2. Language of the proposed regulations
The proposed regulations provide that the FASIT provisions are intended to “promote the spreading of risk on debt instruments by facilitating the securitization of those debt instruments”. The principal purpose of forming a FASIT must also not be inconsistent with the intent of the FASIT provisions and regulations. As a result, generation of capital gains to offset expiring capital losses should be reflected as an incidental benefit resulting from a business decision to participate in a FASIT. Therefore, as long as a transaction furthers the securitization of debt instruments and make their ownership less concentrated in some manner, a FASIT transaction should further the intent of the FASIT provisions and regulations.
The language of Prop. Reg. Section 1.860L-2(a)(3) poses a more challenging requirement: “no FAIST provision may be used to achieve a Federal Tax result that cannot be achieved without the provision unless the provision clearly contemplates that result”. Therefore, if it is found that a FASIT transaction has been designed to achieve a result not contemplated in the provision (e.G to offset expiring non-FASIT losses) the intended tax results may be reversed by the Commissioner. (The authors are not sure if this statement is as problematic as it initially seems since it could be argued that the generation of capital gain is not in itself a tax result that cannot be achieved without the FASIT provision.)
V. Analysis of the scenarios
Based on the legislative history and the language of the proposed regulations, the following is brief analysis of the success of the above scenarios.
Corporation A owns debt instruments, contributes them to a FASIT and subsequently holds both the regular and ownership interests. This transaction would clearly be questionable under the anti-abuse provisions. No spreading of risk or increased securitization accompanies the tax benefit derived since the ownership of the assets to be securitized is identical before and after the creation of the FASIT.
Corporation A purchases debt instruments and contributes them to a FASIT. Corporation A retains the ownership interest and sells the regular interest to Citibcorp. This transaction is also problematic. Essentially, Corporation A has achieved a tax benefit while leaving the economic risk associated with the securitized assets in the hands of Bank – the original owner. The FASIT provisions goals of securitization and distribution of risk are not furthered in this transaction.
Corporation A purchases debt instruments from Bank, creates a FASIT, and retains both the ownership interest and the regular interests. The ownership has been shifted from Bank to Corporation A with resulting in Corporation A being the sole owner of the debt instruments. This ownership shift of credit risk from a large holder of debt instruments to a Corporation A, a company which presumably has had little or no such interest in the past, is arguably more in line with the stated intent of the FASIT provisions. The argument can further be strengthened if. Corporation A proceeds to sell some of the regular interests to the public.