PRIVILEGED AND CONFIDENTIAL — ATTORNEY WORK PRODUCT
MEMORANDUM
CALDERWOOD & HARKNESS LLP 601 Lexington Avenue New York, NY 10022
DATE: September 20, 2022
TO: Douglas Carmichael, Responsible Partner Francesca Morano, Billing Partner Yuki Nakamura, Lead Associate
FROM: Sylvia Hartwell, Partner (Tax)
RE: Review of Tax Disclosure Section — Preliminary Offering Memorandum (v3), Quorum Receivables Funding 2022-1 LLC, $500,000,000 Insurance Premium Finance Asset-Backed Notes
MATTER NO.: 1025-00007
PRIVILEGED AND CONFIDENTIAL — ATTORNEY WORK PRODUCT This memorandum is protected by the attorney-client privilege and constitutes attorney work product. It is intended solely for the use of the addressees and other attorneys within Calderwood & Harkness LLP working on this matter. Do not distribute externally without prior approval of the undersigned.
I. Introduction and Purpose
This memorandum sets forth the results of my review of the "Certain U.S. Federal Income Tax Considerations" section, together with the related state and local tax considerations, FATCA withholding, and ERISA considerations subsections, of the Preliminary Offering Memorandum (v3) for the Quorum Receivables Funding 2022-1 LLC transaction (the "OM"). The OM is dated October 12, 2022. This review was initially conducted on the September 14, 2022 draft (v2) and has been updated to reflect revisions reflected in the near-final v3 circulated as of October 12, 2022. Unless otherwise indicated, page references herein are to the v3 draft of the OM.
Transaction Summary. The transaction involves a Rule 144A / Regulation S private placement of three tranches of asset-backed notes (the "Notes") by Quorum Receivables Funding 2022-1 LLC (the "Issuer" or "QRF 2022-1"), a Delaware limited liability company organized as a bankruptcy-remote special purpose vehicle. The Notes are backed by a pool of insurance premium finance receivables originated by Quorum Premium Finance LLC ("QPF"), a wholly owned subsidiary of Quorum Insurance Holdings Corp. ("QIH," NYSE: QIHC). QPF is the originator and servicer of the receivables. The insurance premium finance receivables consist of loans made to policyholders to finance the payment of insurance premiums, secured by assignments of the unearned premium refund rights under the financed policies.
Capital Structure. The capital structure of the transaction under review consists of the following:
The preliminary ratings set forth above have been assigned by Brindoval Ratings Inc. and Pinnacle Rating Services LLC, respectively. These ratings are subject to confirmation at closing based on final transaction documentation and pool composition.
Purpose of This Memorandum. The purpose of this memorandum is to ensure that the tax disclosure contained in the OM is accurate, complete, and consistent with the following internal work product and supporting analyses prepared in connection with the transaction:
(a) the Tax Structuring Memorandum dated August 12, 2022 (S. Hartwell);
(b) the FATCA Compliance Memorandum dated August 18, 2022 (S. Hartwell, C. Espinoza);
(c) the State Tax Nexus Analysis dated September 1, 2022 (Y. Nakamura); and
(d) the Draft Opinion on Tax Characterization dated October 10, 2022 (S. Hartwell).
Although the offering is not registered under the Securities Act of 1933, as amended, and is being conducted pursuant to the exemptions afforded by Rule 144A and Regulation S, best-practice disclosure standards apply to the OM. Investors in Rule 144A offerings rely on the OM as their primary source of information regarding the investment, including the tax consequences of acquiring, holding, and disposing of the Notes. Accordingly, the tax section must be prepared with the same degree of care and completeness that would be appropriate for a registered offering.
This memorandum identifies recommended revisions to the OM tax section, provides explanatory commentary where appropriate, and confirms the consistency of the OM disclosure with the supporting memoranda and opinion referenced above.
II. Overall Assessment
General Conclusion. The tax section of the OM (v3), as currently drafted, is substantially accurate and well-organized. The recommended revisions set forth in this memorandum are largely clarifying, conforming, or supplementary in nature. I have not identified any material misstatement of law or any conclusion in the OM tax section that is inconsistent with our internal work product. The revisions I recommend are intended to enhance the completeness and precision of the disclosure, to address areas where additional specificity will be useful to investors, and to conform the OM to certain positions reflected in the Draft Opinion on Tax Characterization and the FATCA Compliance Memorandum.
Subsections Reviewed. The OM tax section comprises the following subsections, each of which has been reviewed and is addressed individually in the sections of this memorandum that follow:
1. Classification of the Issuer (QRF 2022-1)
2. Characterization of the Notes as Debt
3. Tax Consequences to U.S. Holders
4. Tax Consequences to Non-U.S. Holders
5. FATCA Withholding
6. State and Local Tax Considerations
7. ERISA Considerations
8. Tax Shelter / Reportable Transaction Disclosure
This memorandum organizes comments by subsection, consistent with the structure of the OM tax section. Within each subsection, I identify specific issues, confirm the accuracy of the existing disclosure where appropriate, and provide redline suggestions and explanatory commentary for recommended revisions.
III. Classification of the Issuer (QRF 2022-1)
A. Disregarded Entity Status
The OM correctly states that QRF 2022-1 is a Delaware limited liability company that will be treated as a disregarded entity for U.S. federal income tax purposes. The OM further states that the sole member of QRF 2022-1 is Quorum Receivables Holding LLC ("QRH"), which is itself a Delaware limited liability company treated as a disregarded entity for U.S. federal income tax purposes, and that the sole member of QRH is QPF.
