Despite reports in the press concerning a German tax initiative aimed at redefining the tax treatment for special-purpose entities and applying trade tax to true-sale transactions, the fears of its effect on securitization are being played down by the market.

The tax authorities of a number of German states are seeking to establish the principle that foreign corporate vehicles used in securitization transactions and involving German assets serviced by German-based servicers should be treated as "onshore" and, therefore, are liable for German tax.

"This issue has been around for a while and seemed much more serious six months ago. The authorities now acknowledge that there are business reasons for continuing to use securitization that might justify waiving the issue," explained Dr. Carsten Kuhlmann, of Ernst & Young Frankfurt.

If established, this new tax regime could have a serious impact on the ABS market. "Such a tax regime would seriously harm the securitization market and limit it to synthetic transactions," says Markus Herrmann, ABS analyst at Deutsche Bank. "However, this would be against the logic of favorable regulatory treatment for securitization transactions, which has been recently put in place by the central authorities."

Standard & Poor's recently published a review of the situation and its possible impact on ratings in securitization transactions, but has taken no rating action at the present time.

"We will continue to monitor the situation to provide ongoing information to investors," said Ian Bell, senior european counsel at S&P. "And, until we are able to ascertain the exact impact of this development, our position will not change. However, we believe it is important that market participants are aware of this issue."

Nothing to worry about?

Many analysts have downplayed the effect of the tax initiative on the German securitization market thanks to the growth of synthetics.

All term transactions in the German market during 2000 - except for HAUS 2000-1 Limited - were synthetic in nature. Year-end volumes almost doubled, ending at $23.8 billion compared with 1999's $11.4 billion. Further, synthetic transactions accounted for more than 90% of the German RMBS market in 2000 with $8.6 billion.

All synthetic transactions where the originator is the issuer of the rated securities should not be affected by the new tax regime, sources say. Equally, transactions where the rated securities of a special-purpose entity are synthetically linked to a reference pool of assets so that the company does not own these assets should also remain unaffected, sources at S&P said.

As a result of both regulatory and legal uncertainties in Germany in conjunction with tax-related issues, most of the ABS transactions involving German sellers are performed using foreign special purpose vehicles.

In many cases, based on the service agreement, the originator is responsible for the servicing of the securitized assets, and is therefore responsible for the debt collecting, credit control, documentation, judicial execution and cash transfer to the SPV.

It is questionable, however, whether the servicing function of the originator creates a permanent establishment (PE) for tax purposes.

If the German tax authorities were to take this position, then all assets and liabilities of the SPV would be allocated to the German PE. Half of the interest paid by the SPV on securities issued would become subject to trade tax. Securities issued by the SPV would be treated as long-term debt and 50% of the interest paid on such securities would not be deductible for tax purposes.

However, the final outcome is still unclear. "Some transactions may benefit from explicit tax rulings which should bind the tax authorities," Mr. Bell explained, "while other transactions may have cash flows that would be robust enough to withstand any possible adverse tax consequences; also, in the case of commercial paper transactions, a blend of legal and structural factors might offset any effect."

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