In these challenging times for domestic securitization in both the U.S. and Canada, two recent developments will serve to ease the burden of cross-border ABS transactions. A number of these transactions have occurred and more are in the works.
Firstly, Canada has eliminated its withholding tax on most arm's length and unrelated party payments of interest, whether the interest is paid to a resident of the U.S. or to any other non-Canadian.
Previously, only a limited category of Canadian interest-bearing obligations could be economically securitized or otherwise funded in the U.S. or other non-Canadian capital markets. And these transactions usually had to be structured as five-year bonds and made subject to other conditions that were not always acceptable to investors, or at least involved significant incremental time and cost. With the elimination of this tax, it is now possible to securitize in the U.S., the U.K. and other foreign capital markets, on a straightforward and economic basis, various types of Canadian receivables, such as credit card obligations, auto loans, residential and commercial mortgages, floor plan facilities and ABCP. A number of these transactions have taken place over the past year, either as 144A deals or private placements.
Although withholding tax on rent remains in place, Canadian leases have also been securitized in the U.S. The leases are transferred to a Canadian SPV, which then funds itself by issuing asset-backed notes to non-resident investors on a withholding tax free basis.
The second recent development involves the long-awaited amendment to the Canada-U.S. tax treaty. The revised treaty will come into force once it is signed by President George Bush and the two governments exchange notes confirming that they have ratified it. This is widely expected to occur before the end of the year.
The amended treaty will eliminate most arm's length and unrelated party payments of interest by U.S. residents to residents of Canada. It will therefore no longer be necessary to rely on the somewhat restrictive portfolio interest exemption for U.S. withholding tax, which excludes various Canadian residents, including certain financial institutions.
Once the treaty amendment comes into force, it will be possible for U.S. issuers to issue ABS, CMBS and ABCP to a wider group of Canadian investors, unburdened by U.S. withholding tax. It should be kept in mind that the revised treaty will contain a "limitation on benefits" test that must be met in order to be entitled to treaty benefits.
These recent developments are already being taken into account in structuring cross-border securitizations between Canada and the U.S. And when the current turmoil subsides, it is expected that significant cross-border transactions will take advantage of the increased investor base that will be made available to both countries.
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