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Which jurisdiction should I choose to wrap non-bankables in a note?

In addition to the size of the capital required, the choice of jurisdiction is another frequently asked question. The jurisdiction can be a decisive factor for the client as well as for the investor. Therefore, we will point out some important aspects, which are to be considered depending upon need.

General information about the structures themselves

If a client wishes to use a securitization structure instead of a direct investment, the structure itself is tax neutral, as it does not generate profits. The proceeds from the investment are paid out to the investors’ less applicable cost factors, which are the running fees of the financial instrument and a potential advisory fee required by the initiator of the solution.

Equity payoffs

Financial instruments that reinvest capital gains or target one or more exit scenarios generate equity returns for the investor. In certain countries, for example, capital gains are tax-free, although this may vary by country.

When looking for an anchor investor, this can be the determining factor as to whether the instrument should be structured as an equity-like solution. The subsequent step-up investors in a bankable solution do not usually have a free choice, as the type of financing has been predetermined. Another factor for some European investors is the origin of the profits. With an offshore solution, such as the Cayman Islands or Guernsey, the future realized profits could experience a different tax rate than with a European solution, such as from Luxembourg. For some investors, this aspect is irrelevant.

In the case of coupon payments, a possible withholding tax for the investors comes into play, based on their domicile. Whether a coupon payment makes sense again depends on the anchor investor, who may want to see recurring payouts in addition to performance. However, these coupons must be redefined by the client each year and cannot be fixed in advance.

Debt payoffs

If a debt solution is sought, a loan agreement normally defines the relationship between the company to be financed and the financial structure, e.g., an issuance vehicle in Luxembourg that ultimately links through a segregated compartment, which in turn serves as a gateway for the financial product effectively launched. These partially predefined coupon payments from the loan agreement could be subject to withholding tax.

Depending on the base country of the borrower and the jurisdiction of the counterparty, any withholding tax may be partially reclaimed, and this is regulated by the double taxation treaties between those countries.

If a new SPV is defined as beneficiary for the project, this aspect must be included in the choice of jurisdiction. Here, a tax ruling may be advisable, so that the regulator recognizes in advance the structure as a single counterparty and does not impose a Lock Through on the structure later. Without a tax ruling, subsequent withholding tax may be due, which would reduce profitability for the recipient of the capital. Whether a withholding tax applies depends on the number of investors. Here, the key criterion with regard to the number of investors on equal terms could lead to the borrower being subject to withholding tax.

Portfolio solutions

For portfolio solutions, the same rules apply on the debt side, where the structure or an operating company has loan agreements with various counterparties.

On the equity side, the exits from the projects only reflect on the performance of the Actively Managed Certificate (AMC). Unless otherwise defined, these profits are recycled within the AMC, which avoids the cumbersome process of finding new capital with each project. The holder of the AMC does not realize individual profits on exits from projects within the AMC and simply holds the notes at a changing valuation in their portfolio.

This potential tax deferral until the sale of the AMC shares can be beneficial to all parties involved, compared to the creation of a new investment solution and subsequent repayment.

Final words

As mentioned above, coupon payments from equity or debt securities may be subject to withholding tax depending on the constellation. For example, according to PwC, Luxembourg has 86 double taxation agreements (DTAs) as of 2023, while Guernsey has only 14. In essence, the choice of jurisdiction of the financial solution could have a direct impact on the capital recipient, as it allows for a later partial recovery of this tax if applicable.

Disclaimer: This article is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.

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