FATCA Could Impact on Global Structured Finance Transactions

The forthcoming US Foreign Account Tax Compliance Act (FATCA) has potentially wide-ranging implications for global structured finance transactions, according to Fitch Ratings. The credit ratings agency (CRA) says that in particular the FATCA status of special purpose vehicles (SPVs) and counterparties handling payments will be a key issue. Under current plans, withholding tax would apply on relevant interest payments from January 2014 and relevant principal payments from January 2015.

Fitch adds that as FATCA is not intended to be retrospective, it does not expect widespread negative rating actions to result. However, the breadth of the Act and its complex practical implications mean there could be possible cash flow disruptions and rating implications in individual transactions. The CRA intends to monitor developments and expects that global structured finance transactions and counterparties will address any uncertainties.

FATCA is US legislation designed to counter tax evasion by US tax payers. It will impose withholding tax at a rate of 30% on US sourced cash flows transferred to foreign financial institutions (FFIs) that do not participate in the regime. A range of non-US entities including SPVs, account banks, paying agents and custodians are expected to fall under the definition of FFI.

FFIs can agree to participate with the US Internal Revenue Service (IRS) or, where applicable, can participate under a country-specific intergovernmental agreement. So far France, Germany, Italy, Japan, Spain, Switzerland and the UK have announced plans to enter into intergovernmental arrangements with the US. It is envisaged that FFIs which elect to participate would be obliged to apply US withholding tax on certain payments made to non-participating FFIs from January 2017. Full details are yet to be finalised.

In cross-border, structured finance transactions with US assets, the FATCA status of the SPVs and counterparties will be under the spotlight. For example, notes may be issued by a non-US SPV while some cash flows may originate from US assets, either due from underlying receivables or from hedging counterparties. To the extent that the SPV (or other counterparties) are treated as non-participating FFIs then a 30% withholding tax may be applied to some intra transaction cash flows, reducing the ability of the transaction to make ultimate payments to noteholders.

This could extend to cash flows from any sources globally from January 2017 as participating FFIs may be obliged to withhold tax from certain payments to non-participating FFIs from this date, wherever the source of the cash flow – although the obligations of FFIs which participate under intergovernmental agreements remain to be finalised.

Fitch says that its structured finance note ratings address the ability of the note issuer to meet its obligations to note holders, and do not take into account the tax status of the note holder or any withholding tax applied on payments to noteholders. Even if the structured finance investor is treated as a non-participating FFI, meaning investors could see withholding tax applied on interest and principal payments made on the notes, this would not be reflected in the rating. Only the impact upon intra-transaction cash flows will be relevant from a ratings perspective.

Under the current timetable, withholding tax would generally only apply to payments in relation to obligations entered into from January 2013. However this cut-off date is applicable to the obligation giving rise to the US-sourced cash flow as opposed to the date of note issuance.

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