Ireland continues to lead the way in offering innovative financial services solutions for investment structures. Recognised as a global hub for investment funds, Ireland has an established investment funds industry with over €1.88 trillion worth of investment fund assets administered in Ireland.1 Ireland has also firmly established itself as a location of choice for the establishment of special purpose vehicles (SPVs) for structured finance transactions. Both industries provides vehicles through which investors can invest indirectly in a wide variety of assets through holding shares, units or bonds issued by these vehicles.2 The respective vehicles can also be combined to provide effective solutions at investor or asset level. In this briefing we summarise some popular structures available to the international financial services industry.
Structured Debt Funds
The combination of a qualifying investor fund ("QIF")3 with one or more Irish SPV subsidiaries has become increasingly common as a structure to invest in a wide variety of forms of debt obligation-type investment funds and, more generally, as a structure to minimise withholding taxes on underlying investments.
The Central Bank of Ireland (the "Central Bank") has approved a wide range of QIFs investing in debt of various types. These QIFs invest in various debt obligations from first loss and BB rated tranches of CDOs to investment grade debt, leveraged loans (such as leveraged loans traded on the U.S. and European loan markets) and various tranches of asset-backed securities ("ABS"). Investments in leveraged loans are acquired not only through participations and sub-participations but also through assignments and novations.
From a timing perspective, QIFs are authorised 24 hours after the fund documentation is filed with the Central Bank. There is no requirement to file draft documents with the Central Bank for its review.
Fund v Special Purpose Vehicle
There are a number of reasons why some promoters structure vehicles to invest in debt as an investment fund. One of the main reasons is that investors typically have more liquidity in a fund (having the ability not only to transfer their shares in the fund but also having the right to redeem their shares on request)4. Shares in an open-ended investment fund are redeemed at their net asset value ("NAV") and are usually issued on an ongoing basis at NAV or at an initial offer price in the case of new share classes. This is in contrast to SPVs that issue debt which are usually not open-ended and which typically raise additional funds through a subsequent offering. In addition, there is no need for the promoter of a fund to take "on book" any part of the offering that is not taken up by investors. In an SPV, the arranger may underwrite the note offering and may have to take "on book" some part of the debt offering which in turn can create regulatory capital issues for the arranger.
Debt funds often use derivatives. For example, debt funds often use credit default swaps where the fund is the credit protection seller. This enables the promoter to structure a synthetic debt obligation as a fund. As a QIF, there is no limit on the exposure such a fund may have to a counterparty provided that the counterparty has a credit rating of A2/P2 and satisfies certain other requirements.
Use of Tax Efficient SPVs
A debt fund may use one or more wholly-owned SPV subsidiaries to minimise foreign withholding taxes on interest payments on its underlying investments. The SPV subsidiary is usually structured as a "Section 110 company". Section 110 of the Taxes Consolidation Act 1997 (Section 110) is the cornerstone of Ireland's securitisation regime which permits qualifying Irish resident SPVs to engage in an extensive range of financial and leasing transactions in a tax neutral manner. (For more information on establishing Section 110 Companies in Ireland see: "Establishing Special Purpose Vehicles in Ireland"). The scope of the regime is particularly broad, applying to companies involved in the holding or management of a wide category of financial assets ("qualifying assets"), and has recently been extended to include the leasing of plant and machinery, and the holding or management of commodities and carbon offsets issued under voluntary as well as compulsory schemes. Certain targeted anti-avoidance provisions have also been introduced although they do not affect fund/SPV structures, with payments by a Section 110 company to an Irish fund and vice versa remaining unaffected.
The use of a Section 110 company in a structure can provide access to a greater range of double taxation treaties. A Section 110 company must be Irish tax resident and is subject to Irish corporation tax. As a result, it can usually access most of Ireland's double taxation treaties and, depending on the particular treaty, receive income on its underlying investments free from withholding tax or at a reduced rate.
