Sabrina Wong, Sania Ilahi, "Tax Implications of Asset Securitizations", 2015 CTF Annual Conference Report

Most commonly-used lease securitization structure: drop-down to LP (pp. 12:4)

In the most commonly used lease securitization structure in the last few years…the lease originator does not retain ownership of the equipment. This is not the case in the sale lease-back structure and the concurrent lease structure. …

[T]he lease originator transfers the equipment that is subject to the underlying leases at fair market value to an SPE, often a limited partnership, in consideration…for limited partnership interests, assumed liabilities, and a note issued by the limited partnership…under subsection 97(2). …

The limited partnership issues asset-backed notes, either directly to investors or to a conduit trust (that in turn issues commercial paper to investors). The limited partnership uses the proceeds from the issuance of the asset-backed notes to repay the limited partnership note and/or return partnership capital to the lease originator.

Quaere correctness of including sales proceeds in gross revenues (p. 12:9)

There is some doubt concerning the correctness [under 1T-443] of including the proceeds of sale of leasing property in gross revenues since leased property is generally considered to be "capital property," and thus the sale proceeds of the property should be considered to be payments on account of capital. Payments on account of capital are specifically excluded from the definition of gross revenues.

Accessing advantages of principal business partnership (p. 12:10)

If the property is specified leasing property, an exception is provided to the application of the half-year rule [in Reg. 1100(2)(a)(v)] when the taxpayer or partnership satisfies the principal leasing requirements.

Principal business corporations or partnerships can…file a special once-and-for-all election to deem all of their subsequently acquired exempt property (which is ordinarily not subject to the specified leasing property rules) to be specified leasing property. Alternatively, they can elect to include one or more exempt properties in a separate class for CCA purposes. … [S]ince the principal leasing business requirement must be met throughout each taxation year, including the first taxation year of a newly formed SPE, it is common to transfer a few leased pieces of equipment to the SPE at the time of its formation.

Quaere whether LP business is separate from the originator’s (p. 12:10-12:11)

An issue may arise when the SPE is a limited partnership and the originator that is a member of the partnership retains some leased equipment. This issue was raised in a CRA technical interpretation [2002-0156515 where] … A Co, B Co, and C Co each retained 10 percent of the leased equipment. …

It is the CRA's position [in IT-443, para. 10] that the gross revenue of the partnership from a particular source is to be included in the gross revenue of the corporation from that source to the extent of the corporation's profit-sharing percentage. …

[I]f the activities of the corporation and the partnership are considered to be two separate businesses of the corporation, the following determinations must be made: (1) which business is the corporation's principal business, (2) whether this principal business is the leasing of leasing property, and (3) whether the gross revenue from that principal business is at least 90 percent of the gross revenue of the corporation for the year from all sources.

Non-application of half-year rule on drop-down from lease originator to LP if not inventory (p.12:10)

This exception to the half-year rule may apply in certain circumstances to the limited partnership in the [above] lease securitization structure… . The originator and the limited partnership should be considered not to be dealing at arm's length since the originator is the sole shareholder of GP Co. If the originator has owned the leased equipment continuously for a period from at least 364 days before the end of the taxation year of the limited partnership in which the limited partnership acquires the leased equipment, the half-year rule should not apply, as long as the leased equipment is depreciable property to the originator before its transfer to the limited partnership. …

[L]eased equipment that is acquired with the intention of immediately selling it to the limited partnership may not be considered to be depreciable property. In this case, the CCA on the leased equipment acquired by the limited partnership is subject to the half-year rule in the year that the equipment is acquired by the partnership (subject to the exception relating to specified leasing property acquired by a partnership that satisfies the principal leasing requirements).

Co-ownership structure for mortgage securitizations (p. 12:14)

The securitization of mortgages has often been structured as the sale by an SPE (the issuer SPE) of undivided co-ownership interests in a pool of mortgages. The basis of the structure is a custodial arrangement in which the issuer SPE purchases the mortgage loans from a mortgage seller (or less often originates the mortgage loans itself) and then transfers all of its rights, title, and interests in the mortgage loans to the custodian who acts as agent, bare nominee, and bailee for the investors. The mortgage seller or a related entity continues to service the mortgages. The securities sold by the issuer SPE to the investors (the certificate holders) evidence undivided co-ownership interests in the mortgage loans and all related rights under the mortgage loans. The certificates typically include…:

  1. fast-pay or sequential-pay certificates issued in a class (for example, classes A to D) under which the certificate holders are entitled to receive (in sequential order, for example, of A to D) payments of certificate interest at a specified rate (commonly called "the passthrough rate") on the certificate balance and payments in respect of the certificate balance, until the certificate balance is reduced to nil;
  2. interest-only certificates entitled to receive only payments of certificate interest at a specified rate on the certificate balance; and
  3. residual certificates entitled to the remaining amounts.

