Stocklending has not been a feature of the Irish equities market primarily due to difficulties arising from the tax treatment of such transactions under Irish law. The Irish Stock Exchange (ISE) has been pursuing the resolution of the taxation issues relating to the introduction of a stocklending regime to the Irish market. In addition a process is currently underway to put in place the necessary commercial and regulatory infrastructure to facilitate the development of stocklending.
The taxation issues related to the fact that the Revenue treatment of these transactions focused on their legal form rather than their underlying commercial substance. The tax treatment of stocklending and of sale and repurchase transactions (repos) potentially gave rise to Irish capital gains tax and/or to corporation/income tax. The Irish Revenue Commissioners issued an information note on this area which came into effect from the beginning of the current Irish tax year, on 6 April. While some aspects of the taxation treatment are still restrictive, such as the six-month limit on and the definition of participants to such transactions, it does deal with the major issues which previously prevailed under Irish tax law.
The key aspects of the revenue’s revised treatment of such transactions are as follows:
o A stock loan or repo will not be regarded as giving rise to a disposal /acquisition for Irish tax
o Any margin or fee earned by the lender will be taxable in full. Where stock is on loan, the borrower is normally entitled to any dividend or interest payments made, because as a transfer of legal title takes place the stock is held in the borrower’s name. However, the borrower will normally be required to reimburse the lender for any such interest or dividend payments. This compensating payment is termed a “manufactured dividend” or “manufactured payment”. These manufactured payments will normally be taxed in the hands of the recipient unless received by a lender for whom the corresponding real dividend /payment would have been exempt from Irish tax.
o Stocklending fees received by tax exempt funds will also be exempt for Irish tax purposes.
o Manufactured payments will normally be deductible by borrowers against the real dividend in computing the borrower’s liability to Irish tax unless the real dividend in the first instance was exempt from Irish tax.
o Any transfers of stock which take place under a stock loan or repo transaction to which the revenue information note applies will be treated as exempt from Irish stamp duties.
o Securities may be denominated in any currency.
To avail of the tax treatment outlined above a number of conditions must be met. These are as follows:
o A stock loan or repo cannot be for a period exceeding six months.
o Statutory financial statements of any participating institutions must reflect the substance rather than the form of the activities and the treatment of such transactions for tax purposes must be in line with the accounting treatment adopted.
o The arrangements will apply to lending and borrowing institutions which are within the scope of Irish tax and which include companies, building societies, pension funds, charities or collective investment funds. There is however no requirement that both parties to the stock loan are within the scope of Irish tax. These arrangements will not apply to individuals or
o The revenue arrangements apply to equities quoted on recognised stock exchanges and to all interest bearing, discounted and premium bearing securities. An exception to the above concerns Irish equities which are lent across dividend payment dates in such circumstances involving Irish equities the revenue arrangements will not apply unless the lender is eligible for exemption from Irish dividend withholding tax. A similar exception relates to Irish corporate bonds which are lent across coupon dates. Again the revenue arrangements will not apply except where the lender of the bonds is eligible for exemption from interest withholding tax provisions or where both parties to the transactions are subject to interest withholding tax provisions.
o An appropriate audit trail must be maintained by participants to such transactions.
o In addition, the revenue reserves the right to review any unusual situations on an ad hoc basis.
As the taxation situation in Ireland is now more conducive to stocklending, the ISE has set about facilitating the development of a master stocklending agreement designed to aid the successful development of stocklending in the Irish market. This master agreement needs to achieve broad acceptance and recognition by all interested market participants. The agreement will act as a model but may be customised by participants to accommodate particular stock lending arrangements.
As an initial step in developing the final agreement the exchange, having obtained the appropriate legal and taxation reviews of the agreement, commenced a consultation process with market participants in August of this year. The initial stage of this consultation process was with member firms of the exchange. This consultation has now been broadened to include interested market participants including institutional investors, dealers in institutional equities, custodians and representatives from CrestCo.
To finalise the master stocklending agreement and to ensure market acceptance, a working group consisting of each of the above interested parties has been formed availing of appropriate legal and financial advice. Once the agreement has been finalised, the next steps in the process will be to ensure that appropriate amendments are made to the regulatory regime to accommodate stocklending and to obtain approval for these changes from the Central Bank of Ireland which is the ultimate supervisory authority for equity markets in Ireland. It is expected that the consultation process, finalisation of the master agreement and necessary regulatory changes will be completed by early 2000.
Brian Healey is head of regulation at the Irish Stock Exchange in Dublin