A “Securitization Trust” is a Trust created under the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002. The main objective of creating a securitization trust is to enable banks and financial institutions to securitize their non-performing assets (NPAs) and convert them into tradable securities that can be sold to investors.
Under the SARFAESI Act, banks and financial institutions are empowered to take possession of the securities and assets that have been pledged as collateral for loans in case of default. Once the possession is taken, they can either sell the assets or transfer them to a securitization trust for the purpose of securitization.
The securitization trust then issues securities backed by the cash flows generated from the securitized assets. These securities are purchased by investors, and the proceeds from the sale of these securities are used to pay back the banks and financial institutions. The securitization trust acts as a pass-through entity, which means that the cash flows generated from the securitized assets are directly passed on to the investors.
The SARFAESI Act provides a legal framework for the creation and functioning of securitization trusts. The Act lays down the requirements for the creation of securitization trusts, the powers and duties of the trustees, and the rights and obligations of the investors. The Act also provides for the regulation and supervision of securitization trusts by the Reserve Bank of India (RBI).
In summary, a securitization trust is a trust created under the SARFAESI Act for the purpose of securitizing non-performing assets of banks and financial institutions. The trust issues securities backed by the cash flows generated from the securitized assets, which are purchased by investors. The SARFAESI Act provides a legal framework for the creation and functioning of securitization trusts and the regulation and supervision of these trusts by the RBI.
(A). ‘Securitization Trust’ as per the SEBI Regulations
In addition to the SARFAESI Act, securitization trusts are also regulated by the Securities and Exchange Board of India (SEBI) under the SEBI (Public Offer and Listing of Securitized Debt Instruments) Regulations, 2008. These regulations apply to securitization trusts that issue securitized debt instruments to the public for trading.
The SEBI regulations lay down the guidelines for the registration of securitization trusts, the eligibility criteria for the assets to be securitized, the disclosure and reporting requirements, and the rights and obligations of the investors.
The key features of securitization trusts as per the SEBI regulations are:
A securitization trust must be registered with SEBI before it can issue securitized debt instruments to the public.
2. Asset Eligibility:
The assets that can be securitized by the trust must meet certain eligibility criteria, such as being capable of generating a predictable stream of cash flows.
3. Disclosure Requirements:
The securitization trust is required to make certain disclosures to the investors, such as the nature and quality of the securitized assets, the structure of the securitization transaction, the rights and obligations of the investors, and the credit rating of the securities.
4. Reporting Requirements:
The securitization trust must provide periodic reports to the investors, such as the performance of the securitized assets, any changes in the structure of the securitization transaction, and any material events that could affect the creditworthiness of the securities.
5. Investor Protection:
The SEBI regulations provide for certain investor protection measures, such as the requirement for credit rating, minimum retention by the originator or sponsor, and minimum disclosure standards.
In summary, securitization trusts that issue securitized debt instruments to the public for trading are regulated by SEBI under the SEBI (Public Offer and Listing of Securitized Debt Instruments) Regulations, 2008. These regulations provide for the registration of securitization trusts, eligibility criteria for securitized assets, disclosure and reporting requirements, and investor protection measures.
(B) Definition of ‘Securitization Trusts’ as per the RBI Guidelines
RBI Guidelines define securitisation as—
- a process by which
- a single performing asset or a pool of performing assets are sold to a bankruptcy remote SPV and transferred from.the balance-sheet of the originator to the SPV
- in return for an immediate cash payment.
“Originator” in these guidelines refer to a bank that transfers from its balance-sheet a single asset or a pool of assets to an SPV as a part of a securitisation transaction and would include other entities of the consolidated group to which the bank belongs.
(1) Securitisation, as per the SARFAESI Act, includes the following exercises namely
(a) acquisition of financial interests of originator
(b) raising of funds by issuing security receipts to QIB ; and
(c) paying the consideration for the acquisition of the financial assets to the originator, i.e., the bank! Fis, which transfers such financial assets.
(2) The main agencies involved in the process of securitisation as per the SARFAESI Act are:
“Originator, obligator, investors, QIB, credit enhancers, legal advisors, receiving and paying agents, servicer of transactions and structure of deals.”
(3) Other definitions in the context of section (2) of the SARFAESI Act and as per the Income-tax Act (section 115TC) are as under:
– means a person, who is holder of any securitised debt, instrument or securities issued by the securitisation trust (clause (a) of the Explanation below section 115TC.
Means the owner of a financial asset, which is acquired by a securitisation company or reconstruction company for the purpose of securitisation or assets reconstruction (section z(r)).
