Ireland: Ireland As A Domicile For Special Purpose Vehicles

Background

Ireland has now emerged as a favoured location for special purpose vehicles (SPVs) which are used in many financial transactions including securitisation and asset repackaging transactions. In particular, it is becoming the domicile of choice for onshore SPVs in Europe and there are positive signs that it is becoming a preferred alternative to the traditional offshore SPV jurisdictions.

The type of transactions that have used Irish SPVs have included plain vanilla (securitisation of receivables, mortgages and non-performing loans), less straightforward synthetic transactions and the more unusual securitisations such as contingent deferred sales commissions arising on the sale of mutual funds and the financing of a toll bridge in Korea using future toll charges. Irish SPVs are also being used by offshore hedge funds and private equity funds to gain access to double tax treaties to avoid foreign withholding taxes (if applicable) on their underlying investments by investing indirectly in the underlying investments via an Irish SPV. The wide diversity of deals has emphasised Ireland's growing importance as an SPV domicile.

Why Ireland?

There are two primary reasons for choosing Ireland as a location for establishing SPVs. Firstly, Ireland has a relatively extensive double tax treaty network (currently numbering 44 with another 10 in the pipeline that are at various stages of progression) and, secondly, it is not offshore.

Frequently cash flows from assets attract withholding taxes on the income and/or capital gain flows on those assets and can only be avoided by locating the SPV in a domicile which has a tax treaty with the country of origin of those assets. There is no doubt that Ireland's primary success as an SPV domicile is because of its double tax treaty network in avoiding withholding taxes on the relevant assets. Irish SPVs have been used in numerous transactions for acquiring a wide range of Korean, Japanese and German assets because of Ireland's favourable double tax treaties with those countries. Even in countries where it is necessary to use a SPV domiciled in the relevant country of origin of the assets, Ireland may still be used as an SPV domicile for issuing the necessary debt and then holding the units/certificates in the underlying SPV on which flows of income and gains arise backed by the underlying assets held by the SPV. Access to a double tax treaty with the relevant country (or access to the EU Directives for European assets) is critical in avoiding withholding taxes on the flows of income/gains from the units/certificates issued by the SPVs.

Quite separately, Ireland is increasingly being used as an alternative to traditional offshore jurisdictions for the very reason that is not offshore. For certain (particularly European) groups, offshore may have negative connotations. Ireland with its favourable SPV tax legislation and membership of the EU and OECD offers an attractive alternative. For example, Ireland has been used as a domicile on many occasions for credit derivatives and synthetic securitisations mainly involving European banks were no withholding taxes arise but the use of an offshore SPV was viewed negatively by the banks concerned.

In addition to the above primary advantages, Ireland also offers an excellent legal and accounting/tax infrastructure, efficient listings, English speaking, stable political and economic environment and good flight access and general infrastructure. All these factors (together with its favourable SPV tax environment) make Ireland a genuine player in the choice of SPV domicile.

Taxation

Tax neutrality is achieved in an SPV if its expenses are deductible for tax purposes and if book/tax differences in the taxation or deductibility of income and expenditure are minimal.

Prior to the introduction of the securitisation tax provisions, one of the major difficulties in establishing an SPV in Ireland was showing that the SPV was carrying on a trade for Irish tax purposes and thereby entitled to a tax deduction for its interest payments and expenses. This would be imperative so that the SPV can achieve a tax neutral position in Ireland. Accordingly, the securitisation rules provide that a "qualifying company" will be subject to Irish corporation tax at a rate of 25% on its taxable profits (which can be eliminated with appropriate structuring) which are calculated under trading principles. There is nothing in the legislation preventing profits arising in the SPV. However, such profits, if they arise, will be taxed in Ireland at 25%.

Qualifying Company

A "qualifying company" means a company which:

• is resident in Ireland;

• acquires "qualifying assets" (see definition below) or as a result of an arrangement with another person holds or manages qualifying assets or enters into a legally enforceable arrangement with another person and the arrangement is itself a qualifying asset (such as a derivative);

• carries on in Ireland the business of the holding and/or management of "qualifying assets";

• apart from activities ancillary to that business, carries on no other activities;

• undertakes the first transaction resulting in the holding and/or management of qualifying assets for a value of not less than €10m;

• notifies the Irish tax authorities that it is a company to which points (a) to (e) apply; and

• carries on no transaction other than by way of a bargain made at arm's length (the legislation specifically excludes profit participating loans from satisfying this requirement).