I have confirmed that this disclosure is consistent with the Tax Structuring Memorandum dated August 12, 2022. As set forth in that memorandum, neither QRF 2022-1 nor QRH has elected (or intends to elect) to be classified as a corporation or as an association taxable as a corporation. The default classification under Treasury Regulation § 301.7701-3 for a domestic eligible entity with a single owner is treatment as a disregarded entity (i.e., an entity that is not treated as an entity separate from its owner for U.S. federal income tax purposes). Because QRF 2022-1 has a single member (QRH) and QRH has a single member (QPF), each is a disregarded entity under the default rules, and no affirmative election is required to achieve this result.
Recommended Addition. I recommend adding a brief disclosure to the OM confirming that neither QRF 2022-1 (EIN: 88-1247653) nor QRH (EIN: 88-1247619) has filed, or will file, an IRS Form 8832 (Entity Classification Election) electing to be classified as a corporation. This disclosure, while perhaps unnecessary from a strictly legal standpoint (because the default classification applies absent an affirmative election), will provide affirmative comfort to investors and their tax advisors that the parties have not inadvertently or deliberately altered the default classification. This is consistent with market practice in structured finance transactions involving chains of disregarded entities.
Disregarded Entity Chain — Flow-Through Treatment. The OM should also confirm, and I recommend adding a sentence to this effect, that the chain of disregarded entities means that for U.S. federal income tax purposes, all items of income, gain, loss, deduction, and credit arising from the receivables pool held by QRF 2022-1 are treated as items of QPF (EIN: 84-2653198), and ultimately flow to QIH (EIN: 82-4391067) on a consolidated U.S. federal income tax return. This is a natural consequence of the disregarded entity structure, but the explicit statement will assist investors in understanding the flow of tax attributes through the structure and will confirm that the Issuer itself is not a separate taxpayer.
B. Qualifying SPE / Taxable Mortgage Pool Analysis
The OM does not currently include a discussion of the taxable mortgage pool ("TMP") rules under IRC § 7701(i). I recommend that a brief clarifying statement be added to the Issuer classification subsection confirming that the TMP rules do not apply to QRF 2022-1.
The TMP rules were enacted to address arrangements involving pools of obligations secured by real property interests, and they impose entity-level taxation on certain arrangements that would otherwise be treated as pass-through vehicles. The receivables in the QRF 2022-1 pool are insurance premium finance loans — short-term obligations made to policyholders to finance the payment of insurance premiums, secured by assignments of unearned premium refund rights under the financed insurance policies. These receivables are not "real estate mortgages" within the meaning of IRC § 7701(i)(2)(A), and accordingly the TMP rules do not apply.
I recommend adding a sentence to the OM confirming this conclusion. This is particularly important for banking entity investors, which may be sensitive to TMP exposure because the TMP rules can affect regulatory capital treatment and could give rise to separate entity-level tax obligations. The addition of this clarification is consistent with the analysis in the Draft Opinion on Tax Characterization dated October 10, 2022.
C. Partnership Classification Risk
The OM includes cautionary language to the effect that the IRS could assert that QRF 2022-1 should be treated as a partnership for U.S. federal income tax purposes if the Notes were recharacterized as equity interests rather than indebtedness. I have reviewed this cautionary disclosure and confirm that it is adequate as a general matter.
However, I recommend that the OM expand the hypothetical discussion of the consequences of partnership recharacterization to provide investors with a clearer picture of what would result if such recharacterization were to occur. Specifically, the OM should note that if the Notes were treated as equity interests and QRF 2022-1 were treated as a partnership (rather than as a disregarded entity), the following consequences could ensue:
• Holders would be treated as partners in a partnership and would be required to include their distributive share of partnership income, gain, loss, deduction, and credit in their taxable income, regardless of whether cash distributions were received. This pass-through treatment could result in phantom income in periods where income accrues but cash distributions are deferred.
• For tax-exempt holders (including pension funds, endowments, and other entities exempt from tax under IRC § 501(a)), the pass-through of income from the receivables pool could give rise to "unrelated business taxable income" ("UBTI") under IRC §§ 511–514, particularly if the partnership were treated as engaged in a trade or business or if the income were debt-financed.
• For non-U.S. holders, the pass-through of income could give rise to income that is "effectively connected" with a U.S. trade or business ("ECI") under IRC § 864(c), potentially subjecting non-U.S. holders to U.S. federal income tax on a net income basis and to U.S. tax return filing obligations. In addition, non-U.S. corporate holders could be subject to the branch profits tax under IRC § 884.
I do not recommend any change to the conclusion stated in the OM — namely, that the Notes should be treated as debt and QRF 2022-1 should be treated as a disregarded entity. The expanded hypothetical discussion is intended solely to provide investors with a more complete understanding of the risks associated with a contrary determination by the IRS, consistent with best-practice disclosure standards.
IV. Characterization of the Notes as Debt
A. Debt vs. Equity Analysis
The OM correctly states that the Notes will be treated as indebtedness of QPF (through the disregarded entity chain) for U.S. federal income tax purposes. This conclusion is consistent with the Draft Opinion on Tax Characterization dated October 10, 2022, which I prepared and which concludes that the Notes should be treated as debt for U.S. federal income tax purposes based on an analysis of the traditional debt/equity factors articulated in Mixon v. United States, 464 F.2d 394 (5th Cir. 1972), and its progeny.
The OM currently states this conclusion in general terms but does not enumerate the specific factors supporting the debt characterization. I recommend adding an explicit reference to the key factors supporting debt treatment, as follows:
• Unconditional Obligation to Pay. The Notes represent an unconditional obligation of the Issuer to pay stated principal and interest to the holders. The obligation to pay principal and interest is not contingent upon the financial performance of the Issuer or any other condition within the control of the Issuer or its affiliates.
• Fixed Legal Final Maturity. The Notes have a fixed legal final maturity date that is 42 months from the closing date. While the actual repayment of principal may occur earlier than the legal final maturity depending on collections experience and the operation of the waterfall, the obligation to repay principal in full by the legal final maturity is unconditional.