Means a person liable to the originator, whether under a contract or otherwise, to pay a financial asset to discharge any obligation in respect of a financial asset, whether existing, future, conditional or contingent and includes the borrower (section z(q)).
(i) immovable property
(ii) movable property
(iii) any debt or any right to receive payment of money, whether secured or unsecured
(iv) receivables, whether existing or future
(v) intangible assets, being know-how, patent, copyright, trade mark, licence, franchise or any other business or commercial right of similar nature (section z(t)).
(5) Qualified institutional buyer (QIB)
Means a financial institution, insurance company, bank, state financial corporation, state industrial development corporation, trustee or securitisation company or reconstruction company, which has been granted a certificate of registration under sub-section (4) of section 3 or any assets management company making investment on behalf of mutual fund or a foreign institutional investor registered under the Securities and Exchange Board of India Act, 1992 (15 of 1992), or regulations made thereunder, or any other body corporate as may be specified by the Board (section z(u)).
(6) Non-Performing Asset (NPA)
Means an asset or account of a borrower, which has been classified by a bank or financial institution as sub-standard, doubtful or loss asset—
- in case such bank or financial institution is administered or regulated by any authority or body established, constituted or appointed by any law for the time being in force, in accordance with the directions or guide-lines relating to assets classifications issued by such authority or body
- in any other case, in accordance with the directions or guidelines relating to assets classifications issued by the Reserve Bank of India (section z(o)).
(7) Reconstruction company
Means a company formed and registered under the Companies Act, 1956 (1 of 1956), for the purpose of asset reconstruction,
(Definitions at S. Nos. 2 to 7 are as per SARFAESI Act)
– mean debt securities issued by the SPV as referred to in the guidelines on securitisation of standard assets issued by the RBI (vide clause (b) of the Explanation to section 115TC).
(9) Securitisation trust
Clause (d) of Explanation to section 115TC defines securitisation trust. It provides that securitisation trust means a trust, being a—
(i) special purpose distinct entity as defined in clause (u) of sub-regulation (1) of regulation 2 of the Securities and Exchange Board of India (Public Offer and Listing of Securitised Debt Instruments) Regulations, 2008, made under the Securities and Exchange Board of India Act, 1992, and the Securities Contracts (Regulation) Act, 1956, and regulated under the said regulations.
(ii) SPV as defined in and regulated by the guidelines on securitisation of standard assets issued by the RBI, which fulfils such conditions, as may be prescribed.
(10) Securitised debt instrument
Securitised debt instrument is defined in clause (c) of the Explanation to section 115TC. The said clause refers to clause (s) of sub-regulation (1) of regulation 2 of the Securities and Exchange Board of India (Public Offer and Listing of Securitized Debt Instruments) Regulations, 2008, which, in turn refers to section 2(h)(ie) of the Securities Contracts (Regulation) Act, 1956.
Securitized debt instrument as so defined has the following ingredients :
- It is any certificate or instrument (by whatever name called).
- It is issued to an investor.
- Its issuer is a special purpose distinct entity.
- It possesses any debt or receivable, including mortgage debt assigned to such entity.
- It acknowledges beneficial interest of such investor in such debt or receivable, including mortgage debt, as the case may be.
If all above ingredients are present, then the certificate or instrument shall be treated as ‘securitized debt instrumenf.
(4) Securitisation in general is a three-stage process and involves three parties to the transactions, namely,:
(ii) the securitisation company
(iii) the qualified institutional buyer
(5) The process could be summarized thus:
(1) the loan is sanctioned by the secured creditor to the borrower.
(2) the secured creditor assigns/sells the financial dues of future from the borrower to the securitisation company.
(3) The borrower becomes the obligor, the secured creditor is referred to as the originator.
(4) the financial assets are sold for a consideration to the securitisation company, which raises the funds from the QIB. Essentially, the QIB is the investor, which subscribes to the securities issued by the securitisation company for the purpose of paying off the originator, or for the purpose of the subscription of the securities.
(5) the QIB receives the payment of the dues made by the obligor to the originator 5 and the transaction becomes self-liquidating type. Due to many considerations, the financial assets may be transferred to the SPV, which may be set up by a securitisation company (as per the Act), which would acquire the assets and issue the security receipt. The idea is to keep the originator/securitisation company separate from the entity, which is to deal and hold the securities issued for the purpose of the transaction.
(5.1) A securitisation company acts as a conduit/spy for transferring the financial assets of the originator to the QIB. This can be referred to as a conduit between the two. There are other reasons for bringing this entity into existence.
(5.2) The structure of SPV can be a trust, like debenture trustees, which are appointed for a very specific purpose.
