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A High Note For Securitisation

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Fairy tales usually begin with 'Once upon a time…' and conclude with a happy ending.

Once upon a time, in the financial year 2008, the Indian securitisation market had a booming business volume of more than Rs 60,000 crore. Since then, it has seen a sharp decline in business: but will new budget proposals provide a fairy-tale ending?

The recent decline in the securitisation market is largely due to the lacklustre participation of Mutual Funds (MFs), which are considered to be the largest subscribers in the securitisation market followed by banks and non-banking financial company (NBFCs). One of the key reasons MFs have shied away from the securitisation market is the ambiguity surrounding the taxation of securitisation trust.

The modus operandi of securitisation trusts is to raise funds from investors such as MFs, banks and NBFCs by issue of 'pass through certificates' and buying loans from financial institutions out of the issue proceeds. The securitisation trust earns interest income from the borrower.

The income-tax authorities initiated proceedings against securitisation trusts alleging that their income was liable for taxation as 'business income'. The entire income of the securitisation trusts was, consequently, subjected to tax at the maximum marginal rate. Trusts argued that since MFs, being the beneficiaries in the securitisation trusts, are exempt under the tax laws, the securitisation trusts should not be liable to pay any tax (based on the principles of trust taxation). Even so, the tax authorities issued tax demands running into hundreds of crores sending tremors through the MF industry and trustees of such securitisation trusts.

In order to clarify the ambiguity surrounding taxation of securitisation trusts, the finance minister has proposed a special taxation regime for securitisation trusts outlined below:
  • Income earned by the securitisation trust will be exempt from tax provided it is regulated by SEBI or RBI.
  • Securitisation trusts will be liable to pay additional income-tax (similar to dividend distribution tax payable in case of companies) depending upon the status of the recipients:

    Individuals and Hindu Undivided Families (HUFs) - 25 per cent
    Any other person - 30 per cent.

    However, if the income is distributed to a recipient who is not liable to tax (like MFs), no additional income-tax will be payable.
  •  Income received from the securitisation trust will be exempt from tax.
The said proposal may give the much needed impetus to the securitisation market especially in cases where the beneficiaries of the securitisation trusts are MFs.

However, while the intention of the finance minister was to remove the ambiguities surrounding the taxation of securitisation trusts and to reduce litigation, the proposals do not address every impediment to the growth of the securitisation market especially where tax paying entities such as banks and NBFCs are the beneficiaries of the trust.

For instance, the expenses incurred by such investors held to be expended for the purpose of earning the exempt income received from the securitisation trust could be disallowed. Furthermore, banks and NBFCs  have previously been able to set-off existing losses against the income from securitisation trust, now the income from securitisation trust being exempt in the hands of banks and NBFCs will not be eligible for set-off (however, the income would be subject to additional income-tax).

Is this a happy ending? Clearly, the finance minister has given heed to the representations made by the bleeding securitisation industry, but only time will tell whether the securitisation market will relive its previous highs.

Vishal S. Shah is Senior Manager and Rajesh Nathwani is Assistant Manager, PwC India

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