• Sequential Payment Waterfall. Under the Indenture, payments of interest and principal on the Notes are made in accordance with a sequential payment waterfall that gives priority to noteholders over the holder of the retained interest. This priority structure is characteristic of a debtor-creditor relationship and distinguishes the Notes from equity interests, which would typically share in residual cash flows on a pro rata or subordinated basis.
• No Management or Voting Rights. Holders of the Notes have no management or voting rights with respect to QRF 2022-1, other than certain protective provisions set forth in the Indenture (e.g., consent rights with respect to amendments that would change payment priorities, extend the legal final maturity, or reduce the interest rate). The absence of management or governance rights is a hallmark of a debtor-creditor relationship.
• Overcollateralization and Subordination. The transaction includes overcollateralization in the amount of $15,000,000 (3.0% of the total capital structure), as well as subordination of the Class B and Class C Notes to the Class A Notes, and subordination of the Class C Notes to the Class B Notes. This meaningful equity cushion, held entirely by the sponsor (QIH, through the SPV chain), supports the characterization of the Notes as debt and the retained interest as equity.
I further note that the retained interest and overcollateralization ($15,000,000) is held by the sponsor, QIH, through the SPV chain (QIH → QPF → QRH → QRF 2022-1). The fact that the sponsor retains the first-loss position is significant because it ensures that the economic substance of the transaction is consistent with the legal form: the Notes represent senior obligations, and the retained interest represents the residual equity. This is consistent with the risk retention requirements under Regulation RR (17 CFR Part 246) and further supports the characterization of the Notes as debt.
Reporting. I also recommend that the OM include a statement confirming that the parties intend to, and will, report interest on the Notes as indebtedness on all applicable tax returns. Specifically, investors should be informed that they will receive IRS Form 1099-INT with respect to interest paid on the Notes (or, for non-U.S. holders, IRS Form 1042-S, as applicable). This statement will reinforce the debt characterization and is consistent with the requirement under Treasury Regulation § 1.385-1(c) that the form in which a transaction is cast be respected if it is supported by substance.
B. Original Issue discount (OID)
The OM correctly addresses the potential for original issue discount ("OID") if any class of Notes is issued at a price below par. The OM's treatment of this issue is generally adequate, but I recommend the following additions to enhance the specificity and usefulness of the disclosure.
De Minimis Threshold. I recommend adding a statement clarifying that OID will arise with respect to a class of Notes only if the Notes are issued at a discount that exceeds the de minimis threshold under IRC § 1273(a)(3). The de minimis amount is equal to 0.25% of the stated principal amount of the Notes multiplied by the number of full years from the issue date to the legal final maturity date. If the discount is within the de minimis threshold, it will be treated as zero for OID purposes, and the holder will recognize capital gain upon retirement of the Notes in an amount equal to the de minimis OID.
For example, with respect to the Class A Notes ($375,000,000 stated principal, 42-month legal final maturity), the de minimis threshold would be approximately $3,281,250 (i.e., 0.25% × $375,000,000 × 3.5 years). If the Class A Notes are issued at a discount of less than this amount, no OID inclusion will be required.
If any class of Notes is issued at a discount that exceeds the de minimis amount, holders will be required to include OID in gross income on a constant-yield basis over the term of the Notes under IRC §§ 1271–1275, regardless of whether corresponding cash payments are received.
Coupon Guidance and Pricing Expectations. The current coupon guidance at launch (Class A: SOFR + 125 bps; Class B: SOFR + 210 bps; Class C: SOFR + 375 bps) contemplates issuance at or near par, which would minimize or eliminate OID. However, final pricing may result in a discount from par, depending on market conditions at the time of pricing. The OM's language is appropriately conditional in this regard, and I recommend no change to this aspect of the disclosure.
Interaction with Revolving / Amortization Structure. I recommend adding a note addressing the interaction of the OID rules with the revolving structure of the Notes. The Notes have a 24-month revolving period during which principal collections may be used to acquire additional receivables, followed by a 12-month amortization period during which principal collections are used to pay down the Notes in accordance with the sequential waterfall. As a result, the weighted average life of the Notes is expected to be shorter than the 42-month legal final maturity. This distinction is relevant to the OID analysis because the constant-yield method of OID accrual takes into account the projected payment schedule, including the effect of prepayments and the revolving structure. The OM should note that the OID accrual schedule may differ from what holders might expect based solely on the legal final maturity, and that holders should consult their own tax advisors regarding the application of the OID rules to their specific circumstances.
C. Market discount
The OM includes a brief paragraph addressing market discount for secondary purchasers of the Notes — that is, holders who acquire Notes in the secondary market at a price below the Notes' adjusted issue price (or, if lower, the Notes' stated principal amount). The OM correctly notes that market discount, if any, will be treated as ordinary income upon disposition or retirement under IRC §§ 1276–1278. I have reviewed this paragraph and confirm that it is adequate. No recommended changes.
V. Tax Consequences to U.S. Holders
A. Interest Income
The OM states that stated interest on the Notes will be includable in gross income as ordinary interest income in accordance with the holder's regular method of accounting (i.e., the accrual method for most institutional investors, or the cash method for individuals and certain other holders). The OM also notes that the Notes bear interest at a floating rate based on SOFR, and that each interest payment will be treated as a payment of "qualified stated interest" under the OID regulations.
I confirm that this disclosure is accurate and consistent with applicable law. No recommended changes.
B. Sale, Exchange, or Retirement
The OM correctly states that a U.S. holder who sells, exchanges, or retires a Note will recognize gain or loss equal to the difference between the amount realized and the holder's adjusted tax basis in the Note. Such gain or loss will generally be capital gain or loss, and will be long-term capital gain or loss if the holder has held the Note for more than one year at the time of disposition. The OM also notes that any gain attributable to accrued but unpaid interest or accrued OID will be treated as ordinary income.