Trust is not a legal entity in law. The trustee typically issues the security receipts/PTCs, which is a certificate of beneficial interest. Beneficial property and legal property are different in law and hence, the security receipts/ PTCs would not amount to the transfer of property by the SPE/ SPV. It just proves that the holder has some beneficial interest. Trustee can hold property.
(5.3) In short, SPV acts as a conduit between the QIB and the originator.
(6) Examination of income-tax provisions
With the above background, the Income-tax provisions relating to Securitisation Trusts (S. Trusts for short) referred to earlier in paras 1 & 2 can be examined.
Need for income-tax provisions
The initial issue that arises for consideration in the context of securitisation provisions introduced by the Finance Act, 2013 is regarding the need for such provisions. Some mention about their necessity can be gathered from the Finance Minister’s speech extracted earlier (in para 1): The major concern justifying such provisions in the Income-tax Act could be said to be the emergence of mutual funds in a major way in the last 2-3 decades and the exemption of their income under section 10(23D) of the Act. Hence, if such mutual funds themselves carry on securitisation, there would be no need for SPV with a distinct entity as income arising from such activity would be exempt from tax. But, this is not permissible under the SARFAESI Act because securitisation activity has to be through an SPy. So, if a separate trust is set up by mutual funds, its income would be taxable under section 161 of the Act at the maximum marginal rate, i.e., at 30% + education cess at the prescribed rates. Section 161 of the Act provides that in case of a trust if its income consists, of or includes, profits and gains of business then income of such trust shall be taxed at the maximum marginal rate in the hands of trust.
7) Salient aspects of the new provisions
(i) The income of Trusts, whose activities are to be regulated by the SEBI or the RBI, will be exempt from tax regarding income from securitisation activities.
(ii) If such trusts distribute any income to its investors, it would be liable to dividend distribution tax (DDT) on the lines levied in the case of mutual funds. The additional income-tax shall be levied at the rate of 28.325% (inclusive of surcharge, education cess and secondary and higher education cess) in case of distribution being made to investors who are individual and HUE and at the rate of 33.99% in other cases. No additional income-tax shall be payable if the income distributed by the securitisation trust is received by a person, who is exempt from tax under the Act.
Section 10(23D) newly inserted in the Income-tax Act, with effect from the assessment year 2014- 15, however, provides that any income of a securitisation trust from the activity of securitisation shall be exempt from tax.
(iii) The distributed income would not be taxable in the hands of the investors (section 10(35)).
The securitisation trust will be liable to pay interest at the rate of one per cent, for every month or part of the month or the amount of additional income-tax not paid within the specified time.
(C) Provisions relating to Tax on Distributed Income by Securitisation Trust
1. [Section 115-TA] : Tax on Distributed Income to Investors by an Securitisation Trust ,
Any distributed income to an investor by a securitisation trust shall be liable to the levy of additional income-tax at the rate of twenty-five per cent. on the distributed income if such income is paid to a person being an individual or Hindu undivided family. The additional income-tax shall be levied at the rate of thirty per cent., if such distributed income is paid to a person other than individual and Hindu undivided family. No additional income-tax shall be levied, if the distributed income is paid to any person who is exempt under the Act. It also provides that the amount of tax shall be remitted within fourteen days of the date of payment or distribution of income. It is provided that no deduction under any provisions of the Act shall be allowed to securitisation trust in respect of the said income. [The section provides that the securitisation trust shall, before the 15th day of September in each year, furnish a statement in the prescribed form providing the details regarding the amount of income distributed to the investors and the tax paid in the previous year.]
2. Statement under of Section 115TA(3)
(1) The statement of income distributed by the securitisation trust shall be furnished as provided in sub-rule(2) to—
- The Assessing Officer so designated by the Chief Commissioner or Commissioner of Income-tax, within whose area of jurisdiction, the principal office of the securitisation trust is situated;
- in any other case, to the Assessing Officer within whose area of Jurisdication, the principal office of the securitisation trust is situated.
(2) The statement of distributed income which is to be furnished under sub-section (3) of section 11 5TA by the securitisation trust shall be in Form No. 63AA, duly verified by an accountant in the manner indicated therein.;
3. Interest payable for non-payment of tax [Section 115TB]
The levy of interest, in case of failure to pay tax within the time provided, at the rate of one per cent. for every month and part thereof on such failure.
4. Securitisation trust to be assessee in default [Section 1 15TC]
In case of failure on payment of tax, the person responsible for making payment of income distributed by the securitisation trust and the securitisation trust shall be deemed to be an assessee in default in respect of the amount of tax payable and all provisions of the Act relating to recovery and collection of taxes shall apply.