In the Russian financial market the popularity of Repo transactions is growing. Such deals enable a lender to substantially decrease credit risks, whilst a borrower to get assets on more favourable conditions. Besides, the Tax Code of RF ensures that a Repo operation is a subject to special taxation order, due to which any Repo deal is one of the most effective lending tools.
What is Repo?
A Repo deal is an agreement for securities sale followed by their buyback at a
Actually all Repos consist of two parts. First, firm A sells its assets to firm
B, while firm B is obliged to sell back to firm A the assets at the price set
forth on the moment of signing the Repo agreement.
The target of Repo operations is not a purchase and sale of assets (deal subject);
whist it is a temporary provision of cash means to firm A in exchange of
temporary ownership of its assets. As a rule, price of primary sale (from A to
B) is less than its repurchase price (from B to A). In this case firm A actually
receives a cash loan from firm B and returns it together with interest.
Sometimes Repo deal is concluded contrariwise, it means that the price of
primary sale of assets is more than repurchase price. In such situation firm A
acts as a lender who provides a loan to firm B, the subject of which is the
assets sold. Gap between prices of the first and second Repo parts are called a
Repo rate (in first instance – a rate on cash loan, in the second one – a rate
on asset loan). In practice the securities are more often the subject of Repo
deals. It is determined by a number of reasons. First, income from sale of
securities in contrast to sale of other assets is exempted from income tax (item
2-12 of Article 149 of Taxation Law of RF). Second, in legal terms it is easier
to make a purchase-sale of securities to the holder, other than to make a
purchase and sale of some types of assets. For example, in order to sell a real
estate it is needed to provide a confirmation that the asset is on the balance
sheet of the transferring party. In case of Repo deal such confirmation cannot
be submitted, because the deal assumes a sale-back of the real estate by the
firm, which on the moment of conclusion of the deal legally is not the owner of
this real estate asset. Third, securities almost always have a higher liquidity
and therefore are most attractive for a firm who acts as a lender.
For a lender (an asset buyer) Repo deal is convenient because he doesn’t become
a pledgee (like in classical loan under pledge), whilst he becomes an asset
owner with full rights. Therefore, if the borrower refuses to buyback the asset,
lender will be able to sell it at the market price without borrower’s permission
and cover his costs from the received income. In addition, he will have not to
monitor the credit history and liquidity of the borrower. The only risk of the
lender can be due to decreasing liquidity of the received collateral. Since in
Repo transactions the lender automatically is avoided of a number of usual
lending-related actions (credit history analysis, mark-to-marketing borrower’s
business plan, etc.), and the borrower is deprived of benefits to be received
from collateral ownership (dividends, interest rates, etc.), then Repo rate, as
a rule, is less than rates for a loan to be provided for similar period and with
the same collateral. Furthermore, with the help of Repo deals loan can be
received by borrowers, who do not meet usual banks requirements with regard to
their credit history or those having it insufficient one. The main thing is that
the collateral (securities or other assets) would be liquid.
The Tax Code of RF provides a special taxation regime for Repo deals (article
282 of Tax Code of RF), which differs from taxation of outright securities deals
(article 280 of the Tax Code of RF).
Special regime is applied to the Repo operations with issuing securities (equities,
bonds, etc.). For example, sale and buyback of notes in taxation terms is not
considered as a Repo deal, so such type of deal is a subject to taxation
according to general provisions specified by Article 280 of the Tax Code of RF.
In addition, the maturity of Repo deal should not exceed six months. Meanwhile,
it can be prolonged for a number of days from the date of deal execution up to
the end of corresponding reporting period. For example, if maturity date is the
16th of June, the agreement can be extended till the 30th of June. Special
taxation regime for Repo deals cannot be applied if buyback of securities has
not taken place (return leg of deal is not executed). In this case income and
cost taxation in the first leg is done in accordance with relevant procedure.
Repo income and costs meeting the abovementioned requirements are calculated for
taxation purposes as a percentage rate for use of cash collateral (or interest
on securities loan).
In other words, the participants of the deal determine the price gap of the
first and return legs of the loan. If the difference is positive (the price of
buyback is more than the price of initial sale), it is treated as expenditure (income)
for the seller (purchaser). If there is a negative difference, then it is
treated as income (expenditure) in the form of securities loan interest. Such
regime is more beneficial than a separate taxation of securities sale-purchase
operations because of two reasons. First, taxation on securities operations is
accounted by taxpayer separately ( item 8 of Article 280 of the Tax Code of RF).
Therefore costs caused by securities sale are related only to decrease of income
from sale of the same securities. If expenditure is more than income, then these
looses can be accounted only in the later periods and as a new income from
securities sale (item 10 of Article 280 of the Tax Code of RF). Expenditure in
the form of Repo rate decreases the taxation base for income tax (subject to
limits specified by article 269 of the Tax Code of RF).
Second, the tax for Repo rate is calculated basing on Repo agreement and
irrespective of market price of the securities on the date of securities
purchase-sale. In outright securities purchase-sale deals the revenue for
taxation purposes should be increased up to the market price of these securities
(items 5 & 6of Article 280 of Tax Code of RF).
Firm “À" has concluded a Repo agreement with Firm "B" as follows. Firm "À" sells
to Firm "B" the securities at the price of RUR 150 000, and after six months
Firm "À" buys back these securities from Firm “B” at the price of RUR 164 250.
On the date of securities sale their market price was RUR 160 000, while on the
date of buyback – RUR180 000. Gap between prices of securities sale and buyback
is RUR 14 250(164 250 - 150 000). This amount is a rate to be paid by Firm "À"
for six months (183 days) for the use of assets amounted to RUR 150 000.
Interest rate 18,9% per year [(RUR14 250 : RUR150 000) : (183 days : 365 days) õ
100%]. Interest rate is treated as income for Firm “B”, whilst the expenditure –
for Firm “A”. Therefore, income tax of Firm “A” decreases, while income tax of
Firm “B” increases in the amount of RUR 3420 (RUR 14 250 õ 24%).
If the results of this operation were a subject to taxation in order specified
by contracts on securities sale-purchase, then the taxation order would be as
follows. Firm "À" earns income from securities sale to be calculated basing on
the market price of the securities, e.g. RUR 160 000. These securities were
purchased by Firm "À" prior to concluding a deal with Firm “B” at the price of
RUR 140 000. Then the taxation base for securities operations of Firm "À" will
be RUR 20 000 (160 000 - 140 000) and the income tax of RUR 4800 will be paid
accordingly (RUR20 000 õ 24%). Income of Firm “B” is derived from reverse sale
of securities to Firm "À" and equals to RUR 180 000 (basing on the market price
of securities on the moment of sale). Taxation base for securities operations of
Firm “B” will be RUR 30 000(180 000 - 150 000), whilst a sum of income tax – RUR
7200 ðóá. (RUR 30 000 õ 24%).
Thus, due to mechanism of reverse sale of securities Repos have a number of
benefits, compared to usual loans. Nevertheless, Repo taxation regime fully
complies with loan taxation that makes them be an efficient lending tool.