I recommend adding a clarifying statement that because the Notes have a legal final maturity of 42 months from the closing date, a holder who acquires Notes at original issuance and holds them through maturity will have held the Notes for more than one year and will therefore realize long-term capital gain or loss (if any) upon retirement. This is a straightforward point, but it will be helpful to investors who may not immediately calculate the holding period implication of the 42-month legal final maturity.
C. Medicare Surtax
The OM correctly notes that certain U.S. holders that are individuals, estates, or trusts are subject to the 3.8% net investment income tax imposed by IRC § 1411 on, among other things, interest income and net gains from the disposition of property not held in a trade or business. The OM states that holders should consult their own tax advisors regarding the application of this tax to their investment in the Notes.
I confirm that this disclosure is accurate and sufficient. No recommended changes.
D. Backup Withholding
The OM includes standard disclosure regarding backup withholding under IRC § 3406. The OM correctly states that payments of interest on the Notes, and gross proceeds from the disposition of the Notes, may be subject to backup withholding at the current rate of 24% unless the holder provides a properly completed IRS Form W-9 (or otherwise establishes an exemption from backup withholding). The OM further notes that backup withholding is not an additional tax and may be credited against the holder's U.S. federal income tax liability.
I confirm that this disclosure is accurate and consistent with current law. No recommended changes.
VI. Tax Consequences to Non-U.S. Holders
A. Portfolio Interest Exemption
The OM correctly states that interest paid on the Notes to a non-U.S. holder (as defined in the OM) will qualify for the portfolio interest exemption from U.S. withholding tax under IRC §§ 871(h) and 881(c), provided the following conditions are satisfied:
(i) the holder is not a "10-percent shareholder" of the Issuer (or, because the Issuer is a disregarded entity, of QPF or QIH) within the meaning of IRC § 871(h)(3);
(ii) the holder is not a "controlled foreign corporation" that is related to the Issuer (or QPF or QIH) within the meaning of IRC § 881(c)(3)(C);
(iii) the holder is not a bank that receives interest on a loan made in the ordinary course of its banking business within the meaning of IRC § 881(c)(3)(A); and
(iv) the holder provides a properly completed IRS Form W-8BEN (for individuals) or Form W-8BEN-E (for entities), certifying the holder's non-U.S. status and eligibility for the portfolio interest exemption, to the applicable withholding agent.
I confirm that this disclosure is accurate. However, I recommend adding a clarifying note addressing the application of the "10-percent shareholder" test in the context of the disregarded entity structure. Because QRF 2022-1 is a disregarded entity, the "10-percent shareholder" test under IRC § 871(h)(3)(B) is applied at the level of the regarded entity that is treated as the issuer of the Notes for U.S. federal income tax purposes — namely, QPF, and through QPF, QIH. QIH is publicly traded on the New York Stock Exchange (ticker: QIHC). As a practical matter, it is remote that a noteholder would also be a 10% shareholder of QIH within the meaning of IRC § 871(h)(3). Nevertheless, this should be disclosed because the analysis is not self-evident, and sophisticated investors and their tax advisors will want to understand the level at which the 10% shareholder test is applied. I recommend adding a sentence to this effect.
B. Effectively Connected Income
The OM includes standard disclosure regarding the treatment of interest on the Notes as effectively connected income ("ECI") under IRC § 864(c) for non-U.S. holders that conduct a trade or business within the United States to which interest on the Notes is effectively connected. The OM correctly states that such holders will be subject to U.S. federal income tax on a net income basis at regular graduated rates (and, in the case of corporate holders, may also be subject to the branch profits tax under IRC § 884) and will not be subject to withholding if they provide a properly completed IRS Form W-8ECI.
I confirm that this disclosure is accurate and adequate. No recommended changes.
C. FIRPTA
The OM correctly states that the Foreign Investment in Real Property Tax Act ("FIRPTA") provisions of IRC §§ 897 and 1445 should not apply to a non-U.S. holder's investment in the Notes because (i) the Notes are debt and not "United States real property interests" within the meaning of IRC § 897(c), and (ii) QRF 2022-1 does not hold United States real property interests and is not a "United States real property holding corporation." The receivables in the pool are insurance premium finance loans, not interests in real property.
I confirm that this disclosure is accurate. No recommended changes.
D. Estate Tax
The OM includes standard estate tax disclosure noting that Notes held (or treated as held) by a non-U.S. individual holder at the time of death may be subject to U.S. federal estate tax under IRC § 2104, unless an applicable estate tax treaty provides otherwise. The OM notes that the portfolio debt exemption from estate tax under IRC § 2105(b) may apply to exclude the Notes from the non-U.S. individual's U.S. gross estate.
I confirm that this disclosure is accurate and adequate. No recommended changes.
VII. FATCA Withholding
The OM includes a subsection addressing the Foreign Account Tax Compliance Act ("FATCA") provisions of IRC §§ 1471–1474. I have reviewed this subsection against the FATCA Compliance Memorandum dated August 18, 2022, and recommend the following updates and confirmations.
Issuer Status. The OM should confirm, and I believe the current draft does so accurately, that QRF 2022-1 will be treated either as a "deemed-compliant foreign financial institution" (if it is treated as a foreign entity for FATCA purposes, which should not be the case given its Delaware organization) or, more accurately, as a disregarded entity of QPF (a U.S. person). Because QPF is a domestic entity, payments received by QRF 2022-1 are not subject to FATCA withholding. I recommend clarifying that the relevant analysis is that QRF 2022-1, as a disregarded entity of a U.S. person, is not a "foreign financial institution" or a "non-financial foreign entity" for FATCA purposes, and therefore FATCA withholding does not apply to payments received by QRF 2022-1 from the receivables pool.
