose the most suitable structure for the planned operation, the Luxembourg lawmaker has created two categories of vehicles: - a capital company incorporated under Luxembourg law with legal personality (public limited company, private limited company, limited joint-stock partnership or cooperative company organised as a public limited company). Its object will consist of the acquisition of assets subjects to securit- 2

5 isation and the issuing of securities related to these assets. The securitisation company has no minimum capital requirements; as a consequence, its minimum capital will depend on the form of the chosen legal form (2). - a securitisation fund administered by a management company (one or several joint co-ownerships, one or several trusts): the securitisation funds do not have a legal personality and the management company, which must has to be a business company, is called on to administrate and manage the securitised assets. Also, according to the choice made, the body may or may not be a legal entity, but in order to limit the risks linked to the securitised assets, the legislator has excluded any vehicle implying an unlimited responsibility for the investors. Besides, whatever the adopted form may be, each vehicle benefits from real patrimonial autonomy. 2. The SPV Articles may allow the creation of several sub-vehicles, each dedicated to a distinct asset which the securitisation company can self-finance by the issuing of shares or bonds and other debt instruments (whether registered or bearer) whose value and/or yield only depend on the assets held in this sub-fund. Each sub-vehicle constitutes a specific legal entity distinct from the others (except where it is stated otherwise, for example in the articles of association of the securitisation company) and are thus independent devices from one another; the insolvency of one compartments does not affect the others. As well, the investors who have invested in one of the compartments have no rights on the other compartments, except where expressly stated in the articles or regulations of the SPV. 3. The securities issued by the SPV are backed up and guaranteed by the assets that they have financed. The transfer of the assets can even be subject to a prior authorisation of the investors, if that is stated in the SPV articles. A liquidation by compartment is even possible. Once securitised, the risk is transformed into registered or bearer titles (shares and/or bonds) of the securitisation body, 3

6 freely negociable and transferable. B The supervision of the securitisation bodies The securities can be listed on the stock market subject to an agreement with the Commission de Surveillance du Secteur Financier (financial sector supervisory commission). The constitution of a securitisation body requires an agreement with the CSSF only if this body continuously issues securities to the public. Indeed, the Law considers that the continuous issuance of securities to the public is equivalent to the activity of a credit institution and as such requires the CSSF agreement and supervision. III. THE TAX REGIME The tax treatment applicable to the securitisation operation depends in part from the legal form of the chosen SPV; other provisions are common to all securitisation bodies. Whether common or specific these provisions share a common objective: the tax neutrality of the securitisation operations. A The tax treatment of the securitization company Incorporated under the form of a capital company, the SPV is a fiscal entity in common law, and therefore is subject to taxation according to the provision of the Luxembourg tax law and as such liable for the corporation tax (impôt sur les collectivités IRC) and the municipal business tax (impôt commercial communal - ICC). On the other hand, it is not subject to wealth tax (impôt sur la fortune - IF). Hence, the SPV constituted under the form of a capital company will be subject on its net income and after deduction of the operating costs, to the IRC increased by the ICC (3). It should be noted that the article 46 of the Income Tax Act (Loi sur l Impôt sur le Revenu, hereinafter LIR) has been modified in order to encompass all the agreements undertaken by the securitisation company towards its investors (shareholders and/or bond holders) and any other creditors are expenses deductible for operating costs. Besides, the SPV is not obliged to keep a taxable profit deriving from its activities as all revenues realised by the SPV can be 4

7 subject to a distribution (or of an agreement of distribution) in favour of the investors and shareholders. Finally, the securitisation company will only be taxed on the part of its benefits that it does not intend to distribute among investors or shareholders. The distribution to the investors and creditors are not subject to any withholding tax in Luxembourg (section 97 (6) LIR), except for payments falling under the scope of the European savings directive in the form of interest payments in favour of actual persons resident in another member State of the EU. The impact of taxation of these revenues on the investors depend on their legal status, and especially on their place of residence for tax purposes; also, to illustrate this, the investors or other creditors resident in Luxembourg are taxed, for the capital revenue, on the distributions and other benefits, which are allocated to them. Bearing in mind that it is subject to the IRC and the Luxembourg ICC at the usual rate, the securitisation company may benefit from the favourable provisions as stated in the double tax treaties as drawn up by the Grand Duchy of Luxembourg, as well as by the Directive on Interest and royalty payments and by the parent companysubsidiary Directive (exoneration and/or reduction of deductions at source on dividends, interest and royalties paid to the securitisation company). In all cases, the revenues paid by the securitisation company being always considered as interests according to the Luxembourg tax law, they cannot benefit from exoneration of the revenues for consequent holdings as stated in Article 166 LIR. The securitisation company cannot be assimilated to a Soparfi ; it is not subject to any limit as regards its debt to equity ratio, which allows it to be financed without tying up a large capital. Besides, the securitisation company is not subject to any thin capitalisation rule. Since the 1 st January 2009, the capital duty, due prior to incorporation of the company, shall not be levied anymore. B The tax system of the securitisation funds The securitisation funds are subject to the tax system for mutual funds, with the ex- 5

8 ception of subscription tax which does not apply. In consequence, a SPV created under the form of investment funds will be exonerated from Luxembourg taxation. C VAT The management of the securitisation bodies is exonerated from VAT; services carried out by third parties for the benefit of securitisation bodies are also exonerated from VAT. IV. USAGE OF THE MECHANISM FOR EXAMPLE: THE SECURITISATION OF A REAL ESTATE ASSET The Law allows the securitisation of a property asset or of a right related to this asset. This flexibility allows, for example, a person owning a real estate property to transfer its bare ownership whilst retaining the right to live in it or to use the facility. The securitisation body will receive the ownership of the property; it will in return issue bearer securities representing the ownership of the property and the resulting revenues. These securities, whose value and yield will directly derived from the profitability of the securitised asset, will be given either to the assignor of the property, or to the investors wishing to acquire the property. In all cases, the security bearers could give, transfer, sell or transmit them to other investors or transferees who will receive the benefits in relation with the management of the property, and eventually, the possible capital gain realised on the transfer of the property by the securitisation body. In this way, the transfer of the property is highly facilitated. The securitisation again allows a discreet acquisition of a real estate asset. The investor will be the holder of the securities, but only the securitisation body, of whatever form, will appear as the owner of the property. The investor will not therefore be named as the owner and his property will not be troubled by any land registration. The securitisation of a real estate property can also be performed by a family group in a perspective of distribution between successors. The acquisition of a real estate asset through a securitisation body by a group of 6

9 investors also allows sharing amongst them the costs and trusts limited to the investment. Therefore, the use of the securitisation mechanism on a real estate asset includes several advantages, either to make an immovable property purchase or to transfer its ownership. Therefore, the use of the mechanism of securitization of a property asset combines several advantages, whether to acquire or to prepare the transmission. G.-H. NOTES (1) Confer our brochure on the protection of investors. (2) i.e ,68 for a Sàrl ; ,69 for a SA. (3) The IRC rate is 22,05% in net income exceeding 15,000 for that year. The ICC rate is 6,75% (for Luxembourg city) calculated on net income exceeding 17,500, giving an overall tax rate of 28,80% (in 2011). 7

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