International Ship Finance Through Ireland
With its favourable tax rules, tax treaty network and pool of skilled professionals and advisers, Ireland has long been an international hub for aircraft leasing. What is less appreciated is that those features also make Ireland an attractive location for shipping activity. Ireland can facilitate ship financing, leasing, debt structuring and securitisation transactions. It is therefore no surprise that in July 2013 a major investor submitted plans to build a shipping finance centre in Dublin's docklands.
Ireland offers a range of options to the sector. A shipping company with strategic and commercial management in Ireland can elect to be taxed on the tonnage of its fleet rather than its profit. A shipping lessor can avail of the 12.5% tax rate and generous tax depreciation. In either case substantial and legitimate tax savings are achieved if the conditions are met. Perhaps more important in view of recent trends in ship finance is Ireland's structured finance regime. We discuss this below and consider some tax, structuring and commercial issues.
Ship Finance Trends
Shipping companies have traditionally relied on bank debt to finance their fleets. However, the on-going effects of the financial crisis and the increased capital requirements of Basel III have led banks to reduce their exposures to the shipping sector and replenish capital buffers. This has prompted an increased focus on alternative forms of funding and, in particular, the debt capital markets.
Debt Capital Markets – Options
For a shipping group, the options range from a vanilla corporate bond issued by the group itself to a structured bond issued by a standalone special purpose vehicle ("SPV") which is guaranteed by the group and secured over its ship assets. Alternatively, a shipping group could securitise its ship leases by transferring them to an SPV which issues bonds to investors that are secured over the ships and lease payments (see Appendix 1). This takes the assets off balance sheet and ring-fences them from any insolvency of the shipping group. Lenders can do something similar with their shipping loans, transferring title to the loans to an SPV which issues bonds to investors that are secured over those loans (see Appendix 2). In either case, the bonds can be listed or privately placed, rated or not, or issued as a single class or in several classes. Moreover, a higher rating for the bonds can be achieved through credit enhancement, whether by way of over-collateralisation or a guarantee from the shipping group, a financial institution or an export credit agency.
Debt Capital Markets – Advantages
The advantages of these techniques for shipping companies are that they gain access to a wider pool of investors, at lower rates, for longer terms and possibly a lighter covenant package. For investors, there is the prospect of attractive returns in a low rate environment while diversifying into an uncorrelated asset class. Above all, there is the flexibility in creating a capital structure that meets the demands of investors with different risk/yield requirements while at the same time reducing the overall finance cost.
Ireland's Tax and Securitisation Regime
Ireland has a special tax regime designed to facilitate debt capital markets transactions. A qualifying Irish special purpose company, funded wholly by debt, can hold 'qualifying assets' in a tax neutral manner. These include all types of receivables and loan or lease portfolios and, following a recent change in law, plant and machinery. This would include both ships and offshore oil and gas equipment. While asset backed deals were done in Ireland before this change the ability of an SPV to hold ships and other equipment directly considerably simplifies finance/security structures.
Investors can subscribe for bonds that are tranched into classes (A, B, C etc.) with differing seniority and interest coupon. A subordinated bond can also be issued (typically to the sponsor) which pays out an amount equal to the profit left in an SPV after paying other bondholders and costs. The return is fully deductible if properly structured thereby minimising tax leakage in Ireland and avoiding the need for complex deferred payment mechanisms. An SPV would typically be an 'orphan' company with its shares held on charitable trust and its assets held on security trust for the benefit of the bondholders. To achieve Irish tax residence an SPV must have a majority of at least two Irish resident directors. However, it does not have to be incorporated in Ireland. For example, many such Irish resident SPVs are incorporated in the Cayman Islands and this can have certain company law and insolvency benefits, while at the same time the tax benefits of being an Irish tax resident company.
The bonds can be listed on an exchange such as the Irish Stock Exchange. If so, interest can generally be paid free of withholding tax to investors wherever resident. However, if the bonds are not listed, one must ensure that the beneficial owner of the interest is either a tax exempt entity (e.g. pension fund or QIF) or is resident in an EU or treaty state where the interest is subject to tax and is not, for example, regarded as an exempt distribution. Ireland has double tax treaties with 69 countries, including the major shipping powers of Europe and Asia, so this should be a limited restriction on the investor base in practice.
An Irish SPV is a fully taxable Irish limited company and generally entitled to the benefits of Ireland's treaty network. This gives Ireland an advantage in facilitating transactions in mobile global industries such as shipping and aircraft.
Other Tax Considerations
The indirect tax regime in Ireland is also beneficial for ship finance transactions. The leasing of most ships with a gross tonnage in excess of 15 tonnes is zero-rated for VAT purposes. As for stamp duty, a number of exemptions apply including for transfers of ships, ship leases or loans and the issue or transfer of bonds issued by a qualifying SPV.
If an SPV disposes of a repossessed ship, there may be tax to pay if the sale price exceeds original cost although an exemption for wasting assets may also apply. More likely a loss will be incurred. The tax treatment of this will depend on whether capital allowances have been claimed. Although an SPV may be entitled to allowances in Ireland it may choose not do so where tax capacity is minimal owing to matching income and expense.
To widen the investor base and lower the finance cost, it is often preferable for the bonds issued by an SPV to be rated. The rating agency will need full disclosure of financials and a well-defined path to repossession of the shipping assets. Moreover, to access the US capital markets a Rule 144A or Reg S offering will be required with attendant legal and accounting disclosure and documentation. For European deals new retention requirements for securitisations may require the sponsor to hold a certain proportion of the bonds on book. Large high quality and diverse assets feed investor appetite and are easier to rate so optimum transactions are likely to involve high value operating assets (LNGs, drilling rigs and drill ships) on long term charter to quality credits.
The contraction of bank finance for ships coupled with the search for yield and diversification into real assets has stoked demands for debt capital market funding of ships. But the market is complex and challenging and requires skilled professionals as well as a tried and tested, user-friendly tax and regulatory regime to get deals over the line. Ireland has led the way in facilitating global debt capital markets transactions for a number of years and is ideally placed to do the same in the ship finance space.
For further information on the topic covered in this update, or generally, please speak to your usual Maples and Calder contact.