Tejas Mehta, Ankit Mehta
The Financial minister’s proposal to exempt Securitisation Trusts from taxation is likely to revive the interest of Mutual Funds in the Securitisation business, which was on a standstill recently due to the notices thrashed by the income tax authorities seeking to tax the Securitisation Trusts.
Securitisation is a process involving pooling of various types of contractual debt such as residential mortgages, commercial mortgages, loans or credit card debt obligations and selling the repackaged consolidated debt as bonds, pass-through securities or collateralised mortgage obligation to various investors.
In India securitisation is largely adopted via a trust structure with the underlying assets being transferred by way of sale to a Trust. Let us take a simple case of a typical loan securitisation transaction. In this case the lender grants a loan to a borrower backed by an asset. The receivables are transferred by the lender to a special purpose vehicle, formed as a Trust registered under the Indian Trusts Act, 1882. The Trust thereafter typically issues a Pass Through Certificate (‘PTC’) to the various investors. The investors are normally financial institutions like Banks, Mutual Funds and Insurance Companies. The investors holding PTCs are entitled to a beneficial interest in the underlying assets held by the Trust.
The securitisation market has been facing several issues, one of which was lack of special dispensation from taxation of the Trusts created for securitisation. In case where investors were Mutual Funds the Trusts had been generally taking a position that as the income of the Mutual Fund (i.e. beneficiaries) is exempt from payment of tax, the Trust should also not liable to pay any tax in respect of the share of the Mutual Fund.
However, the income tax authorities rejected the above stand of the Trusts and in the last quarter of 2012 slapped demand notices to various Trusts seeking to recover tax from them on behalf of the Mutual Funds in respect of the PTC’s issued. The Trusts in turn went back to the Mutual Funds asking them to pay the tax demanded by the income tax authorities in proportion to the PTCs subscribed by them. The income tax authorities also in some cases initiated recovery proceedings directly against the Mutual Funds as they were the beneficiary of the Trusts. The Mutual Funds filed petitions in the High Court, seeking relief from the tax claim given that they are exempt from income tax. The High Court granted an interim stay on the matter until final decision by the appellate authorities.
The Finance Bill 2013 has sought to address the above controversy by introducing a special code for taxation of such Securitisation Trust with effect from 1 June 2013. Firstly, it has been proposed to insert a new section 10(23DA) providing a tax exemption in respect of the income of the Securitisation Trust earned from the activity of Securitisation.
Secondly, it has been proposed to insert a new Chapter XII-EA, which deals with provisions relating to tax on distributed income by Securitisation Trusts. It provides that on distribution of any income to its investors, the Securitisation Trusts, will be required to pay additional income distribution tax at the rate 25% (plus surcharge of 10% and education cess of 3%) of the distributed income in case the investor is an individual / HUF or at the rate 30% (plus surcharge of 10% and education cess of 3%) of the distributed income in any other case. However, an exemption from payment of distribution tax has been granted in cases where the income is distributed by Securitisation Trust to any person whose income is not chargeable to tax. As a result, in case where the income is distributed to Mutual Funds, the Securitisation Trusts will not be required to pay any distribution tax in respect of the income distributed to the Mutual Funds.
The income distribution tax will have to be paid to the credit of the Central Government within fourteen days from date of payment or distribution whichever is earlier. The delay in payment of income distribution tax will attract interest liability of 1% per month or part of the month. The failure to pay income distribution tax may also attract penalty and recovery proceedings under the Income-tax Act. The proposed Chapter also separately defines Securitisation Trust, which refer to the definitions provided in Securities and Exchange Board of India (‘SEBI’) guidelines and Reserve Bank of India (‘RBI’) guidelines.
Lastly, it also been proposed to insert a new section 10(35A), providing an exemption to the investors in respect of the income so distributed by the Securitisation Trust. This amendment will be applicable from the financial year 2013-14.
The above clarity on taxation of Securitisation Trust is likely to give the much required boost to the securitization market in India. It may however be noted that the above exemptions are proposed to be applicable from financial year 2013-14 and hence there could still be some uncertainty on the taxation in respect of earlier years.
Views expressed are personal.
Tejas Mehta is a Senior Manager with Deloitte Haskins & Sells.
Ankit Mehta is a Deputy Manager with Deloitte Haskins & Sells.