Using a Special Purpose Vehicle (SPV) can provide various benefits to you as a business owner. Such advantages include the reduction of financial risk, ease of asset transfer, tax benefits, and restricted legal liability. However, choosing the right SPV for your business requires various considerations.
Types of SPVs
There are mainly two categories of SPVs: On-balance sheet and off-balance sheet SPVs. Generally, you will need to merge the financial results of on-balance sheet SPVs with those of the sponsoring firm. You will also need to revert any income generated by this SPV to its affiliated parent company.
In contrast, there is no consolidation of the off-balance sheet SPV’s financial records with the parent company. You will not transfer any of the SPV’s income to the sponsoring firm.
Subsequently, off-balance SPVs are favored over the on -balance SPVs because they offer greater financial flexibility as a stand-alone entity. These SPVs also allow higher management of assets and liabilities and reduce the financial risk posed to the sponsors and investors. Off-balanced SPVs also helps business owners in securing a better credit rating and get funding at a lower cost.
Off-balance SPVs typically have a service agreement that mandates the SPV to manage assets. They also do not have any independent managers or personnel. Another feature of off-balance sheets SPVs is that they are thinly capitalized and cannot go bankrupt. A trustee performs administrative functions following the set guidelines on how to receive and distribute cash.
Tax Considerations
When deciding on an SPV for securitization matters, knowing the taxation of the SPV will assist you in financial planning. This consideration is necessary because your costs tend to rise if the taxation of your SPV will lead to double taxation of the business owner’s income. Setting up an SPV in a tax haven territory would also help you in reducing some of the taxes charged.
Based on the tax options, there are three types of SPVSs. The first possibility is an independent entity level tax. Here, you treat any income recorded by the SPV as its income. This type of SPV will pay tax on its income; hence the originator is taxed twice. The interest income it distributes is a tax-deductible expense for the entity and profit to the investors.
Another option is known as the tax spread or pass-through entity. In this case, you will not register the SPV as a taxable organization. Instead, the government will tax the investors on the income they have generated. The SPV is a link between the sponsor and investors not earning any income or making any profit. For this reason, it is not liable for taxes.
You could also register your SPV under representative taxation. Here, the SPV represents the investors. There is a marginal maximum rate at which you will pay taxes, and the income of investors is not taxed. This option is the most preferred SPV finance option for start-ups and companies.
Drawbacks to Consider
Although an SPV may provide several benefits to your company, you should also consider a few drawbacks. Starting an SPV is often costly, and requires a considerable amount of capital. Once you have set up the SPV, it does not enjoy the same tax breaks or incentives that the parent business had.
Additionally, as a legally registered limited liability company, the SPV needs to comply with all the legal requirements of such an entity. The funding options for an SPV are also limited.
Aside from the start-up considerations, managing the SPV will also require running general and board meetings, maintaining the statutory registers, and filing of numerous documents and returns. Consulting organizations that specialize in the implementation and administration of SPVs could assist in the set-up and management of your SPV.
For instance, Assure fund administrators help business owners with the creation and running of the SPV, ensuring that they comply with all state regulations. These include rules provided by the Financial Accounting Standards Board, which ensure that all parties involved in the SPV are protected.
SPVs offer various pros to business owners while reducing their financial risk. However, to select the best SPV for your business, it is essential to consider all the financial and legal matters surrounding the entity.