Payments to Non-U.S. Holders. The OM correctly states that payments of interest on the Notes to non-U.S. holders may be subject to 30% FATCA withholding if the holder (or any intermediary in the chain of payment) fails to comply with FATCA reporting requirements. This includes the requirement that non-U.S. holders provide properly completed IRS Forms W-8BEN, W-8BEN-E, or W-8IMY (with appropriate attachments), as applicable, to the withholding agent.
Gross Proceeds — Proposed Regulations. The OM currently states that payments of gross proceeds from the sale or other disposition of the Notes may be subject to FATCA withholding. This language should be updated. In December 2018, the IRS published proposed regulations (REG-132881-17, 83 Fed. Reg. 64757) that would eliminate FATCA withholding on gross proceeds. The preamble to the proposed regulations states that taxpayers may rely on the proposed regulations pending their finalization. I recommend that the OM be revised to reflect that the IRS has proposed eliminating FATCA withholding on gross proceeds from the sale or other disposition of the Notes, that taxpayers may rely on the proposed regulations pending finalization, and that if the proposed regulations are finalized as proposed, no FATCA withholding will apply to gross proceeds. The OM should retain a caveat that if the proposed regulations are not finalized, or are finalized in a form that differs materially from the proposed regulations, FATCA withholding on gross proceeds could apply.
Paying Agent. I recommend that the OM reference Calvoneth Trust Company, N.A., in its capacity as paying agent under the Indenture, as the party responsible for FATCA withholding compliance on payments made to holders of the Notes. This is consistent with the paying agent's obligations under the Indenture and the Paying Agent Agreement, and will assist investors in understanding the chain of FATCA compliance responsibility.
VIII. State and Local Tax Considerations
The OM includes a brief disclaimer stating that holders should consult their own tax advisors regarding the state and local tax consequences of acquiring, holding, and disposing of the Notes. This disclaimer is appropriate and should be retained. However, I recommend that the state and local tax subsection be modestly expanded to include the following additional disclosures, which are consistent with the State Tax Nexus Analysis dated September 1, 2022.
Issuer Organization and Delaware Tax. The OM should note that QRF 2022-1 and QRH are organized in Delaware and have been structured to avoid state-level franchise tax or income tax nexus in states other than Delaware. As Delaware limited liability companies, QRF 2022-1 and QRH are each subject to the Delaware LLC annual tax of $300, which is a flat tax and not based on income or assets. No other Delaware-level income or franchise tax should apply to QRF 2022-1 or QRH.
Nexus Avoidance. QPF is licensed in all 50 states and the District of Columbia and originates insurance premium finance receivables across all 50 states. However, the securitization structure has been designed so that QRF 2022-1's activities are sufficiently limited to avoid creating state income tax or franchise tax nexus in states where QPF operates. QRF 2022-1's activities are limited to owning the receivables, issuing the Notes, and making payments on the Notes — it does not maintain offices, employees, or agents in any state other than Delaware (other than the Indenture Trustee's offices, which should not create nexus for the Issuer). The State Tax Nexus Analysis confirms that QRF 2022-1 should not have income tax or franchise tax nexus in any state other than Delaware, although this conclusion is subject to change if states adopt more aggressive nexus standards, including economic nexus standards that could reach passive investment vehicles.
No State Withholding Tax. I recommend that the OM confirm that no state withholding tax applies to interest payments on the Notes under current law in the states where QPF has significant origination activity. As set forth in the State Tax Nexus Analysis, the three states with the highest geographic concentration of receivables in the pool are Texas (14.8%), California (12.3%), and Florida (8.5%), which together comprise approximately 35.6% of the pool by unpaid principal balance. None of these three states imposes a withholding tax on interest payments made by a Delaware SPV on asset-backed securities. (Texas has no state income tax; Florida has no state individual income tax and does not impose withholding on interest payments to non-residents; California does not impose withholding on interest payments on publicly offered or privately placed debt securities.)
Holder-Level State Tax. I recommend that the OM add a modestly expanded warning that holders located in, or subject to tax in, states that impose income tax on interest income from pass-through entities, or that apply economic nexus standards that could reach holders based on their ownership of the Notes, may have state income tax obligations arising from their investment. The OM's current general disclaimer that "holders should consult their own tax advisors regarding state and local tax consequences" is sufficient as a general matter, but could be modestly expanded to flag these specific issues for the benefit of institutional investors that may be subject to tax in multiple jurisdictions.
IX. ERISA Considerations
A. Plan Asset Issues
The OM includes a subsection addressing the acquisition of the Notes by employee benefit plans subject to Title I of the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), individual retirement accounts ("IRAs") and other plans subject to IRC § 4975, and entities whose underlying assets include "plan assets" by reason of any such plan's or IRA's investment in the entity (collectively, "Benefit Plan Investors").
The OM correctly concludes that the Notes should qualify for the exemption from the definition of "plan assets" under the ERISA plan asset regulations (29 CFR § 2510.3-101, as modified by Section 3(42) of ERISA). The plan asset regulations provide that if a Benefit Plan Investor acquires an "equity interest" in an entity, the underlying assets of the entity will be treated as plan assets of the Benefit Plan Investor unless an exception applies. One key exception is that the plan asset rules do not apply if "equity participation" in the entity by Benefit Plan Investors is not "significant" — i.e., Benefit Plan Investors hold less than 25% of each class of equity interests in the entity (disregarding equity interests held by the manager of the entity and its affiliates).
The critical analysis here is straightforward: the retained interest and overcollateralization ($15,000,000) constitutes the only equity of QRF 2022-1, and this equity will be retained entirely by QIH (through the SPV chain: QIH → QPF → QRH → QRF 2022-1). No Benefit Plan Investor will hold any equity interest in QRF 2022-1. Accordingly, the 25% threshold will not be exceeded, and the plan asset regulations should not cause the receivables held by QRF 2022-1 to be treated as plan assets of any Benefit Plan Investor that acquires Notes.
