The Loan Syndications and Trading Association, the U.S trade group for the syndicated loans market, is urging the U.S. Treasury and Internal Revenue Service to cut offshore collateralized loan obligations some slack when it comes to meeting the new U.S reporting requirements on U.S. investors living overseas.

A subset of collateralized debt obligations, CLOs are a form of securitization where payments multiple business loans are pooled together and passed onto different classes of owners in various tranches. While interest just about died after the financial crisis, the market for CLOs is now staging a comeback driven by investors' hunger for high-risk, high-return securities. Sales of CLOs topped $6.8 billion in the US so far this year, according to S&P Capital IQ LCD. That's more than sales for all of 2009 and 2010 combined.

CLOs invest in syndicated loans and in a fourth letter to the IRS, the LSTA is asking the Treasury and IRS to exempt loans whose terms are changed after January 1, 2013 from complying with the Foreign Account Tax Compliance Act as long as the maturity dates of the loans don't change. Under the current version of the Foreign Account Tax Compliance Act or FATCA if the CLO buys any loan that is issued or materially modified after January 1, 2013, the loan is subject to FATCA's rules. 

The goal of FATCA is to ensure US persons living overseas to pay their fair share of taxes; the legislation, still being developed, does allow financial entities to enter into agreements with the IRS to become participating foreign financial intermediaries as long as they agree to the IRS' requirements. Topping the list of requirements is providing information to the IRS on US persons holding accounts overseas. Or in the case of some European markets -- France, Germany, Italy, Spain and the U.K. -- they can notify their local tax authorities. Doing so prevents the financial entity from being hit with a 30 percent withholding tax on interest payments, principal payments and sale proceeds on US sourced income.   

The LSTA says that in the case of existing CLOs, whose payments are made through a trustee or a clearinghouse, the IRS should allow the trustee or clearinghouse to meet FATCA's requirements. As a result, existing CLOs could be considered as compliant foreign financial intermediaries -- meeting the IRS' requirements -- and exempt from a 30 percent withholding tax for interest payments, principal payments or sale proceeds on loans issued or amended after January 1, 2013. The withholding tax could be considered as a "tax event" for the CLO and result in its liquidation.

"Unfortunately, if existing CLOs are subject to FATCA, the result could well be large scale liquidations of CLO assets causing significant damage to the U.S. corporate loan market and corporate borrowers that rely on it," says Meredith Coffey, executive vice president of the LSTA, which held a webinar on May 2 on the subject entitled: "FATCA and CLOs: What You Don't Know Can Hurt You." Coffey calls FATCA's potential effect on the CLO market "catastrophic."

The LSTA has written four letters to the IRS; the first two in July and November 2010 and the third in June 2011. Its last one was written on April 30 in response to the latest proposed version of FATCA released by the IRS on February 8. In its fourth letter to the IRS, the LSTA notes that while existing CLOs will be subject to FATCA's requirements, many deals were structured before the reporting requirements existed. CLOs may not know who their US investors are so they won't be able to comply with FATCA's requirements. If the CLO cannot become a participating FFI then the loan agent can withhold the 30 percent tax from the CLO itself.

So far, the IRS and Treasury have agreed to allow clearinghouses to do the reporting work about US customers on behalf of the CLOs and give the CLOs the status of participating foreign financial intermediaries. However, CLOs still need trustees to report on debt or equity that is not cleared through clearinghouses to get that designation. 

Written by Chris Kentouris, Editor-in-chief (Chris can be contacted through Chris.Kentouris@hotmail.com)

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