In order to ensure that the investors in an Irish fund continue to benefit from the tax exempt status of the Irish fund while at the same time the assets of the fund are held by one or more taxable SPV subsidiaries, the Section 110 company or companies are typically funded by a profit participating loan (the "Loan") from the Irish fund. Under the terms of the Loan, the Irish fund finances the Section 110 company in return for the Section 110 company agreeing to repay the principal amount of the Loan and interest equivalent to the majority of profits received by the Section 110 company on its investments. No Irish withholding tax applies on the payment of interest by the Section 110 company to the Irish fund. The net effect of this loan structure is that the Section 110 company should have negligible taxable income and the Irish fund will receive via the Section 110 company interest payments in respect of its underlying investments at the applicable treaty withholding tax rates. Payments by the fund to non-Irish residents can be made tax-free. The following diagram illustrates this structure:
This structure can be applied beyond debt funds to funds investing in foreign shares and securities where treaty access may not otherwise be available. This structure has also been popular in seeking to address new rules on substance requirements in treaty jurisdictions, such as Circular 601 (the interpretation of "beneficial owner") issued by the State Administration of Taxation in China, and German anti-treaty shopping provisions.
The reverse structure of an Irish SPV holding the shares in an Irish fund is also possible and has been used, for example, to facilitate qualification for benefits under the Ireland/U.S. double taxation treaty.
A Section 110 company is the investor facing vehicle in this structure with investors holding notes issued by the Section 110 company. Depending on the intended investor base, the notes are often listed on the Irish Stock Exchange or other recognised stock exchanges and may be structured as quoted eurobonds so that payments can be made free from withholding tax. (For more information see: "Establishing Special Purpose Vehicles in Ireland").
The Section 110 company in turn holds all of the units in the Irish fund. As an "exempt Irish resident" for the purposes of the applicable Irish tax rules, no withholding tax applies on payments to the Section 110 company by the Irish fund. An Irish fund is expressly recognised as a resident of Ireland for the purposes of the Ireland/U.S. double taxation treaty and should also satisfy the base erosion test in the Limitation on Benefits (LoB) article of the treaty, as applicable. Whether the Irish fund meets the other provisions of the LoB article will differ depending on the ownership of the Irish fund and in turn the Section 110 company. In this regard the Section 110 company can provide flexibility in the structure of its financing as to the treatment of its securities for foreign tax purposes. The following diagram illustrates this structure:
Additional Irish funds between the Section 110 company and the investment fund may also be used in the chain in master/feeder type structures, with the Irish feeder fund potentially qualifying as a "qualified person" for the purposes of the LoB article of the Ireland/U.S. double taxation treaty in the manner outlined above.
Life Settlement and Structured Settlement funds
Arthur Cox has been to the fore in structuring a number of life settlement and structured settlement funds for investment into the U.S. using variations of the structures outlined above.
The development of fund/SPV structures illustrates the innovation available in the financial services sector in Ireland by resolving potential investor and asset level issues.
1 Source: Irish Funds Industry Association (February 2011).
2 For more information on Irish regulated investment fund vehicles and Irish SPVs, see "UCITS and Non-UCITS Funds in Ireland" and "Establishing Special Purpose Vehicles in Ireland", respectively.
3 A QIF must have a minimum subscription per investor of €100,000 (or its equivalent in another currency). A qualifying investor includes: (i) an investor who is a professional client within the meaning of MiFID; (ii) an investor who receives an appraisal from an EU bank, a MiFID firm or a UCITS management company that the investor has the appropriate expertise, experience and knowledge to understand adequately the investment in the QIF; or (iii) an investor who certifies that it is an informed investor by confirming that it has such experience in financial and business matters as would enable the investor to evaluate properly the merits and risks of the prospective investment or confirming that the investor's business involves, whether for its own account or for the account of others, the management, acquisition or disposal of property of the same kind. Certain knowledgeable employees are exempt from the minimum subscription requirement and qualifying investor criteria.The Central Bank does not impose any restrictions on the investment objectives and policies or on the degree of leverage employed by a QIF subject to satisfying certain disclosure and counterparty requirements.
4 The redemption right is often subject to the qualification that the fund has the right to satisfy redemption requests on a pro rata basis and defer the excess to subsequent dealing days if the redemption requests are in excess of a specified redemption "gate". If required, open-ended QIFs can also be structured as limited liquidity funds with lock-in periods and/or more limited redemption rights for investors.
This article contains a general summary of developments and is not a complete or definitive statement of the law. Specific legal advice should be obtained where appropriate.