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OUR OUTLOOK AT A GLANCE
- Bill n° 7825 presented to Parliament on 21 May 2021 and amending the law on securitization aims to further improve the flexibility and attractiveness of the (already very successful) Luxembourg framework for securitization.
- The draft law provides for some adjustments to the law on securitization in order to improve legal certainty by clarifying certain modified market practices and to increase the flexibility of the Luxembourg regime vis-à-vis other jurisdictions.
- New opportunities will be created for the active management of securitization vehicles.
- New or improved tools will be available to effectively structure securitization.
- These adjustments can also provide practical solutions to the conundrum of interest deduction limitation rules that many existing securitization vehicles face.
The law of 22 March 2004 relating to securitization (the “Securitization Law“) has created a very efficient and reliable framework to enable a wide range of securitization, financing and repackaging operations.
Bill no. 7825 amending the law on securitization (the “Law Project“) was presented on 21 May 2021 by the Luxembourg government to Parliament to build on the success of the law on securitization, with a view to further increasing its flexibility and legal certainty by clarifying certain market practices appreciated by market players.
This initiative supports the players concerned and, more generally, the attractiveness and continued growth of the Luxembourg securitization market.
Based on the provisions of the Securitization Law currently in force, securitization vehicles can be set up either in the form of securitization funds (one or more co-ownerships or one or more fiduciary assets without legal personality) or in the form of public limited companies. (such as a public limited company,
anonimous societyor a limited liability company, limited liability company). The bill opens up securitization transactions to new legal forms of companies that have gained popularity in recent years, particularly with private equity firms and real estate players:
- Partnerships: the simple limited partnership (Limited partnership“SCS”), the special limited partnership (Special limited partnership“SCSp”) and the limited liability company (Société en nomcollectif, “SNC”);
- Another type of company: the simplified joint-stock company (Joint stock company“SAS”).
The possibility of using these new types of structures provides a fertile environment for product development, allowing more flexibility and efficiency in structuring transactions, in particular through partnerships such as SCS or SCSp which are transparent to Luxembourg tax needs (please refer to the “Tax consequences” section below).
The bill further confirms that securitization companies will have to publish financial statements and will no longer benefit from the existing exemption in this respect.
As regards multi-compartment securitization vehicles, the treatment of profit distributions when a compartment is financed by equity is specified in the draft law. The shareholders of a compartment must approve only the financial statements relating to this compartment and the valuation of the distributable sums and the allocation to the legal reserve must also be made compartment by compartment.
The bill provides a set of subordination rules governing the rank of the different classes of financing, with the possibility of opting for a different order. In principle, (i) debts are subordinated to shares, units and profit shares and (ii) non-fixed rate debts are subordinated to fixed rate debts issued by the securitization vehicle.
The bill confirms that a securitization vehicle can acquire securitized assets directly or indirectly. The securitization vehicle can then acquire the risks to be securitized indirectly through a wholly or partially owned subsidiary.
Active management by the securitization vehicle or a third party will now be expressly authorized for Luxembourg securitization vehicles for risks relating to loans (collateralized loan obligations, “CLOs”), bonds or other debt instruments, unless securitization is offered to the public. This clarification removes uncertainty and provides an effective framework for CLO structures. This will improve Luxembourg’s attractiveness for CLO managers who have historically set up their structures in other countries.
According to the rules currently in force, the securitization vehicle is not authorized to grant any security on its assets for the purpose of guaranteeing the obligations of a third party. Otherwise, this warranty would be null and void. The draft law increases the flexibility to also allow security to be given for third-party obligations insofar as these obligations relate to the securitization transaction.
The bill allows the securitization vehicle to finance itself using financial instruments and also to incur debt by borrowing via loans, provided that the value or return of these loans depends on the underlying risk securitized .
A securitization vehicle issuing securities continuously to the public must be approved by the CSSF. The draft law introduces a definition of the concept of “on a continuous basis to the public”, according to which any vehicle which issues financial instruments to the public more than three times a year should be authorized.
The bill clarifies that the program will not be deemed to be offered to the public if one of the following criteria is met:
- the issue is only intended for professional clients within the meaning of the law of 5 April 1993 relating to the financial sector; or
- the nominal value of the financial instruments exceeds EUR 100,000; or
- the financial instruments are distributed in the form of a private placement.
As mentioned above, the bill introduces the possibility for a securitization vehicle to take the legal form of a partnership, namely an SCS or an SCSp. This has significant tax consequences since these partnerships are normally considered transparent for Luxembourg tax purposes, which means that the income they generate is not taxable at the level of the securitization vehicle itself, but is attributed directly to investors.
Until now, securitization vehicles could be set up either as funds or as companies (for example as anonimous society or as limited liability company). Unlike securitization vehicles set up as partnerships, securitization vehicles set up in the form of a company are fully subject to tax on income and capital gains from the assets they hold. Interest payments (for example, on asset-linked bonds issued by the securitization vehicle), as well as certain liabilities to investors, are however deductible under Luxembourg tax law and, therefore, securitization structures are expected and expected to achieve tax neutrality, while investors are ultimately subject to taxation based on their own tax status and residency.
However, with effect from 1 January 2019, the interest limitation rules provided for in Article 168bis of the Luxembourg income tax law (“LITL“) under Council Directive (EU) 2016/1164 of 12 July 2016 (also known as the Anti-Tax Avoidance Directive “ATAD“) established a new paradigm under which interest and other costs economically equivalent to interest are deductible only up to certain thresholds. Although some exclusion and grandfathering provisions exist, the scope of very wide and general application of the interest limitation provision has brought a significant level of uncertainty as to which expenses of a securitization vehicle are actually subject to the interest limitation rules, and many have found it necessary to reconsider how of which certain securitization transactions are structured and managed.
As a fiscally transparent entity, an SCS or SCSp is not normally subject to the provisions of article 168bis LITL, as it is not considered as an entity separate from its associates for Luxembourg tax purposes. Circular 168bis/1 from the Luxembourg tax authorities of July 28, 2021 confirms that the interest deduction rules apply to the holder of a participation in a fiscally transparent vehicle and not to the vehicle itself. Investors in securitization companies will therefore have to apply these rules by controlling the share of income, gains and interest charges allocated to them due to the tax transparency of the securitization vehicle.
The draft law introducing the possibility of using partnerships, which can benefit from pass-through tax treatment in Luxembourg, may therefore be an interesting step towards increased tax certainty for securitization structures, but it will also require a precise examination of the tax situation of each of the investors in such structures.
The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.