A "qualifying asset" means an asset which consists of, or of an interest in, a "financial asset" which includes shares, bonds and other securities, futures, options, swaps, derivatives and similar instruments, invoices and all types of receivables, obligations evidencing debt (including loans and deposits), leases and loan and lease portfolios, hire purchase contracts, acceptance credits and all other documents of title relating to the movement of goods, and bills of exchange, commercial paper, promissory notes and all other kinds of negotiable or transferable instruments.

There are two tests of tax residence in Ireland – a central management and control test and an incorporation test. The tests can be quite complicated however, suffice to say that if the SPV is owned by a charitable trust (thus not having to consider any group ownership for the purposes of the test) then it is most likely that the SPV would be regarded as tax resident in Ireland under the incorporation rule. In respect of the central management and control test, this concept is not defined in Irish legislation and its meaning is taken from the UK case law (which is not legally binding in Ireland but is regarded as persuasive). The case law meaning of central management and control is, in broad terms, directed at the highest level of control of the business of the company and is to be distinguished from the place where the main operations of the business are to be found.

Case law has established that the location of certain functions is relevant in determining where the central management and control of a company is exercised. The most important of these is the location of directors' meetings. This assumes that such meetings are the medium through which major and strategic decisions are taken by the company. Therefore, an SPV will be regarded as tax resident in Ireland if meetings of the board of directors are held in Ireland and major policy and strategic decisions of the company are taken at those meetings.

Test (c) of a "qualifying company" (i.e. that it carries on in Ireland the business of the holding and/or management of qualifying assets) is satisfied via the participation of typically two Irish resident directors in the affairs of the SPV and the appointment of an Irish based corporate administrator to the SPV. The role of the Irish administrator is generally limited (but can be wider if required) to keeping books and records of the SPV, preparing accounts, providing directors etc.

It will be noted from test (d) above that the SPV must not carry on any other activities (apart from those that are ancillary to the business of the holding and/or management of qualifying assets). This is to ensure that the SPV is only used for particular types of activities so as to confine the favourable tax treatment afforded to Irish SPVs only to qualifying assets.

Financing & Withholding Tax

Typically debt is used to finance the Irish SPV. There are no tax restrictions on what form of debt is used (i.e. whether the SPV raises monies by means of a loan, the issue of notes or bonds etc.). Interest payments made by the SPV may be made free of Irish withholding taxes provided the recipient of the interest is tax resident in a country with whom Ireland has a double taxation agreement or is tax resident in a Member State (other than Ireland) of the EU. Ireland's current double taxation treaties are set out in Appendix I.

SPVs can also take advantage of the "Eurobond" exemption to pay interest gross. A "Eurobond" is defined in the tax legislation as a security which is quoted on a recognised stock exchange and carries a right to interest (i.e. zero coupon bonds do not qualify). Interest on Eurobonds may be paid free of Irish withholding tax if the paying agent is not based in Ireland or, if they are, the Eurobonds are held in a recognised clearing system. Similar to swap payments above it should be noted that a technical exposure to Irish income tax (as opposed to withholding tax) may still arise on interest arising on Eurobonds. However in practice it is not an issue and the Eurobond route is an attractive route for those SPVs wishing to raise finance from a wide range of persons resident in different countries.

Lastly, SPVs can take advantage of Ireland's "wholesale debt" exemption for avoiding Irish withholding taxes. This exemption will apply to debt securities issued by a company where:

(a) If the person by or through whom the payment is made is resident in Ireland:

• the debt security has a maturity of less than 2 years; and

• either (i) the debt security is held in a recognised clearing system and issued in minimum denominations of US$500,000 or €500,000 or its foreign currency equivalent or (ii) the person beneficially entitled to the interest is resident in Ireland and has provided their tax reference number to the person making the payment, or (iii) the person who is the beneficial owner of the debt security and who is entitled to the interest is not resident in Ireland and has made a declaration to that effect.

OR

(b) If the person by or through whom the payment is made is not resident in Ireland:

• the debt security has a maturity of less than 2 years; and

• the notes are held in a recognised clearing system; and

• the notes are issued in minimum denominations of US$500,000 or €500,000 or its foreign currency equivalent.

Profit Extraction

Profit participating loans/notes

Interest payments (even those which vary with the SPV's profits) made by the SPV (on moneys raised to enable it to hold or manage qualifying assets) will be tax deductible provided that payments of interest are not made to a 75% non-Irish tax resident parent company or sister company (to the extent to which both companies are 75% subsidiaries of a third non-Irish resident company).

However, even if interest payments are made to a non-resident group company it may be possible to still claim a tax deduction in such circumstances as most of Ireland's double tax treaties will override the domestic Irish tax provision prohibiting such a deduction and, in addition, there is a statutory override for interest payments to EU resident companies.

