This article is written by Saurabh Mishra, a student of HNLU.
A special purpose vehicle (SPV) as the name says, is formed for a special purpose. Its powers are limited to what might be required to attain that specific purpose and its life is destined to end when the purpose is attained. The operations are limited to the acquisition and financing of specific assets. SPVs are generally a subsidiary company whose obligations are secured even if the parent company goes bankrupt.
A corporation sponsors an SPV for a particular purpose. It includes isolation of an activity, asset or operation from the rest of sponsor’s business. The isolation is essential for external investors as they are not affected by the generic risks of the originating entity. There are usually no offices, management or employees. It may consist of legal documents containing share holding agreement, Trust Deed or a joint venture agreement.
Originator has flexibility in choosing appropriate legal structure for SPV based on its requirement. SPV can be in the form of a company, trust (with or without company as a trustee), Mutual Fund, a Statutory Corporation, a society, a firm, etc. An SPV can be in all possible forms of a business entity that is capable of being formed. Accordingly the provisions of parent law for incorporation of such entity, i.e., the Companies Act, Trust Act, the Partnership Act, etc will apply to formation of such SPVs.
Characteristics of SPV
- It should be capable of acquiring, holding and disposing of assets.
- It would be undertaking activity of asset securitization and no other activity.
- The bankruptcy of the originator should not affect the interests of holders of instruments issued by SPV.
- It should not be capable of being taken into bankruptcy in the event of any inability to service the securitized papers issued by it.
- An SPV must have a distinct identity from its promoters/sponsors/constituents/shareholders. Its creditors cannot obtain satisfaction from them.
Types of SPVs
The type of SPV floated depends upon the purpose to be fulfilled by such an SPV. A broad categorisation can be made as On- Balance Sheet SPV and Off Balance Sheet SPV.
In the case of ‘on-balance sheet SPV’ is that entity whose financial results are consolidated with the results of its sponsor. The financial results of such SPV are reported in the Annual Reports of the sponsor. In the case of off balance sheet SPV, the financial statements are not required to be reported in the financial results of its sponsors. The SPVs are structured in such a way that they remain isolated from its parent company.
In case of on balance sheet SPV the income or receivables are some way or the other transferred to sponsor company this may not be the case of an off balance sheet SPV.
An off balance Sheet SPV has following characteristics:
- They are thinly capitalized
- They do not have independent management or employees;
- Assets held by the SPV are serviced by through a servicing agreement.
- They are structured in a way so that they do not become bankrupt.
SPVs Formed by Banks/Financial Institutions For Securitisation
The total assets of banks or financial institution mainly comprise of loans and receivables along with their future cash flow to a separate entity, which may be formed for a specific purpose. The SPV is allowed to raise debt which will be backed by these receivables and their future cash flows. The difference between the incomes received from these receivables and cost of servicing that debt will be profit/earning of the SPV. By securitization through SPV the risk involved in this activity is separated from the general business of the bank.
SPVs formed by Government under PPP
We have witnessed a trend by government sector entities by forming SPVs for specific projects. The PSUs operating in infrastructure industry float entities with investment from Central and State Government and a portion by Private Sector Participant. It provides convenience in obtaining approvals from the State and Central Government at many levels. On completion of project easy exit route exists for government.
SPVs by FII
Foreign Companies also resort to SPV route by foreign companies to enter into areas of business in India, which are prohibited for them under Automatic route. The foreign policy does not permit foreign investors to invest in certain business activities in India without the approval from FIPB. As a result, the foreign investors take SPV route to reach the Indian Markets.
SPVs can be used for acquiring assets indirectly so that they are prevented from being caught in the tax net. In this method, the sponsor takes the assets on lease from its SPV on rent. Expenses incurred as rent is allowed as a deduction to sponsor for income tax purpose. On the other hand, the SPV acquires the asset through raising debt, the interest on which is a deductible expense for tax purpose. This way the same asset can be used claim deduction by both. Apart from tax saving it prevents any debt being shown in Sponsor’s balance sheet.
Hives of the Risk:
SPVs act as a “bankruptcy remote” . If the sponsoring firm has financial problems, it can safely escape its creditors because in any way creditors because in any creditors cannot seize the assets of the SPV. SPVs help investors and firms as it isolates high risk projects from the parent organization and by giving to new investors the opportunity to take a share of specified risk in the firm with a simple and clear balance sheet.
Best suited for Project Financing:
Long term investment in infrastructural and industrial projects based on the projected cash flows of the project is project financing. A project financing structure involves a number of equity investors and a syndicate of banks that provides loans to the operation. The loans are commonly secured by the project assets and paid entirely from future cash flow generated from the project, rather than from the general assets or creditworthiness of the project sponsors. The assets are shielded by creating a special purpose entity for each project. The special purpose entity has no effects other the project.
The SPV owns the asset and all the permits; this permits selling of SPV as a self contained package rather than attempting to assign over numerous permits.
A special purpose entity is established often to overcome regulatory transactions such as regulations relating such as regulations relating to nationality of ownership of specific assets.
SPVs are often used to make a transaction tax efficient by choosing the most favourable tax residence for the vehicle. SPVs are method of financial engineering schemes which have as their main goal, the avoidance of tax or the manipulation of financial statements. Some countries have different tax rates for capital gains and gains from property sales.
Debts raised through SPV are not reflected in the balance sheet of the sponsor. It reflects a pleasant picture and enhances the debt raising ability of the sponsor. Losses incurred by SPV are not shown in the balance sheet of the sponsor, so it helps to maintain the healthy picture of the sponsor in the eyes of its stakeholders.
SPV prevents competitors accessing the technology through pre-existing license deals.
There is a lot of costs involved in setting up of an SPV, like cost of incorporation, cost of registration, stamp duty at the time of transfer of company.
Incorporation of SPV as a Company will require continuous fulfillment of compliances.
No deduction available for taxation purpose:
The tax benefits are lost in off balance sheet SPVs. Tax deductions which are provided for incurring certain business expenses are not available to the sponsor, if such transaction are carried out through SPV. The debt taken by SPV will also not provide any tax benefit to the sponsor.