CFM72510 - Other tax rules on corporate finance: securitisation: periods beginning on or after 1 January 2007: the regulations: the payments condition: introduction

The ‘payments condition’: introduction

Regulation 11 sets out the payments condition. Its purpose is to ensure that the company does not hoard the cash received as part of the CMA, thus acting as a money box, receiving and retaining cash tax free and paying it out at a later time. It also helps to ensure that the regulations are targeted at companies which are genuinely special purpose companies dedicated to securitisations. One of the distinguishing features of such companies is that they operate on a ‘cash in, cash out’ basis. This stems from their fundamental reason for existence, which is to provide a bankruptcy remote framework for holding the securitised assets, collecting the cash flows from those assets and distributing those cash flows amongst the capital market investors and other interested parties.

The company must meet the payments condition in every accounting period for so long as it falls within one of the defined categories of ‘securitisation company’. It cannot move in and out of the regulations according to whether it meets the payments condition in different periods. Failure to meet the payments condition will therefore result in a company being permanently excluded from the regime. However, the payments condition only applies to a company with effect from the time when it becomes a “securitisation company” within the meaning of the regulations and for so long as it continues to be within that definition. A company will not be treated as having failed to meet the payments condition solely because it has not complied with the formula in Regulation 11 at a time when it was not a securitisation company. In this connection, it should be borne in mind that a company will be treated as commencing a new accounting period upon becoming a securitisation company, and treated as ending an accounting period when it ceases to be a securitisation company (CFM72620).

The payments condition is expressed as a formula. In any accounting period R must be equal to or less than P+RA+RP. The formula is explained in more detail in CFM72520.

The payments condition can be very broadly paraphrased by saying that where a securitisation company receives any amounts (‘R’) during an accounting period, it must basically make, during the accounting period or within 18 months thereafter, aggregate payments out (‘P’) at least equal to R. As an alternative to making payments out, amounts of R may be placed in reserves (‘RA’) to the extent that this is required to maintain the company’s creditworthiness or provide against expenses. Or, where applicable, amounts of R may be retained as profit (‘RP’).

If, during the accounting period, any amounts of RA (whenever retained) either (a) cease to be required for those purposes or (b) are actually required to be applied in meeting the losses or expenses provided for, such amounts will be added back to R for the period and will go back to being required to be paid out as part of P for the period.

The importance of the transaction documentation

In the normal case, the documentation relating to the securitisation will include a detailed ‘priority (or priorities) of payments’, and a ‘cash management schedule’ (or similar). This will set out in detail how all amounts received by the company are to be collected into collection accounts, earmarked for various purposes, transferred into and between holding accounts and finally transferred into payment accounts from which payments are made to meet the liabilities of the company in accordance with the applicable priorities of payments. The terms of the cash management schedule will themselves often reflect the contents of a computer system which is maintained by the ‘servicer’ of the securitisation to monitor cash flows received and generate instructions for all of the requisite account transfers and payments to third parties. In simpler securitisations, the transaction cash flows may be administered manually rather than by using a computer system.

Whether the systems used are computerised or manual, a company will be able to satisfy the payments condition by showing

• that the transaction documentation include a priority of payments and cash management schedule (or similar documents) which provide for payments to be made, with reference to amounts received, on a basis which is fully in accordance with the payments condition, and
• that transaction cash flows are administered in accordance with good practice according to market standards, to ensure that amounts received are monitored, allocated, transferred and paid out in accordance with the terms of the applicable documents.