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Understanding the Repo Transactions: A True Sale or Not? Several legal and financial angles must be considered when characterizing a repurchase agreement (repo) as a true sale. A repo is formally defined as a sale of securities combined with an agreement for the seller to repurchase them later, leading many appear that ownership has passed through to the purchaser. However, the substance of what is effectively a transfer presents an interesting dilemma as to whether it amounts in fact to be a sale or not.
Legal Ownership Transfer
If the repo transaction, legal title in securities (which is security) will transfer from seller of repurchased to buyer of it. This transfer was specifically created to give the buyer a safety measure against default and gives them the right sell if they need. Nonetheless, as the seller needs to be repurchase obligation debt related legal frameworks might consider it secured lending and not a real sale46.
Tax Effects & Ownership Rights
From the perspective of taxation, while legally sold during a repo, taxable ownership is retained by the seller. Translated, this means that all dividends or interest income arising out of the repoed products is deemed received by the seller for tax accounting purposes15. The distinction between legal and tax ownerships may raise some issues in defining repurchase agreement from financial reporting and regulatory compliance viewpoints.
Judicial Interpretation and Risk of Recharacterization
Depending on the specifics, courts will examine repos through a variety of factors and determine their character. For example, rights that are similar to those retained in certain secured loan transactions—such as a right of redemption or a continuing obligation with respect the maintenance and servicing of mortgage loans it no longer owns—could cause a repo involving such significant features to be recharacterized as financing rather than sale. This recharacterization has important consequences in bankruptcy, where assets that are deemed true sales may not be part of a debtors estate235
To summarise, repos are conceptually sales with an obligation to repurchase having the legal form of a sale, but whether they should be classified as true sales depends on which elements among transfer of economic ownership (legal or beneficial), pass-through tax treatment and judicial construction are deamed priority in lacuna cases. It is vital for counterparties in repo transactions to grasp these intricacies.
