The U.K. HM Revenue & Customs has issued draft regulations that will provide a new tax regime for securitization companies. The new regulations are expected to clarify certain provisions of the International Financial Reporting Standards (IFRS) and U.K. GAAP and quash concerns regarding their effect on securitization taxation.

The draft regulations address tax issues arising from the implementation by U.K. companies of the IFRS, or of the new U.K. GAAP that retain the principles of the IFRS, particularly the adoption of fair value accounting for derivatives. According to Fitch Ratings analysts, the change in accounting could have led to unfunded tax liabilities arising in U.K. Special Purpose Entities (SPEs) - that were previously mostly tax neutral - due to taxable profit being broadly derived from accounting profit. Tax liabilities are typically a senior expense in the transaction's priority of payments, although ratings could be threatened where the extent of such amounts are not easily predictable.

An interim solution was introduced by the Finance Act 2005, which required U.K. securitization companies to continue to apply the older version of U.K. GAAP for the purposes of determining taxable profit, but this provision only extends as far as accounting periods ending prior to January 1, 2008. "The regulations would introduce a new taxation regime and will apply for existing as well as future transactions," explained Royal Bank of Scotland analysts. "The industry and the Inland Revenue have worked long and hard to achieve this new regime... The regime will replace the existing interim arrangements on current regulations."

The draft regulations apply to U.K. SPEs that perform roles at various levels in securitization structures and fulfill certain conditions, including that they pay out all their receipts except those that fund certain reserves or comprise contractually defined retained profits. According to lawyers at Linklaters, who published a report on the draft regulations in June, there are significant differences in the proposed permanent regime compared to the current temporary regime. These include the requirement that a securitization company satisfy a retained profit condition and that the assets being securitized be "financial assets." This means that although the regulations are expected to apply to asset classes such as RMBS, CMBS or consumer ABS; they would not encompass transactions such as whole business, inventory or real estate securitizations where the collateral does not meet the definition of a financial asset.

The draft regulations provide that SPEs be taxed upon their retained profit as defined by the transaction documentation, rather than on a taxable profit derived from their accounting profit. Implementation of the draft regulations into a permanent securitization tax regime is slated to take effect on January 1, 2007.

Analysts at Fitch said that the draft regulations are a step closer to providing ratings certainty for U.K. structured finance transactions. "The publication of the draft regulations underlines the U.K. tax authorities' willingness to work with the securitization industry to resolve the tax issues arising from the implementation of the IFRS, or of new U.K. GAAP reflecting the principles of the IFRS, and thus help create tax certainty for the structured finance markets," said Stuart Jennings, managing director in Fitch's structured finance department.

Linklaters said that a simultaneous consultation exercise is looking at whether insurance securitization SPVs, which do not fall under the current proposed permanent regime, should be brought into the scope of that regime.

(c) 2006 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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