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Just when Asian credit market seemed to have settled down, Indonesian tax authorities have issued two new regulations that are fanning fears and volatility, lawyers and market participants told Debtwire.
The regulations go into effect 1 January and appear to close a loophole that allowed Indonesian corporates who borrowed through offshore special purpose vehicles (SPVs) to avoid paying the full 20% withholding tax on bond coupons. That concerns investors because many of the borrowers in question wrote clauses into their bonds making them callable at par should the Indonesian government cause a hike to the withholding taxes payments.
“There is an increased awakening that something has changed,” said Pieter de Ridder, tax lawyer in Singapore for Dutch headquartered Loyens & Loeff, who has advised on many Indonesian bond issuing structures, including Matahari’s. However, he noted, “Indonesia was just catching up with the rest of the world.”
CFOs and credit investors are scrambling to understand the implications of the change even as traders mark the impacted bonds lower.
Bonds issued by Matahari Putra Prima and Ciliandra Perkasa, for example, dropped three and one points, respectively, after news of the changes hit the credit market over the weekend, but have since rebounded. Matahari’s 2012s were indicated at 103.375/104.375 today, down from a 105.5 bid late Friday, and Cilandra’s 2011s were at 102.5/103.5, compared to 103/04 last week, said a buysider.
JP Morgan, Morgan Stanley and Citigroup helped calm the markets by issuing reports this week opining that even companies that can call their notes are unlikely to do so when the regulations go effective. The main deterrents are refinancing needs -- Indonesian companies are generally still in fund-raising mode following the credit crunch -- and reputation risk.
Indeed, Indofood Sukses Makmur is still considered a pariah by the credit market for its decision to call in its USD 280m Eurobond due in 2007 by executing a tax call option in 2006, said the market participants. That option was triggered when Indonesia, in 2004, cancelled its tax treaty with Mauritius, the jurisdiction where the Indofood bond issuing SPV was registered.
That doesn’t mean bond investors will get off scot-free. Companies are going to face a step up in their withholding tax payments, from the 10% most pay now, cutting into their cash flow and diminishing their credit profile, analysts said. This could especially hurt recent issuers, which were forced to commit to hefty coupons that are now going to rise yet another 10%.
The regulations could also dampen Indonesian companies’ enthusiasm for issuing USD-denominated notes, limiting opportunities for credit investors just as the credit market in Asia has reopened. And ultimately, even the small chance of a take out at par will soften secondary prices for Indonesian notes.
Going Dutch
Nearly all Indonesian corporate bonds sold in recent years were issued via offshore SPVs based in relatively low tax jurisdictions – like the Netherlands – covered by a double taxation treaty with the archipelago nation. The structure allowed borrowers to halve the required 20% withholding tax.
But under the new regulations, offshore entities need to show that they exist for reasons other than tax avoidance in order to be covered by double-taxation treaties. Among the requirements to qualify, SPVs must demonstrate they have employees and use less than half of their income to satisfy interest and royalty obligations to other parties.
“It is clear that special purpose vehicles established for Indonesian bond issuance under the current ‘SPV issuer’ structure would not meet this criteria,” law firm O’Melveny & Myers warned in a 13 November client report that first brought the change to the attention of many credit market participants. Indeed, the SPV bond indentures typically bar the entities from doing anything other than servicing the notes to prevent entanglements in other obligations.
The lawyers and bankers that structured the deals have expected some sort of action by the Indonesian authorities for years, hence the boilerplate warning about the possibly in the risk section of indentures as well as the tax call. Government policy on the matter has been muddled by two conflicting circulars issued in 2005, said Joel Hogarth, a Singapore-based lawyer at O’Melveny & Myers.
As the circulars, by their nature, were only advisories, companies continued using the SPV structure, paying a minimum of 10% withholding tax, even for Netherlands-based issuers.
The ambivalence will finally end in January when the two circulars will be withdrawn and issuing SPVs, as currently structured, will have to begin paying a 20% withholding tax for coupons.
More cat and mouse?
Most bonds issued by Indonesian companies, such as government-owned Perusahaan Listrik Nagara, Indosat, Excelcomindo Pratama, Indika Energy and Bumi Resources, have call options triggered only for withholding tax exceeding 20%, excluding them from potentially calling their notes due to the new regulations.
But about one-third of the country’s USD-denominated issuers, including Berau Coal, Paiton Energy, Bakrie Sumatera and Medco Energi, can call their notes if they are forced to withhold more than 10%, according to a survey of 31 bond indentures conducted by Citi. Those companies could theoretically choose to use their option.
Then there are Matahari and Ciliandra, whose indentures state vaguely that a call at par can be executed if the withholding tax is increased at above the effective rate at the time of issue. That has left investors confused as to whether it is referring to the 20% rate in Indonesia, or the 10% rate the companies were actually paying. Ciliandra, for one, interprets it as 10%.
One thing new issuers, at least, might be able to do to get around the new regulations is to imbue their issuing offshore SPVs with real, if nebulous operations, such as consultancies, noted Loyens & Loeff’s de Ridder. In order to avoid breaching the 50% cap on obligatory payments to third parties, these SPVs could then issue the notes via yet another subsidiary, he said.
Conceivably, even current issuers with viable offshore businesses could attempt this, with a few tweaks to their bond indentures, he said. That would kick off yet another round of regulatory ping pong.
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