I recommend adding a clarifying disclosure to the OM: the Notes are debt instruments and do not constitute "equity interests" for purposes of the plan asset regulations. However, if the Notes were recharacterized as equity interests (which, as discussed in Section IV above, we do not expect), the plan asset regulations could apply, and the assets of QRF 2022-1 could be treated as plan assets of Benefit Plan Investors that hold Notes. The OM currently includes this cautionary language, and I recommend that it be retained.
B. Prohibited Transaction Exemptions
The OM references the following prohibited transaction class exemptions ("PTCEs") and the statutory exemption that may be available to Benefit Plan Investors acquiring the Notes:
• PTCE 84-14 (relating to transactions determined or effected by a "qualified professional asset manager," or "QPAM");
• PTCE 90-1 (relating to investments by insurance company pooled separate accounts);
• PTCE 91-38 (relating to investments by bank collective investment funds);
• PTCE 95-60 (relating to transactions involving insurance company general accounts); and
• PTCE 96-23 (relating to transactions determined by an "in-house asset manager," or "INHAM").
The OM also references the statutory exemption under ERISA § 408(b)(17) (and the parallel exemption under IRC § 4975(d)(20)) for transactions between a plan and a person that is a "service provider" to the plan (or an affiliate thereof), provided that the plan pays no more than adequate consideration and the service provider is not a fiduciary (or an affiliate of a fiduciary) who exercises authority or control over the assets involved in the transaction.
I have reviewed the descriptions of these exemptions in the OM and confirm that they are correctly described. No recommended changes to the substance of these descriptions.
I do recommend, however, adding a statement that each plan fiduciary acquiring Notes must independently determine that the acquisition and holding of the Notes is (i) consistent with the plan's governing documents and investment policies, (ii) prudent and in the best interest of the plan's participants and beneficiaries in accordance with the fiduciary duty standards of ERISA § 404, and (iii) in compliance with the terms and conditions of the applicable prohibited transaction exemption. This statement is standard in ERISA disclosure sections for asset-backed securities offerings and serves to remind fiduciaries of their independent obligations.
C. IRC § 4975 (IRA Holders)
The OM includes appropriate disclosure that IRAs and other plans described in IRC § 4975(e)(1) are subject to the prohibited transaction rules of IRC § 4975. The OM notes that IRA holders do not have the benefit of the ERISA fiduciary duty standards (because ERISA Title I does not apply to IRAs), but are subject to the excise taxes imposed by IRC § 4975 if a prohibited transaction occurs. The OM recommends that IRA holders consult their own tax advisors and legal counsel before acquiring Notes.
I confirm that this disclosure is adequate. No recommended changes.
X. Tax Shelter / Reportable Transaction Disclosure
The OM includes a brief disclosure regarding the reportable transaction rules under Treasury Regulation § 1.6011-4. This regulation requires taxpayers to disclose their participation in "reportable transactions" on IRS Form 8886, and requires "material advisors" to disclose their involvement in such transactions on IRS Form 8918.
I recommend confirming in the OM that the transaction is not expected to constitute a "listed transaction" within the meaning of Treasury Regulation § 1.6011-4(b)(2) or a "reportable transaction" within the meaning of Treasury Regulation § 1.6011-4(b)(1). The securitization of insurance premium finance receivables through a bankruptcy-remote SPV is a well-established financing technique and does not appear on the IRS's list of "listed transactions" published in Notice 2009-59, as updated.
However, I recommend adding cautionary language to the OM noting that certain aspects of the transaction — for example, the use of a chain of disregarded entities, or the potential for losses arising from the disposition of Notes at a price below the holder's adjusted tax basis — could theoretically trigger reportable transaction disclosure obligations under the "significant book-tax difference," "loss," or "transaction of interest" categories for some investors, depending on their individual circumstances. The OM should state that investors are encouraged to consult their own tax advisors regarding any reportable transaction disclosure obligations that may arise from the acquisition, holding, or disposition of the Notes.
XI. Conforming and Cross-Reference Issues
In the course of my review, I identified several conforming edits and cross-reference issues that should be addressed before the OM is finalized:
Section References to Transaction Documents. The OM tax section contains several references to specific sections of the Indenture, the Servicing Agreement, and the Note Purchase Agreement. These section references should be verified against the near-final execution drafts of these documents — specifically, the v4 Indenture, v3 Servicing Agreement, and v3 Note Purchase Agreement, all dated October 12, 2022. Because the transaction documents have undergone multiple rounds of revision, it is possible that section numbers have shifted since the earlier drafts that were used as the basis for the OM tax section. I recommend that Y. Nakamura or C. Espinoza prepare a cross-reference table confirming the accuracy of each section citation.
Tax-Related Risk Factors. The risk factors section of the OM includes several tax-related risk factors, including risk factors addressing recharacterization risk (debt vs. equity), FATCA risk, and state tax risk. These risk factors should be cross-checked for consistency with the disclosures in the tax section. In particular, the risk factor addressing recharacterization risk should be reviewed to ensure that it is consistent with the expanded hypothetical discussion recommended in Section III.C of this memorandum.
"Servicer" Terminology. I noted that the OM tax section uses the term "Servicer" inconsistently. In certain places, the tax section refers to the servicer as "Quorum Premium Finance LLC" (which is correct — QPF is the servicer under the Servicing Agreement). In other places, the tax section refers to the servicer as "Quorum" or "QIH." This is incorrect: QIH is the sponsor and administrator, not the servicer. The term "Servicer" should consistently refer to Quorum Premium Finance LLC (QPF) throughout the tax section. I recommend a global search-and-replace to correct this inconsistency.
