A Guide to the Law of Securitisation in Australia - Clayton Utz

365.4 Debt/equity rulesDivision 974 of the 1997 Tax Act contains rules which define thedebt/equity borderline for tax purposes.Where notes used to fund a securitisation vehicle are regardedas equity for tax purposes, interest on the notes is not deductiblewhich may disrupt the tax neutrality of the securitisation vehicle.The notes will only be treated as equity interest where they beara return which is contingent on the economic performance of theissuer or they are convertible into equity interests.5.5 Thin capitalisationDivision 820 of the 1997 Tax Act contains Australia’s thincapitalisation rules and applies to Australian resident entitiesthat are foreign controlled, to Australian controllers of foreignentities and to Australian entities that carry on business throughan overseas branch (as well as certain foreign entities).There is an exemption from the thin capitalisation measures forcertain special purpose entities. In order to qualify for thisexemption, the following conditions must be met:• the entity must be established for the purposes of managingsome or all of the economic risk associated with assets,liabilities or investments (whether the entity assumes the riskfrom another entity or creates the risk itself);• at least 50 percent of the entity’s assets are funded by debtinterests; and• the entity is an “insolvency remote special purpose entity”according to the criteria of an internationally recognisedrating agency applicable to the entity’s circumstances.As noted in the Explanatory Memorandum, the exemption forspecial purpose entities seeks to cover “a broad and everexpanding range of securitisation activity and structures.”5.6 Foreign exchange gains/lossesFrom 1 July 2003, the foreign exchange rules may apply to thesecuritisation vehicle if certain events (“forex realisationevents”) happen. Subject to certain exceptions, if thesecuritisation vehicle makes a gain from a forex realisation event,it must include that gain in its assessable income, if it makes aloss from a forex realisation event, that loss is an allowablededuction.Short term forex realisation gains and losses (less than 12months) are covered by special rules, in section 775-70 of the1997 Act and section 775-75 of the 1997 Act.There is an election in section 775-80 of the 1997 Act in respectof these special rules.Generally, the operation of those rules is positive in the sensethat it should enable a matching of foreign exchange gains withforeign exchange losses to maintain neutrality through theconduit structure. However, there is a technical defect in therules which could produce timing mismatches.The issue can potentially arise because the income derived by theconduit will invariably be recognised for tax purposes on a dailyaccruals basis. The funding expense will also be recognised on adaily accruals basis. However, the exchange loss which willtypically arise on a swap or forward foreign currency purchase(for principal) will only be realised (and thus tax deductible) uponmaturity of that hedging transaction.Therefore, if a swap is realised after the financial year end, thenthe deduction will not be crystallised until after year end and, tothe extent that the corresponding income has been accrued as atyear end, a mismatch will arise.5.7 ConsolidationThe tax consolidation system applies to 100 percent ownedgroups of companies and, relevantly for securitisation, trusts.Where consolidation is elected, the ultimate Australian residentholding company (the Head Company) is treated as the only taxentity. The separate entity status of wholly owned companies andtrusts is ignored – their businesses are regarded as divisions ofthe Head Company. Where consolidation is elected members ofthe consolidated group cannot be selectively included or excludedfrom consolidations. The “one in all in” principle requires allwholly owned entities to be consolidated.Where a securitisation vehicle is a wholly owned entity within agroup which has elected to consolidate, it will form part of aconsolidated group. This could have significant tax consequencesas tax neutrality will not be determined in respect of a specialpurpose vehicle as a stand alone entity. Instead, a single taxliability would be determined by reference to the consolidatedgroup, treated as a single entity.There are specific rules dealing with the recovery of income taxowing by the Head Company of the consolidated group, wherethe Head Company defaults on its primary obligation for theincome tax debts of the consolidated group. A group member willbe jointly and severally liable for all the tax liabilities of thegroup.