Use of corporate funds in projects of real estate construction
Part 3: targeted bonds
The targeted bonds were widely used as a mechanism to attract the money into construction. The mechanism is a legal model to finance the construction and contains the real tax preferences for developer.
The model of investment into construction using targeted bonds and the collective investment institution (hereinafter referred to as CII) is more complex and expensive for developer that the models that we discussed in the first two parts: “CII in projects of real estate construction – forward contracts” & “Use of Collective Investment Institutions (CII) in projects for real estate construction”. However, the model is actively used, although as a rule by large developers.
The preliminary stage at launch of the model with targeted bonds is important as in any other model. Originally, a developer issues the targeted bonds. In parallel, a venture corporate investment fund (hereinafter referred to as CIF) or a venture share investment fund (hereinafter referred to as SIF) is established, where an investor-founder may be a developer itself or investors (buyers of securities) of CIF or SIF may be the persons, not affiliated with a developer.
All parameters of such investment project shall be thoroughly planned and it is recommended that a specialized company would be engaged into preliminary actions. The succession of actions is shown on Picture:
Thus, CII’s participants buy the fund’s securities (step #1) – SIF’s investment certificates or CIF’s shares, depending on the kind of fund that is used in the model. Placing securities, CII will attract money (M1), which then is invested into the targeted bonds (step #2). The bonds become CII’s asset. The important nuance is that AMC purchases these bonds at developer due to nominal price.
The transaction in sale of targeted bonds is not levied with income tax and VAT that is an important element of tax planning.
Targeted bonds – the bonds, the fulfillment of obligations under which is held with goods or services. Such goods for targeted bonds, which are used to finance the construction, are square meters of living area. The money, attracted from emission of targeted bonds, is used for the purposes, defined in issue prospectus. An owner of bond in fact grants a loan to emitter for construction of apartment, instead, it receives the right to purchase it pursuant to certain conditions. The total sum of bonds issue cannot exceed the cost of construction project.
With next step (#3.1) CII sells the targeted bonds to end buyers of real estate but already due to market price (M2). The income (difference between M2 and M1) will be accumulated at CII. At the same time with the purchase of targeted bonds, a natural person – end buyer concludes a contract for reservation of apartment with developer (step #3.2). This contract specifies the precise specification of apartment, which will be transferred to the end consumer.
After a building is put into operation, the final stage takes place – final settlements and transfer of property rights. Accordingly:
- the owners of apartments submit the targeted bonds to the developer, after that the exchange of bonds for square meters of built housing takes place according to contract for reservation of apartment (step #4);
- the developer submits CII’s securities for repurchase: the fund repays the invested money, which were deposited by founders (step #5);
- the income (M3), formed at CII, is reinvested or paid out to CII’s participants in the form of dividends.
The model to finance the construction using the targeted bonds is attractive by the fact that it contains the legal mechanism to optimize the taxation for developer.
The transactions in issue of targeted bonds and sale to their owners are not an object of VAT taxation. The use of CII in this model allows reducing the tax consequences from income tax.
Thus, the company releases the significant current assets, becomes an incentive for active own development and implementation of new projects.