If a trustee on behalf of a charitable trust normally holds the SPV's share capital, interest payments to group companies will not arise.

Total return swaps

Other common mechanisms used to extract profits from the SPV in a tax efficient manner are total return swaps (TRSs). The idea is that the SPV enters into a TRS with a group company of the promoter(s) of the SPV (the swap counterparty) where the SPV undertakes to effectively swap all its receipts to the swap counterparty in return for the swap counterparty providing it with enough monies to discharge its liabilities. In addition to this being a very simple mechanism for extracting profits it also has the added advantage of no Irish withholding tax on swap payments made to non-Irish residents. There may be a technical liability to Irish income tax for recipients (i.e. the swap counterparty) who are not resident in a country with which Ireland has a double tax treaty but in practice this liability is not enforced by the Irish tax authorities.

Other mechanisms

Other mechanisms such as deferred consideration, servicing fees, management fees and arrangement fees may also be possible if properly structured (from an Irish tax perspective).

Stamp Duty

For so long as the SPV remains a qualifying company (within the meaning of Section 110) no charge to Irish stamp duty arises when bonds or notes are issued by an SPV. In addition, there is no Irish stamp duty arising on the transfer of such notes or bonds.

The Irish Government announced in the 2007 budget (and legislated for in the Finance Bill 2007) the abolition of stamp duty on the creation and transfer of mortgages and charges executed on or after 7th December 2006. This legislation is expected to be enacted in the Finance Act, 2007 (due out in late March or early April 2007) and draft legislation has already been published with a result that, on a practical level, the Irish Tax Authorities no longer require that such charges and mortgages are presented to them for stamping.

While the stamp duty which was payable was usually minor (typically €630 on each original instrument, and €12.50 on each counterpart or collateral instrument), this is a welcomed change which streamlines the administration of SPVs and reduces their costs as, prior to this amendment, the relevant security documents (including every counterpart) were required to be presented to the Irish Tax Authorities in Ireland for stamping within 30 days of execution.

Capital duty in Ireland was abolished with effect from 7th December 2005.

Value Added Tax (VAT)

An SPV will not be subject to Irish VAT on its securitisation activities. However, to the extent to which it suffers any Irish VAT (which if structured properly should be minimal) it may be able to recover all or a percentage of its VAT costs depending on where the securitised assets are located. If the SPV is securitising non-EU assets, it will be able to recover 100% of any Irish VAT input costs.

Revenue Notification

In order to avail of Section 110 status it is necessary that the SPV complete and submit to the Irish Revenue a Form 110 before the end of its first accounting period. This is only a one-page notification containing minimal detail with no return approval or Revenue Ruling required.

Double Tax Treaties

As mentioned above Ireland is party to an extensive double tax treaty network (currently numbering 44 with another 10 in the pipeline at various stages of progression – See Appendix I).

International Accounting Standards (IAS)

Due to concerns raised over the treatment of various items in the financial statements under IAS accounting which could compromise the profit neutrality of an SPV, representations were made by the industry to the Irish Revenue. As a result of these representations the legislation was amended to permit SPVs to continue to use profits as per accounts drawn up in accordance with Irish GAAP (as they existed as at 31st December 2004) as the starting point for calculating taxable trading income. Nevertheless, these SPVs may also base their taxable profits on accounts drawn up in accordance with IFRS as the starting point for calculating taxable trading income by making a specific election to do so. Once an SPV elects to use IAS accounting (for tax purposes) it will not be entitled to revert to GAAP accounts.

Irish Legal Requirements

Irish SPVs may be established either as limited or unlimited companies under the Companies Acts 1963-2006. Private limited companies are the most common form of business entity used in Ireland, however, until recently many structured finance and securitisation transactions required the use of a public limited company where there was a "public" offer of securities. This situation was changed in December 2006 when the Investment Funds, Companies and Miscellaneous Provisions Act 2006 (the "2006 Act") was implemented. The Act will have an enormously positive impact on the Irish structured finance market as it allows, among other things, private companies to be used for an increased number of transactions. Other positive developments in the Act include the clarification that guarantors/monoline insurers will only be responsible for the contents of a prospectus insofar as it contains statements (or omissions) regarding the monoline insurer or the insurance policy. The Act also clarifies pre-existing uncertainty regarding the requirement to obtain the consent of experts to the inclusion in a prospectus of reports prepared by such experts. For example, Irish law no longer requires auditor's consent to the inclusion of historical financial information in the prospectus where not prepared for the purpose of inclusion in the prospectus.

