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UK Securitisation Market Under Threat From New Tax Rules

by Robert Lee,, London

24 December 2004

UK capital market experts are currently in discussions with the Inland Revenue in a bid to prevent unrealised derivative profits from being taxed when new international accounting standards take effect on January 1, the Financial Times has reported.

Under this new international accounting regime, the value of assets will have to be adjusted regularly to reflect their market value.

However, special purpose vehicles (SPVs), set up to allow companies to securitise cash flows, may find themselves paying tax on notional increases in the value of interest rate swaps if they are caught by the new IAS rule 39.

This eventuality would seriously hamper the development of the securitisation sector – one of the fastest growing areas of the bond market - which works on very tight cash margins, and could cause widespread insolvencies.

Securitisations allow companies to bring forward revenues and create new capacity on their balance sheets, and SPVs, created to hold the underlying assets, use interest rate swaps to hedge their interest rate risk, turning variable-rate earnings flows into fixed-rate flows and vice versa.

"The accounts may show an unmatched movement on the swap and this can be taxable without there being any cash to pay," noted Stephen Shea, a tax partner at the law firm Clifford Chance, according to the FT.

What’s more, strict rules in this area prevent SPVs from borrowing money to meet additional costs.

Whilst the Inland Revenue has agreed to apply special rules preventing SPVs from being taxed on changes to fair value, Mr Shea is concerned that a number of details concerning the new rules still need to be addressed.

"The rules have to be finalised in the next two months to get them into the 2005 finance bill. This is something that industry must focus on,” he warned.

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