Application of PDO (Reg. 7000(2)(b)) rules (p. 12:15)

Since the co-ownership interests evidenced by the certificates are unequal with respect to their rights to principal and interest payments on the underlying mortgage loans, each investor does not necessarily receive the same percentage of each payment of interest and principal. A certificate holder's co-ownership interest in a mortgage loan constitutes a prescribed debt obligation under regulation 7000(1)(b).

Interaction of servicing fees and PDO calculation (p. 12:16)

[T]he certificate holder's share of various fees and expenses relating to the servicing of the mortgage loans…should generally be deductible on a current basis, provided that they are reasonable. However, it is generally difficult to determine which certificate holder is responsible for which portion of the fees and expenses. A practical approach is for the certificate holder to report the net amount received and compute the prescribed-debt obligation accrual on the basis of the net amounts. The CRA agrees with this position [in 2007-022514lR3].

Carve-out re interest coupons received (or reversal of PDO overaccrual) in a mortgage securitization structure (p. 12:17)

The application of subsection 12(9.1) of the Act is important in relation to the treatment of amounts received by the certificate holders. Because the proportion of interest and principal amounts in any distribution paid to a certificate holder is not determinable from the outset, a certificate holder may receive interest payments that exceed the amounts designated in the deemed accrual rules under the prescribed debt obligation regime, and may even receive payments that are made up entirely of interest. …

Subsection 12(9.1)…exclud[es] from the certificate holder's income the portion of the proceeds of disposition received by the certificate holder from the disposition of an interest in the mortgage loan that can reasonably be considered to represent a recovery by the certificate holder of the cost of acquiring the interest [see 9206645]. …

Conversely… subsection 20(21)…should allow a deduction of the overaccrual on the disposition of the certificate for fair market value.

Quiescence of CRA post-Canada Trustco (p. 12:21)

No significant assessments have come to light in connection with the treatment of the servicing since...Canada Trustco … [R]eaders should be cautioned that…[s]tructuring of the securitization is critical to ensure that a third party is not granted responsibility for servicing the financial assets sold to an SPE.

Typical structure of a trade receivables securitization (pp. 12:21)

[In] [t]he typical structure of a trade receivable securitization…the seller agrees to sell and the SPE agrees to purchase, on a continuing basis and over an agreed term, the trade receivables of the seller. … The purchase price for the receivables is typically the face amount of the receivables less a discount. The SPE issues commercial paper to fund the purchase price of the receivables. In most trade receivables securitizations, the seller holds back a portion of the purchase price, which is known as "the deferred purchase price." The deferred purchase price is payable to the seller only after the SPE recovers all amounts payable on the purchased receivables.

Sale v. secured loan in securitization (p. 12:21)

The courts [In re George Inglefield Limited, [1933] Ch. 1 (CA)] have also indicated that a difference between a sale and a secured loan is that in a sale the seller is not entitled to recover the subject matter of the sale by returning the purchase price to the purchaser. In a typical RPA in a trade receivables securitization, the seller is not entitled to a return on the purchased receivables on repayment of the purchase price. Another distinction between a sale and a secured loan is that if the SPE is unable to collect the full amount of a purchased receivable following termination of the RPA, the SPE has no right to collect any balance owing from the seller. …

Computation of profit on sale of trade receivables to securitization trust (p. 12:22)

Generally, it is the CRA's view [see 9206645] that the sale of accounts receivable, other than as part of the selling of a business, is on income account since the sale occurs in the ordinary course of the seller's business. …

Generally, the CRA takes the position [2007-022514lR3] that when the purchase price in a securitization consists of upfront cash payments plus amounts received as a deferred purchase price, the fair market value of the deferred purchase price is included in the seller's income on the date of the sale of the receivables. The amount of the deferred purchase price is considered to be a separate property, and any further recovery or loss is recognized when amounts are received from the SPE.

Potential liability of securitization trust for vendor’s unremitted GST (p. 12:23)

[A]ny tax owing that is not remitted by the seller may become an obligation of the SPE as a result of the trust provisions in ETA subsection 222(1).

Advantages of sale to securitization trust on recourse basis (p. 12:25)

P-029R [states]:

...It is the Department's position that where a person agrees to buy or take back a receivable, in whole or in part, that was previously transferred to a third party, the person may claim a deduction under subsection 231(1) of the Excise Tax Act provided the conditions have been met.

...It is therefore advisable to sell trade receivables on a recourse basis, which allows any bad debts to be transferred back to the original supplier to claim the bad debt adjustment. However, this condition may be at odds with the accounting provisions that limit the recourse by an SPE to the assignor... .

Potential application to Canadian debtors under cross-border securitization (p. 12:26-12:27)

[W]hen trade receivables that arise from services rendered to Canadian obligors are sold cross-border by a Canadian seller to a non­resident SPE, the Canadian obligors may be subject to regulation 105 withholding requirements when they make payments owing under the service receivables.