Payment Waterfall Description. The OM tax section includes a description of the payment waterfall for purposes of analyzing the OID rules and the contingent payment debt instrument rules. This description should be confirmed for consistency with the sequential waterfall as set forth in the Indenture. Based on my review of the v4 Indenture, the sequential waterfall is as follows:
1. Indenture Trustee fees and expenses
2. Servicing fee (to QPF, as servicer)
3. Class A Note interest
4. Class B Note interest
5. Class C Note interest
6. Class A Note principal
7. Class B Note principal
8. Class C Note principal
9. Overcollateralization replenishment (to restore OC to the target level)
10. Residual distributions (to the retained interest holder)
The OM tax section should accurately reflect this priority of payments. I recommend verifying that the description in the OM tax section matches this waterfall, including the placement of the OC replenishment step (which occurs after all principal payments but before residual distributions).
XII. Contingent Payment Debt Instrument (CPDI) Rules
The OM includes a brief discussion of whether the Notes could be subject to the contingent payment debt instrument ("CPDI") rules under Treasury Regulation §§ 1.1275-4. These rules apply to debt instruments that provide for one or more contingent payments, and they require the holder to accrue interest income at a "comparable yield" (rather than at the stated coupon rate) and to treat all gain on sale or disposition as ordinary income (rather than capital gain).
I have reviewed the OM's analysis of the CPDI rules and confirm that it correctly concludes that the Notes should not be treated as CPDIs, based on the following factors:
• Qualified Floating Rate. The Notes bear a floating rate of interest based on SOFR plus a fixed spread. This rate qualifies as a "qualified floating rate" within the meaning of Treasury Regulation § 1.1275-5(b), which provides that a variable rate is a qualified floating rate if variations in the rate can reasonably be expected to measure contemporaneous variations in the cost of newly borrowed funds in the currency in which the debt instrument is denominated. SOFR (Secured Overnight Financing Rate) is a widely recognized benchmark rate that satisfies this standard. Because the Notes bear a qualified floating rate, the interest payments on the Notes are not "contingent" for purposes of the CPDI rules.
• Principal Payments — Sequential Waterfall. Principal payments on the Notes are determined by the collections on the receivables pool and are paid in accordance with the sequential waterfall described in the Indenture. While the timing of principal payments may vary depending on collections experience, the amount of principal is fixed (i.e., each class of Notes has a stated principal amount that must be repaid in full). The variability in timing does not make the payments "contingent" within the meaning of the CPDI regulations, because the obligation to pay the stated principal amount is unconditional.
• Early Amortization Triggers. The Indenture includes early amortization triggers that could accelerate the payment of principal on the Notes if certain adverse performance metrics are breached. These triggers include a net loss rate exceeding 2.00%, a delinquency rate exceeding 3.50%, and a pool balance declining below $450,000,000. The existence of these triggers could accelerate the return of principal but does not make the amount of principal contingent. The stated principal amount remains unchanged regardless of whether an early amortization event occurs.
I recommend adding a caveat to the OM noting that if the IRS were to successfully assert that the Notes are CPDIs, the tax consequences to holders would differ materially from those described in the OM. Specifically, holders would be required to accrue interest income at a "comparable yield" determined at the time of issuance (which could be higher or lower than the actual payments received in any given period), and all gain recognized on the sale, exchange, or retirement of the Notes would be treated as ordinary income rather than capital gain. This caveat is appropriate because, although we believe the CPDI rules do not apply, the IRS's position on the application of the CPDI rules to asset-backed securities with variable payment structures has not been fully developed, and investors should be aware of the potential consequences of a contrary determination.
XIII. Information Reporting
The OM should confirm that Calvoneth Trust Company, N.A., in its capacity as paying agent under the Indenture, will be responsible for filing all applicable information returns with respect to payments on the Notes. Specifically, Calvoneth Trust (or its designee) will be responsible for filing:
• IRS Form 1099-INT with respect to interest payments made to U.S. holders;
• IRS Form 1099-OID with respect to any original issue discount required to be reported to U.S. holders;
• IRS Form 1042-S with respect to payments made to non-U.S. holders that are subject to withholding (or with respect to which withholding is waived or reduced under an applicable treaty or exemption); and
• Any other information returns required by applicable law or regulations.
I recommend adding a brief statement to the OM advising holders that they should expect to receive tax information reporting from Calvoneth Trust Company, N.A., or its designee, and that they should retain such information for use in preparing their federal, state, and local income tax returns.
XIV. Summary of Recommended Revisions
The following is a numbered summary of all recommended revisions to the OM tax section, organized by the OM subsection to which each revision pertains:
1. Classification of the Issuer — Form 8832 Disclosure. Add disclosure confirming that QRF 2022-1 (EIN: 88-1247653) and QRH (EIN: 88-1247619) have not filed, and will not file, IRS Form 8832 electing corporate classification.
2. Classification of the Issuer — TMP Inapplicability. Add a clarifying statement that the taxable mortgage pool rules under IRC § 7701(i) do not apply because the receivables are insurance premium finance loans, not real estate mortgages.
3. Classification of the Issuer — Partnership Recharacterization Risk. Expand the "if the Notes were treated as equity" hypothetical to specify the potential consequences, including pass-through treatment, UBTI issues for tax-exempt holders, and ECI issues for non-U.S. holders.
4. Characterization as Debt — Supporting Factors. Add explicit reference to the key factors supporting debt treatment: unconditional obligation to pay principal and interest, fixed legal final maturity (42 months), sequential waterfall priority, absence of management or voting rights, and overcollateralization / subordination equity cushion ($15,000,000 / 3.0%).
5. Characterization as Debt — Reporting. Add a note confirming that the parties intend to report interest on the Notes as indebtedness on applicable tax returns, and that investors will receive IRS Form 1099-INT (or Form 1042-S for non-U.S. holders).
