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Last Updated : Feb 25, 2016 12:32 PM IST | Source:

Budget 2016: Right time to incentivise the securitisation market

Securitisation essentially assists in attaining capital adequacy, restricting/availing sector exposure, risk management.

Naresh Makhijani

The Reserve Bank of India (RBI) has created a conducive regulatory environment for the securitisation market. Securitisation essentially assists in attaining capital adequacy, restricting/availing sector exposure, risk management, etc. In the Indian context, securitisation has worked as a tool to achieve priority sector lending targets mandated by the RBI by certain private sectors / foreign banks who lack extensive rural reach.

Simply put, securitisation is the process of conversion of loans into securities. It can be done through the issue of instruments in the form of a Pass-Through Certificate (PTC), promissory note, bond or a debenture by a Special Purpose Vehicle (SPV) which is created for acquisition of a loan portfolio. Typically, choice of the legal form of the SPV in a securitisation arrangement depends upon the administrative ease and tax implications. Over the years, a ‘trust’ has emerged as one of the most widely used form for the SPV and pool money from investors through issuance of PTCs.

A trust is easy to establish and does not stipulate any minimum capitalisation requirements, besides being a transparent entity from a taxation perspective. In spite of an opportune regulatory regime, the securitisation market has been on a downward trend in the last couple of years primarily due to tax reasons. PTCs volume has plunged to INR 17,000 crore in 2015 vis-à-vis INR 27,000 crore in 2014 and INR 30,000 crore in 2013.

In case of a determinate trust, the tax transparent status results in taxation of income directly in the hands of the PTC holders (in the same proportion in which they hold PTCs issued by the trust) without any tax leakage at the trust level. The mechanism of a trust being the SPV was widely being accepted until the tax department assessed certain securitisation trusts to tax in the status of an Association of Persons (AOP) and levied tax on such trusts at a maximum marginal rate.

In the wake of huge tax demands raised on securitisation trusts, representations were made to the Central Board of Direct Taxes to clarify that securitisation trusts are indeed transparent entities and that tax is payable by PTC holders.

The Finance Act, 2013 with an aim to reduce litigation in relation to securitisation trusts, introduced a new section in the Income tax Act, 1961 (the Act) whereby tax is levied on distributions made by securitisation trusts. Consequently, the distributions received by the PTC holders are exempt from tax. No distribution tax is payable where distributions are made to entities whose income is not chargeable to tax, such as mutual funds.

While the aforesaid amendments were essentially to reduce litigation, the same led to the following:

(a) The distribution received by the PTC holders suffered taxation on a gross basis at a significantly high rate of 30 per cent (for taxpayers other than an individual and a Hindu Undivided family);

(b) As the income received by PTC holders is exempt from tax, Section 14A of the Act may lead to a disallowance of expenses incurred in relation to the said income.

(c) Increased compliance burden for securitisation trusts.

Given the above, securitisation has become unattractive due to higher incidence of tax.

Pertinently, the Report of the Committee on Medium-Term Path for Financial Inclusion, released in December 2015, led by Mr. Deepak Mohanty, Executive Director of the RBI also recognises the disincentive nature of the tax provisions. One of the recommendations made by the committee is for restoration of the pass through status for securitisation trusts so that such entities do not have to pay distribution tax, given their critical role in efficient risk transmission. This should not lead to any loss of tax revenues since the income distributed by securitisation trusts can still be fully taxable in the hands of PTC holders.

Therefore, in order to lurk investors back into PTCs investments, it is necessary to create a favourable and secure tax environment for the market players. This can help in growing the PTC market due to its tradable nature, and in turn enhance liquidity.

Author is Head- Financial Services, KPMG in India
The views and opinions expressed herein are those of the author and do not necessarily represent the views and opinions of KPMG in India.

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First Published on Feb 24, 2016 03:32 pm
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