January 2007 International Financial Law Review
A new reporting system has eased issuance
Since September 2005, Spanish financial entities have launched over $25 billion Rule 144A notes in the US market (including a $3.5 billion extendible short-term notes issue made by one of the top Spanish savings banks), in most cases through wholly owned Spanish subsidiaries.
The issues were mainly placed among US institutional investors and were led by top investment banks, acting as leading bookrunners, such as Lehman Brothers, Deutsche Bank Securities, Morgan Stanley, JP Morgan Securities, Citigroup, Credit Suisse, Banc of America Securities, Goldman Sachs and Merrill Lynch, Pierce, Fenner & Smith.
The $4 billion 144A floating rate senior notes issue made by Santander Central Hispano (SCH) on September 21 2005 was the first of an increasing list of transactions made by Spanish issuers focused on the US institutional market.
These deals have established new procedures to collect, process and submit information regarding the identity and tax residency of the beneficial owners of the issued securities, to comply with the requirements established by Spanish law (Additional Provision Two of Law 13/1985 on investment ratios, own funds and information obligations of financial intermediaries and Royal Decree 2281/1998, which sets out certain obligations to submit information to the tax authorities).
Pursuant to the Spanish issuers and the international bookrunners' request, the US clearing system through which issues have been channelled, the Depository Trust & Clearing Corporation (DTC) designed, developed and implemented the identification procedures. Technical and operative assistance was provided by Acupay System, a member of Bondholder Communications Group, which provides services to identify investors and put them in touch with issuers. Uría Menéndez provided legal assistance. This project has resulted in an operative system through which, with the cooperation of the financial entities that act as participants of DTC, all beneficial owners information has been collected and submitted.
The procedure to collect beneficial owners' information is comprised of two parts: (i) the relief-at-source procedure enables bondowners to obtain full relief on coupon payments, as well as on imputed income from the exchange of extendible notes for non-extendible notes, if investors in extendible notes do not expressly state their choice to extend the maturity of these securities; and (ii) the quick refund procedure is for those owners who received interest net of 15% Spanish withholding tax (which will be increased to 18% on January 1 2007), but are entitled to receive gross payments.
Relief at source
At least 20 business days before each payment date (that is, coupon, interest, remuneration of preferred stock), DTC participants (usually, financial entities) are notified, through a notice on the clearing system website, about the relevant interest payment and about certain tax relief entitlement procedures.
As from the 15th business day before each payment date and until 8 pm on the business day immediately before the payment date (once the market has been closed), DTC participants obliged under the Spanish regulations to certify the identity and tax residency of the beneficial owners of the securities, each DTC participant that is a financial entity (including collective investment institutions, pension funds and insurance entities) resident in an OECD country or in a country with which Spain has entered into a double taxation treaty, that is subject to a specific administrative registration or supervision scheme, and that acts for its own account or as an intermediary on behalf of third parties must: enter, into the tax certification agent's web-based system, all the information set out by Spanish law regarding the beneficial owners of the securities on whose behalf the DTC participants act as custodians and who claim an exemption from Spanish withholding tax; and notify DTC of the portion of the notes that is exempt from Spanish withholding tax (known as the election).
The tax certification agent, together with DTC, carries out certain verification procedures and tasks aimed to detect and correct any discrepancies that might arise between: (i) all the information regarding the transactions of securities carried out until the close of market of the business day before the payment date; (ii) the beneficial owner information; and (iii) the election. DTC participants must ensure that beneficial owner information entered into the system and the EDS elections are updated to reflect any changes.
By 11 am on the payment date, and once any inconsistencies or errors in the information have been solved, the tax certification agent, acting on behalf of the issuer and the guarantor, collects the relevant tax certificates in the form of Annex I and Annex II (as required by the Spanish Order of September 16 1991) generated using the inputted beneficial owner information, and ensures that this information refers to the beneficial owners of the securities on the relevant payment date and that the beneficial owners will, at 1 pm on the payment date, be paid the relevant income.
The failure to correct any inconsistency results in payments for all of that participant's position being made net of Spanish withholding taxes.
To authenticate the signature of each DTC participant's representative, the tax certifications include a bar code, automatically generated by the system, which constitutes an electronic summary of the tax certifications, enabling the following information to be verified: (i) identity of the DTC participant and the person empowered to sign the tax certification on its behalf; (ii) the type of tax certification (Annex I or Annex II); and (iii) the version of tax certification, if different tax certificates have been issued as a result of changes in the beneficial owner's positions.
