IN186 - Tax Efficient Structures to Manage Distressed Assets in Recessionary Times

Basel II confirmed a new set of standards to establish minimum capital requirements for internationally active banking organisations. Capital requirements are now much more closely tied to risk, as measured by credit ratings.

Distressed assets directly impact on risk ratings and therefore capital requirements. In a number of situations placing distressed assets off the balance sheet of a repossessing or lending organisation is a useful way to manage both the assets and the capital funding levels.

Assets such as commercial property and merchant shipping vessels are good examples of assets which may benefit from this type of structuring.

Distressed Assets

From a lending institution perspective distressed assets fall into three categories:

• Borrowers with an increased potential to default
• Borrowers who will default unless their loans are restructured
• Borrowers who are eminently in default (non-performing), with loans that must be recovered

The second and third categories of distressed assets may particularly benefit from being placed in an orphan structure. This may form part of the restructuring of the loan or to separately manage the income generating potential or sale of the asset, to ensure that the loan is recovered.

Orphan Structures

An orphan structure refers to a Special Purpose Vehicle (SPV), often a company whose shares are held by the trustee of a purpose trust. The company is said to be an "orphan" as it is not beneficially owned by anybody.

Orphan structures can be used to ensure that the assets and liabilities of a defaulting borrower are treated as "off-balance-sheet" for the sponsor of the structure, the sponsor being the repossessing or lending institution. Orphan structures are relatively common features of securitisation vehicles, where the asset backed bonds are issued by the orphan company.

A Structure for the Holding of Distressed Assets

A suitable structure for the holding of distressed assets is a purpose trust with an underlying SPV to hold the asset(s).



An Isle of Man Non-Charitable Purpose Trust

A number of jurisdictions including Guernsey, Nevis and the Isle of Man have purpose trust legislation, or the ability to form a purpose trust included within the framework of their Trust Law.

The concept of a purpose trust was introduced into the Isle of Man by the Purpose Trustees Act 1996. A purpose trust is a trust established to fulfil a particular purpose, rather than for the benefit of specific beneficiaries. There are no beneficiaries who can be taxed as the ultimate owners or receivers of the assets or income of the trust.

The purpose must be certain, possible and not contrary to law, morals or public policy. The purpose trust has an enforcer, who is completely independent of the trustees and has strong statutory powers to ensure that the purpose of the trust is properly carried out. There is no protector. The trust cannot exceed 80 years, and at the end of the trust period the assets revert to the settlor.

An Isle of Man purpose trust cannot hold any interest in land in the Isle of Man, and cannot be used for charitable purposes. There must be two or more trustees, one of whom must be professionally qualified. Alternatively a trust corporation, approved and regulated by the Isle of Man Financial Services Commission, can act as a single trustee.

Taxation of Purpose Trusts in the Isle of Man

Taxation of purpose trusts follows Isle of Man Tax Law. There is no liability to income tax in the Isle of Man provided no person resident in the Isle of Man receives benefits under the trust.

Special Purpose Vehicle “Orphan Company”

The shares of the SPV are held by the purpose trust for the duration of the arrangement. The management and administration of the SPV can be undertaken by Dixcart, with day to day management of the assets provided by an appropriate experienced professional.

Treatment of Different Types of Asset

Property Assets

Where the assets consist of property, the property within the SPV may be managed as income generating units, or sold in order to recover all or part of the loan. Two key agreements need to be put in place. The first is between the SPV and the bank for continued insurance of the property, and the second is between the SPV and the third party property managers.

Shipping Assets

Ships can continue with their existing flag of registration and two key agreements need to be established. The first is between the SPV and the bank to provide for the continued insurance of the vessel, and the second is between the SPV and the third party technical managers. These arrangements would allow for the vessel to continue trading or, alternatively, to be “laid up” for the period of ownership by the SPV.

Summary

The use of an Isle of Man purpose trust with an underlying SPV to hold assets can, in the correct circumstances, provide a useful means of holding distressed assets off balance sheet. In recessionary times this can impact positively on an organisation’s credit rating and therefore capital funding level.

Additional Information

If you require additional information on this topic, please speak to Simon Kelly or Bruce Watterson at our office in the Isle of Man or contact us

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