6. OID — Revolving / Amortization Structure. Add a note addressing the interaction of the OID rules with the revolving period (24 months) and amortization period (12 months), and the potential impact on the weighted average life and OID accrual schedule.
7. Non-U.S. Holders — 10% Shareholder Test. Add a clarifying note that the 10% shareholder test for the portfolio interest exemption is applied at the level of QPF / QIH (a publicly traded company, NYSE: QIHC), and that the likelihood of a noteholder being a 10% shareholder of QIH is remote.
8. FATCA — Gross Proceeds Withholding. Update the FATCA subsection to reflect the IRS proposed regulations (REG-132881-17) eliminating FATCA withholding on gross proceeds, and confirm that taxpayers may rely on the proposed regulations pending finalization.
9. FATCA — Paying Agent. Reference Calvoneth Trust Company, N.A., as the party responsible for FATCA withholding compliance on payments made to holders.
10. State and Local Tax. Expand the state and local tax subsection to note (a) Delaware organization and $300 annual LLC tax, (b) nexus avoidance structure, (c) no state withholding tax in the three largest origination states (Texas, California, Florida — 35.6% of pool), and (d) expanded warning regarding economic nexus and pass-through entity income tax obligations.
11. ERISA — Equity Retention. Clarify the plan asset regulation analysis to confirm that the retained interest / OC ($15,000,000) is held entirely by QIH through the SPV chain, and that no Benefit Plan Investor will hold equity.
12. ERISA — Fiduciary Duty Statement. Add a statement that each plan fiduciary must independently determine that the acquisition and holding of the Notes is consistent with the plan's governing documents, ERISA fiduciary duties, and the terms of the applicable prohibited transaction exemption.
13. Reportable Transaction. Add cautionary language that certain aspects of the transaction could theoretically trigger reportable transaction disclosure obligations for some investors.
14. Cross-References — Transaction Documents. Verify all internal section references to the Indenture (v4), Servicing Agreement (v3), and Note Purchase Agreement (v3), all dated October 12, 2022.
15. Servicer Terminology. Confirm that the term "Servicer" consistently refers to Quorum Premium Finance LLC (QPF) throughout the OM tax section, and correct any references to "Quorum" or "QIH" as servicer.
16. Payment Waterfall Consistency. Confirm that the description of the payment waterfall in the OM tax section is consistent with the sequential waterfall described in the Indenture (Trustee fees → Servicing fee → Class A interest → Class B interest → Class C interest → Class A principal → Class B principal → Class C principal → OC replenishment → Residual).
17. CPDI Caveat. Add a caveat noting that if the Notes were treated as contingent payment debt instruments, the tax consequences would differ materially, including accrual at a comparable yield and ordinary income treatment on all gain.
18. Information Reporting — Paying Agent. Add a statement confirming that Calvoneth Trust Company, N.A., as paying agent, will be responsible for filing applicable information returns (Forms 1099-INT, 1099-OID, 1042-S) and that holders should expect to receive tax information reporting.
XV. Open Items and Next Steps
The following open items remain and should be addressed before the OM tax section is finalized:
Draft Opinion on Tax Characterization. The Draft Opinion on Tax Characterization dated October 10, 2022 has not been finalized. The OM tax section should be updated to conform to the final opinion once delivered, assuming the transaction proceeds to closing. I do not anticipate any material changes to the conclusions set forth in the draft opinion, but any changes in analysis, caveats, or qualifications should be reflected in the OM tax section.
Pricing Supplement / Final OM. I recommend that the OM tax section be reviewed again in connection with any pricing supplement or final OM prepared in connection with the closing, with particular attention to the following:
• Actual Issuance Prices. The OID analysis in the OM is necessarily conditional because actual issuance prices will not be known until the Notes are priced. If any class of Notes is priced at a discount from par that exceeds the de minimis threshold, the OM should be updated to include a more definitive statement regarding OID treatment, and the OID accrual schedule should be provided to investors.
• SOFR-Based Coupon Rates. If the final coupon rates differ materially from the guidance levels referenced in the current OM (Class A: SOFR + 125 bps; Class B: SOFR + 210 bps; Class C: SOFR + 375 bps), the OM should be reviewed to confirm that the tax analysis remains valid at the final spread levels. I do not anticipate that changes to the spread would affect the debt/equity analysis or the CPDI analysis, but this should be confirmed.
• Legislative and Regulatory Developments. The OM should be reviewed for any legislative or regulatory developments that occur between the date of the preliminary OM and the closing date. Areas of particular focus include any changes to the FATCA gross proceeds regulations, any changes to the reportable transaction rules, and any relevant guidance from the IRS regarding the tax treatment of asset-backed securities.
Supporting Memoranda. The Tax Structuring Memorandum dated August 12, 2022, the FATCA Compliance Memorandum dated August 18, 2022, and the State Tax Nexus Analysis dated September 1, 2022 remain the primary analytical support for the conclusions reflected in the OM tax section. I have reviewed each of these memoranda in connection with this review and confirm that no material changes to the conclusions set forth in those memoranda have occurred since their issuance. I do not recommend updating any of these memoranda at this time, although they should be reviewed again if the transaction is delayed or if material changes to the pool composition or transaction structure occur before closing.
Availability. I am available for questions from the deal team, from Ridgeline Capital Markets (the lead underwriter), or from Calloway & Brandt LLP (underwriter's counsel, lead partner Harrison Collier) regarding any aspect of the tax disclosure in the OM. Please direct any inquiries regarding the tax section to me in the first instance.
Sylvia Hartwell Partner (Tax) Calderwood & Harkness LLP 601 Lexington Avenue New York, NY 10022 Telephone: (212) 555-4800
Email: shartwell@calderwoodharkness.com
cc:
Carlos Espinoza, Working Associate, Calderwood & Harkness LLP
Nolan Whitford, General Counsel, Quorum Insurance Holdings Corp.