Special purpose vehicles have become popular structures for investors around the world to channel finance into a wide range of sectors and assets. Although there is no fixed legal and regulatory definition of an SPV, the term covers vehicles that are legally and organisationally efficient, facilitating the separation and segregation of business risks, reducing the cost of external financing, and relatively straightforward to establish in many jurisdictions, according to a study by two UK academics commissioned by L3A.
The Real Role of Special Purpose Vehicles, by Richard Taffler, professor emeritus of finance and accounting at Warwick Business School, and Dr. Shehub Bin Hasan, a lecturer in finance at the University of Reading's Henley Business School, examines the business case for the creation and use of SPVs, drawing on in-depth interviews with practitioners, corporate service providers and legal advisers.
Separating risk and ownership
Professor Taffler and Dr. Bin Hasan note that SPVs are designed to separate risk assets from their sponsors, providing greater capacity for debt and facilitating synthetic leases. Cash savings can also be generated through leverage and the carrying forward of net operating losses, particularly where SPVs are used for research and development, or for holding intangible assets.
Irrespective of their exact structure, whether traditional partnerships, limited liability partnerships or limited companies, SPVs and broader special purpose entities have legal personality. This feature is important, since it provides the legal mechanism to insulate investors from risks arising from the vehicles’ activities, such as securitisation and project finance.
From a legal perspective, SPVs operate under the bankruptcy remoteness principle, since their assets are not consolidated with on-balance sheet assets and are protected from the risk of bankruptcy should its originators face insolvency. The principle of separation can also result in a lower cost of external financing because creditors are also protected from any deterioration in the solvency of the SPV’s owners.
Transparency and reputation
Taffler and Bin Hasan also highlight potential downsides. Although SPVs facilitate ownership of underlying assets by multiple parties and the transfer of ownership between them, structures involving different layers of SPVs to invest in cross-border assets can lead to a lack of transparency and complications for tax authorities and regulators, who must track ownership, beneficiaries and earnings.
As previously noted, SPVs also face reputational issues, especially since the tax avoidance label is often misapplied even to the most transparent vehicles.
The authors note: "Substance is a notoriously elusive concept. Many valid SPV structures with clear economic purpose do not require their own employees or physical offices, with their administrative needs appropriately outsourced to specialist corporate service providers […] One size does not fit all!" Therefore, potential investors and supervisors need to analyse each SPV on a case-by-case basis.
Regulation is also in flux; the European Commission has recently drawn up draft rules designed to curb the creation of entities solely intended for tax avoidance or that have little or no substance. The Commission’s new business taxation agenda aims to prevent the misuse of entities without active business operations or significant assets for tax purposes.
The report examines a number of actual business cases and the use of structures involving Luxembourg-domiciled SPVs by investors. The authors find genuine and compelling business cases for their use as well as genuine substance in master and subordinated SPVs, particularly where projects and assets are spread across a number of countries.
Although SPVs are often misunderstood, characterised as ‘offshore’, dismissed as ‘shell companies’ or construed as structures designed for tax avoidance, Taffler and Bin Hasan point to the genuine economic substance and commercial rationale in the real-life cases they reviewed as part of the study. Academic literature adds weight to their findings, arguing that SPVs are principally designed to ensure tax neutrality rather than savings.
To find out more on how SPVs are being deployed to structure assets as diverse as green energy projects, private equity investment in the pharmaceutical sector, property, debt funds, research and development, and lowering the cost of aircraft financing, please read the full report.