If the beneficial owner holds the securities through a chain of intermediary entities, and if the payment is received on behalf of a third party, the third party's identity and home country must be provided to the tax authorities. The system works on the basis of three options: (i) the DTC participant holds the securities on its own account; (ii) the DTC participant holds the securities on behalf of a third party, which happens to be the beneficial owner of the securities; and (iii) the DTC participant holds the securities on behalf of a third party (that is, an intermediary entity), which, in turn, holds such securities on behalf of another third party, and so on. At the end of the chain, the beneficial owner of the securities would be the recipient of the income paid by the issuer.
In (i) and (ii) above, the DTC participant enters into the system the information regarding the relevant DTC participant or the beneficial owner on whose behalf the DTC participant acts, as the case may be, and sends the duly signed tax certificates to the tax certification agent, in accordance with the procedures described above.
Where there is a chain of intermediaries between the DTC participant and the beneficial owner of the securities, the system sets out a procedure through which the beneficial owner information flows from the intermediary entity that is in the last position of the chain, that is, the one that ultimately acts on behalf of the beneficial owner, to the DTC participant:
- DTC participants may provide access to the system to the intermediaries they act for. In turn, each of the intermediary entities, once they have gained access to the system, may grant access to the other intermediaries on whose behalf they act.
- The system automatically denies access to all those intermediaries that are in countries or territories regarded as tax havens under Spanish tax regulations. In this case, the whole position held by the intermediary will receive, automatically, net payments on the relevant securities.
- The beneficial owner information entered into the system by any of the intermediaries must be validated, regarding the number of positions to which the information refers, by the intermediary or the DTC participant that is acting the intermediary's behalf. Any intermediary whose position is not validated by the intermediary or the DTC participant in the next position of the chain will automatically receive net payments on the relevant securities.
Quick refund procedure
Beneficial owners of the securities entitled to receive interest payments gross of any Spanish withholding tax but who have been paid net of Spanish withholding tax as a result of: (i) not complying with the relief-at-source procedure; or (ii) holding interest in the securities through a participant not legally entitled to issue the tax certificates, are entitled to follow the quick refund procedure. The investor can request the refund of the amount withheld no later than on the 10th calendar day of the month after that in which interest was payable.
With regard to (i), DTC participants should follow, mutatis mutandis, the relief-at-source procedure, which establishes a mechanism that prevents the portion of the position for which the refund is claimed from exceeding that resulting from the election made by that same participant through the DTC system.
In the second case, the beneficial owner must submit to the issuer documentation to confirm that it is entitled to securities, as well as a certificate of tax residency issued by the tax authorities of their country of residence.
The practical experience
Since December 21 2005, Spanish issuers have been regularly paying the quarterly coupons regarding their respective issues in accordance with these procedures.
All the beneficial owners information has been collected and provided in time (on the coupon payment date), with no delays in the relief-at-source procedures. There has only been one quick refund request. Within the relief-at-source procedure and in view of the 16 coupon payments made between December 2005 and November 2006, payments corresponding to about 99.88% of these coupon payments have been made free of any Spanish withholding tax, including the issuance of the relevant tax certificates, while 100% of the tax information concerning the identity and tax residence of the beneficial owners receiving income has been delivered to the issuer for its disclosure to the Spanish tax authorities.
The web-based system and the procedures designed and developed by DTC and the tax certification agent have removed the potential obstacles and the uncertainty created by Law 19/2003 regarding the disclosure of information about investors, which put the US institutional and retail-targeted Spanish market on hold for almost two years. They have also provided an investor-friendly tool that releases ultimate beneficial owners from burdensome tasks (such as the need to obtain a certificate of tax residence from their tax authorities) while complying with all the information duties on financial entities subject to supervising regimes.
A new set of procedures covering the Spanish tax information requirements deriving from preferred securities issues has also been recently developed. Their main feature, from a Spanish tax standpoint, is that the initially issued restricted preferred securities may be exchanged for new unrestricted preferred securities freely tradable among retail investors, once a registration statement to be filed with the US authorities has been complied with, which is deemed as a taxable event under Spanish tax law and so could give rise to taxable income in Spain. The new procedures, while taking advantage of the existing procedures for senior debt and extendible notes, introduce certain additional mechanisms to collect and process beneficial owner information in respect of the exchange of the restricted preferred securities for new unrestricted preferred securities. This new procedure is likely to be used within the scope of new Spanish preferred securities issues before the end of the year.