In terms of the changes to the rules relating to offers of securities by private limited companies, historically, private companies were prohibited from making any offer to the public of their shares or debentures. As a result of the 2006 Act, private companies may now offer the following types of debt securities which they had been previously been restricted or prohibited from doing so:-

• an offer addressed solely to qualified investors;

• an offer addressed to less than 100 persons (other than qualified investors);

• an offer where the minimum consideration is at least €50,000 per investor for each separate offer;

• an offer of debentures whose denomination per unit amounts to at least €50,000;

• an offer of debentures where the offer limits the amount of the total consideration for the offer to less than €100,000;

• an offer of classes of instruments which are normally dealt in on the money market (such as treasury bills, certificates of deposit and commercial papers) having a maturity of less than 12 months.

The most likely applicable exemption for most securitisation transactions is where the notes or bonds issued by the Irish SPV have a minimum denomination of €50,000. This is usually the case for non-retail offerings to get around the provisions of the Transparency Directive.

Private Companies

The essential features of a private limited company are that the liability of members is limited to the amount of share capital subscribed and that certain obligations imposed on public limited companies do not apply to private limited companies.

The main advantages of using a private limited company are that:

• it usually takes no more than five working days for a private company to be registered with the Companies Registration Office.

• the minimum number of shareholders is 1;

• the minimum issued share capital is €1 (the requirement for a PLC is approximately €40,000);

• there is no requirement to obtain a certificate of entitlement to do business/trading certificate and so the SPV can be ready to start trading with five working days;

• for US federal income tax purposes, a private company may elect to be treated as a flowthrough or corporate entity (whereas public limited companies automatically default to corporate tax treatment.).

Public Companies

Public limited companies have the same essential characteristics as private limited companies i.e. the liability of members is limited to the amount of nominal capital subscribed but there are certain key differences, many of which, as outlined above, are significant in the context of securitisation and structured finance transactions. In addition, there is no restriction on the number of members in a PLC but the minimum number is seven; shares may be issued to the public and may be listed on a stock exchange and certain additional reporting and capital requirements apply to such companies.

It can take up to three weeks from the date of filing registration documentation with the Companies Registration Office for a certificate of entitlement to trade to issue for public companies.

Ongoing Obligations

An Irish SPV as well as having to file annual tax returns will also have to prepare and file annual audited accounts with the Companies Registration Office.

An SPV will also need to file details of all "charges" over its assets to preserve their priority with the Companies Registration Office within 21 days of the creation of such charges.

In addition, an Irish SPV must have a registered office located in Ireland and maintain its books and records at a designated location. Typically it must have a minimum of one Irish resident director although in practice there are normally two Irish resident directors in order to ensure that the SPV is tax resident in Ireland under the central management and control test. It should be noted that the maximum number of directorships which a person may hold in a private company is 25 so this should be borne in mind when selecting an appropriate director of the SPV.

The SPV will generally not be regulated by the Irish authorities but "public offer" and other regulatory requirements may be relevant depending on the scope of the offer and whether the securities issued by the Irish SPV are to be listed. The nature of the activities and the assets held by the SPV will also determine whether other regulatory requirements apply. For example, reinsurance SPVs, which are becoming increasingly common in Ireland, must be authorised by the Irish Financial Regulator.

Listing

A number of years ago, the Irish Stock Exchange introduced rules regarding the listing of specialist debt securities. These rules, which were updated following the implementation of the Prospectus Directive, have provided a relatively inexpensive and timely listing process and have proved very popular for many arrangers since their introduction (not just for Irish domiciled SPVs but also non-Irish domiciled SPVs). The Irish Stock Exchange has a turnaround time of maximum of 3 working days on the initial draft followed by a 2 day turnaround on subsequent drafts.

APPENDIX I

Appendix I Ireland's Network of Double Tax Treaties
Australia Austria Belgium Bulgaria Canada China Croatia Cyprus Czech Republic Denmark Estonia Finland France Germany Greece Hungary Iceland India Israel Italy Japan Korea (South)	Latvia Lithuania Luxembourg Malaysia Mexico Netherlands New Zealand Norway Pakistan Poland Portugal Romania Russia Slovak Republic Slovenia South Africa Spain Sweden Switzerland United Kingdom United States Zambia

• A new agreement with Chile was signed on 2 June 2005. Subject to the necessary parliamentary procedures being completed by Chile, it is hoped that the agreement will enter into force on 1st January, 2008

• New treaties with Argentina, Egypt, Kuwait, Malta, Morocco, Singapore, Tunisia, Turkey, Ukraine and Vietnam are being negotiated. Existing treaties with Cyprus, France and Italy are in the process of re-negotiation.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.