Wednesday, August 31, 2016

Ushering a New Era for ARCs: Stamp Duty Exemption on Assignments

[The following post is contributed by Vinod Kothari and Nidhi Bothra of Vinod Kothari & Co. The authors may be reached at vinod@vinodkothari.com and nidhi@vinodkothari.com respectively]

Introduction

Assignment of actionable claims/ receivables is achieved by an instrument, and such an instrument requires stamp duty. The United Kingdom (UK), Hong Kong, Malaysia and India are examples of jurisdictions where assignment agreements are liable to stamp duty. Currently, in India, stamp duty in case of assignment of actionable claims/ receivables is significantly high. It is a State subject, and in several states the duty is ad valorem. Some states have over the years provided specific exemption on stamp duty in case of assignment, or have reduced the rates of stamp duty. Considering the volume of assignment transactions undertaken, whether by asset reconstruction companies or by way of securitization, the stamp duty levied becomes a significant cost in such transactions.

The Enforcement of Security Interest and Recovery of Debt Laws and Miscellaneous Provisions (Amendment) Act, 2016[1] has introduced several amendments to the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act, 2002), Recovery of Debts due to Banks and Financial Institutions Act, 1993 (RDDBFI Act) and other incidental laws. One of the amendments pertains to stamp duty exemption on agreement or other document for transfer or assignment of rights or interest in financial assets of banks or financial institutions under section 5 of the SARFAESI Act, 2002, in favor of any asset reconstruction company (ARC).

The Exemption

The exemption from stamp duty is achieved by the insertion of section 8F to the Indian Stamp Act, as provided in the First Schedule to the Amending Act. The text of section 8F as inserted is as follows:

8F. Notwithstanding anything contained in this Act or any other law for the time being in force, any agreement or other document for transfer or assignment of rights or interest in financial assets of banks or financial institutions under section 5 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, in favour of any asset reconstruction company, as defined in clause (ba) of sub-section (1) of section 2 of that Act, shall not be liable to duty under this Act.

The proviso, as apparent from the Joint Committee Report, was inserted with the intent of eliminating any scope for misuse of the exemption, in case of acquisition for purposes other than asset reconstruction or securitization.

Noted Issues on the Exemption

Some points may be noted as regards the stamp duty exemption:

1. Most importantly, the draftsman seems to have omitted, possibly out of inadvertence, to grant exemption to stamp duty payable under stamp laws other than the Indian Stamp Act. It was quite easy for the draftsman to see the language of the exemption granted by several of the preceding sections. For example, the exemption granted under section 8E of the Indian Stamp Act, inserted by the Banking Laws (Amendment) Act 2012, provides exemption, not just to the stamp duty payable under the Indian Stamp Act, but also “under any other law”, thereby exempting the duty payable under the stamp laws of the states that have their own stamp laws:

8E. Notwithstanding anything contained in this Act or any other law for the time being in force,-

(a) conversion of a branch of a bank into a wholly owned subsidiary of the bank or transfer of shareholding of a bank to a holding company of the bank in terms of the scheme or guidelines of the Reserve Bank of India shall not be liable to duty under this Act or any other law for the time being in force; or

(b) any instrument, including an instrument of, or relating to, transfer of any property, business, asset whether moveable or immoveable, contract, right, liability and obligation, for the purpose of, or in connection with, the conversion of a branch of a bank into a wholly owned subsidiary of the bank or transfer of shareholding of a bank to a holding company of the bank in terms of the scheme or guidelines issued by the Reserve Bank of India in this behalf, shall not be liable to duty under this Act or any other law for the time being in force.

Similarly, section 8D, inserted by the Factoring Regulation Act, provides exemption from stamp duty, not only payable under the Indian Stamp Act, but also under any other stamp law:

Agreement or document for assignment of receivables not liable to stamp duty.

8D. Notwithstanding anything contained in this Act or any other law for the time being in force, any agreement or other document for assignment of “receivables” as defined in clause (p) of section 2 of the Factoring Regulation Act, 2011 in favour of any “factor” as defined in clause (i) of section 2 of the said Act shall not be liable to duty under this Act or any other law for the time being in force.

The 2016 Amending Act could not be having the intent of exempting merely the stamp duty payable under the Indian Stamp Act, as there several significant states, notably Maharashtra and Gujarat, which have their own stamp laws. However, the amendment stops by referring to stamp duty payable under the Indian Stamp Act only.

2. The exemption is limited only to financial assets, and not physical assets. For example, when a loan or a portfolio of loans is transferred, there may be a mortgagee’s interest in property getting transferred. The mortgagee’s interest is covered by the definition of “financial asset” given in sec. 2(1)(l). However, where there is an enforcement of security interest by the ARC, and subsequently the mortgaged property is getting transferred from the ARC to a buyer, there is no question of exemption on the conveyance of the said property.

3. One of the biggest sources of confusion will be whether the benefit of exemption will be available where the ARC is acquiring the asset in its capacity as a trustee. As is well-known, most of the assets acquired by ARCs are bought in their capacity as a trustee of a trust, in which the assets are housed. The trust is a special purpose vehicle. The ARC is simply the trustee of the trust. The exempting section in the Stamp Act refers to transfer of financial assets to an asset reconstruction company as defined in section 2(1)(ba). It is possible to argue that what the ARC does in its own capacity, and what it does in capacity as a trustee, are different, as the latter is covered specifically by section 7(2A). On the other hand, it is possible to contend that the business of reconstruction includes purchase of assets in a trust and the issuance of security receipts against that, since the holding of the assets in a trust is merely a way of ring-fencing the assets for the benefit of the holders of the security receipts. While this confusion could have been avoided by use of clear language, the authors’ view is that it will be impractical, and contrary to the intent of the law to keep the exemption limited to acquisition of assets on the balance of the ARC itself.

4. Also, the exemption is only for acquisition of “financial asset” by the ARC, and not on disposal of financial assets by ARCs. Financial assets may be transferred either by the ARC to a third party, or back to the transferring bank (for example, in case of breach of representations or warranties). There is no exemption in case of transfers by ARCs.

Stamp Duty Exemption to Apply in Case of Securitization Transactions Too

One notable feature of the exemption is that the exemption is available in case of transfer of financial assets to an ARC, either for the purpose of asset reconstruction, or for the purpose of securitization. Currently, the marketplace for securitization seems to have shunned the ARC option, though, the way the law was framed, the institution of ARCs was envisaged as “securitization companies” and “reconstruction companies”.

Stamp duty has been one of the biggest pain points for securitization in India. In case of securitization of mortgage-backed loans, there have often been curious legal opinions, limiting the portfolio of home loans to certain states only.

Conclusion

Considering the growing burden of non-performing assets (NPAs) in the country, the exemption has been introduced at the most opportune time whereby it would reduce costs of transferring bad assets to ARCs. While the intent of the exemption was to facilitate acquisition of financial assets by ARCs, the limited scope of stamp duty exemption and the lack of clarity in the language may render the exemption largely ineffective.

Also, with a bit of thoughtful tweaking of the guidelines of the Reserve Bank of India (RBI) pertaining to asset reconstruction companies, it is possible to move to a scenario where the purpose, with which ARCs were envisaged 14 years ago, may be achieved – that is, to act as special purpose vehicles for securitization business as well, and in the process, one of the bottlenecks for securitization business in India may also get removed.

- Vinod Kothari & Nidhi Bothra


[1] The Act received President’s assent on 12 August 2016, enforcement notification has not been passed, the text of the Act can be accessed here http://egazette.nic.in/WriteReadData/2016/171305.pdf

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