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| PREFACE | |||
| .....This book is a new edition of The Federal Income Taxation of Mortgage-Backed Securities (Revised Edition, Probus Publishing Company, 1994). It has been expanded to cover securities backed by non-mortgage assets (including revolving pools) and updated to reflect the many changes in the law and in practice that have occurred since 1994. The title of the book has been changed from prior editions to reflect not only the inclusion of other asset-backed securities within its scope but also the fact that it addresses securitization transactions broadly, from the perspective of the sponsor, issuer, and investors, and not just the resulting securities. The three most notable tax law changes are the adoption of a check-the-box system for determining the tax classification of trusts, limited liability companies, and other unincorporated entities; the enactment of the FASIT rules; and the extension of the prepayment assumption catch-up method (PAC method) for calculating accruals of discount and premium to pools of debt instruments, including pass-through certificates representing interests in such pools. Significant changes also have occurred or are proposed relating to information reporting by trusts and holders of trust interests. For periodic updates on pertinent tax law developments after December 2000, readers are referred to the book's Web site (see page ii, the copyright page, above). .....In preparing the third edition, changes have been made throughout the book. Chapter 1 has been revised to provide an outline and overview of the topics covered in the book. The description of the different types of asset-backed securities in Chapter 2 has four new entries, reflecting tax law changes and market developments: callable pass-through certificates, LEGO certificates (our term for pass-through certificates that can be pulled apart or recombined by investors), FASIT interests, and securities issued by offshore corporations. .....In expanding the book beyond mortgage-backed securities, we have dealt more comprehensively with some of the core tax issues that affect a broad range of securitization transactions. A new Chapter 3 addresses the tax law distinction between a sale and a financing and between equity and debt. The sale/financing discussion contrasts the governing tax standards with the tests that apply under GAAP (FASB 140, the successor to FASB 125) and in testing if there is a true sale that removes assets from the reach of creditors of a transferor. The chapter also addresses the risk that debt will be recharacterized as equity based on the thin capitalization of the issuer as well as the arguments for upholding the intended treatment as debt of trust certificates backed by revolving pools of loans (a structure used most prominently to finance credit card balances). .....Chapter 4 discusses the tax classification of issuers (other than REMICs or FASITs), including the new check-the-box classification sys- tem. The new rules make it easier to avoid classification of a trust or other unincorporated entity as a taxable corporation. Nonetheless, it is still the case that an unincorporated entity will be treated automatically as a corporation (subject to the corporate income tax) if it has outstanding publicly traded equity and fails to meet a passive income test (requiring 90 percent of its income to be passive). Passive income generally includes interest unless the interest is derived from a financial business. A financial business includes securities dealing and loan origination, but not investing or trading in securities. The publicly traded partnership rules received little attention in prior editions because the passive income test would invariably be met in any fixed-pool securitization, which is the common pattern for mortgage-backed securities. Non-mortgage securitizations, on the other hand, often involve revolving pools. Chapter 4 includes an extensive discussion of when an issuer holding changing pools of receivables crosses the line and is engaged in a financial business. A similar distinction also is important in taxing offshore issuers (more about them below) and FASITs. Chapter 4 also includes a new section discussing how the definition of a taxable mortgage pool applies to revolving pool structures. .....The check-the-box rules change the standards for classifying business entities, but do nothing to clarify the tests for deciding whether an entity organized as a trust under local law will be classified for tax purposes as a trust (and therefore taxed as a grantor trust) or instead will be classified as a business entity (and, assuming more than one owner, taxed as a partnership). Although neither a grantor trust nor a partnership is subject to the corporate income tax, it is still important to know how a local-law trust is classified. To assist readers in understanding the stakes, a new Chapter 5 describes and compares the substantive tax rules governing grantor trusts and tax law partnerships. .....Chapter 8 addresses the tax treatment of investors holding securities taxable as debt, including pass-through certificates representing interests in grantor trusts holding debt instruments. The chapter includes a new discus- sion of how discount and premium rules apply to such certificates in light of the change in law extending the PAC method to pools of debt instruments. .....A mark-to-market system applies to asset-backed securities held by securities dealers. For this purpose, the definition of dealer is quite broad, and generally includes any person who originates loans for resale. In addition, securitization transactions raise many technical issues in applying thedealer rules. Chapter 11 includes an expanded discussion of this topic. .....Offshore issuers are widely used in securitizations of high-yield bonds and loans. The tax issues faced by offshore issuers and holders of interests in those issuers are considered in a new Chapter 13. It includes a brief discussion of offshore issuers of catastrophe bonds. .....Chapter 16 addresses the qualification and taxation of FASITs and the tax treatment of FASIT sponsors and investors. Market participants welcomed the FASIT rules with some enthusiasm when they came into the world in 1996 (effective September 1, 1997). Unfortunately, the legislation is not user-friendly. While the Internal Revenue Service could have taken action to remedy some of the problems, the agency has proceeded at a most deliberate pace. In the second month of the new millennium, proposed FASIT regulations were issued that, in brief, need work. In practical terms, the FASIT vehicle is not likely to be viable in most settings until revised regulations are issued. .....In prior editions, we reproduced Internal Revenue Service rulings and advice. Because those materials are now readily available electronically to any reader, we have dropped them from this edition. .....Many people have contributed to the third edition. The authors wish to acknowledge the efforts of their colleagues at Cleary, Gottlieb, Steen & Hamilton and Orrick, Herrington & Sutcliffe LLP, including Eric Atkerson, Linda M. Beale, S. Douglas Borisky, Jennifer M. Brown, Bobby Chan, Kenneth W. Chase, Leonard M. Cole, Sherri Druckman, Lita Inderjit, Kristofer W. Hess, Richard Horan, Kim Killion, Rachel Kleinberg, Steven L Kopp, Janet Rothholz, and Ann Wood. .....We also wish to acknowledge the contributions of Martin J. Rosenblatt and Terence B. Meyers, who commented on accounting and information reporting matters, and the efforts of Frank J. Fabozzi and the other people of Frank J. Fabozzi Associates. James M. Peaslee New York City |
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