Introduction to the UK Bank Levy

November 2010

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Introduction

The UK Government announced in June 2010 that it would introduce a Bank Levy on a unilateral basis. A consultation document was published in July 2010, and draft legislation was published on 21 October 2010. The levy will be payable from January 2011.

One aim of the levy is to incentivise a reduction in the use of wholesale finance by banks, with a view to reducing the risk of another financial crisis being triggered by liquidity issues.

This note summarises the current proposals in general terms and indicates some of the issues which arise.

This note is general only and specific advice will need to be sought in relation to the impact of the levy on a particular bank group.

Which banks must pay the levy?

A banking group headed by a UK company will be liable on a global basis. UK subsidiaries and branches of non-UK banks will also be subject to the levy by reference to their UK activities. In addition, corporate groups which include a bank will liable by reference to the balance sheet of the bank entity.

Liability for the levy only arises where the tax base as measured under the regime is £20 billion or more.

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What is the tax base?

The tax base is based on total liabilities and equity as shown in the relevant balance sheet excluding:

  • tier 1 capital
  • insured retail deposits
  • certain policyholder liabilities for Bank assurance entities
  • certain revaluation reserves
  • tax liabilities (including deferred tax liabilities)
  • liabilities under certain retirement benefit schemes
  • liabilities to pay compensation under financial services compensation schemes
  • client money
  • liabilities relating to currency note issuance
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How is the tax base ascertained?

For UK headquartered bank groups, the consolidated holding company balance sheet will be used. Group is defined by reference to accounting, not tax, tests and IFRS will normally be used for this purpose, but a non-UK group which can and does account under US GAAP can use that as an alternative, at least for determining which entities form part of its group. However, it is unclear under the current drafting whether the use of US GAAP also extends to determining the tax base; whilst it would seem from some of the drafting that this might be intended to be the case, at present it is not clear that this is actually achieved. A bank group is defined in a similar way to that used for the payroll tax. For UK banks which are part of a corporate or non-banking group, the balance sheet of the bank entity will be used.

Where the entity being taxed is a UK branch of a non-UK bank or group, the levy will be applied by reference to a notional balance sheet derived using broadly the same methodology as applies for determining permitted interest deductions for corporation tax purposes (known as the capital attribution tax adjustment or CATA). This is based on allocating assets to the UK branch based on Key Entrepreneurial Risk Taking principles and then determining the proportion which the branch assets bear to the overall group assets. (Certain assets which the branch has which represent borrowings raised by the branch as agent or intermediary for another group company may be ignored for this purpose).This proportion is then used to allocate what part of the group’s overall equity and liabilities are to be attributed to the UK branch. These are then allocated into long and short term categories based on the proportion which the non-UK bank group’s long and short term liabilities bear to each other.

Where a non-resident group has both UK subsidiaries and a UK branch the calculation is more complex, and careful review of the current draft legislation will be necessary to ensure that there is no double counting of liabilities where, as will normally be the case, the non-resident group funds the subsidiaries by way of intra company loan.

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What rate is the levy charged at?

The rate as originally announced is 0.07 per cent from 2012, with a reduced rate of 0.04 per cent applying in 2011. Liabilities having a maturity exceeding one year will be charged at only half these rates. However, it is possible the rates will be revised in order to ensure that only the target amount of tax is raised by the levy.

The levy will only apply to equity and liabilities in excess of £20 billion; this is a welcome change from the original proposal under which the £20 billion was a threshold, not an allowance. The £20 billion allowance is apportioned between long and short term liabilities pro rata for the purposes of determining the amount of the levy.

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Which liabilities will be treated as having a maturity of more than one year?

All equity will be treated as long term. In determining whether other liabilities are for more or less than one year, the basic test will be that a liability will only be regarded as long term (over 12 months) if it is not required and cannot be required to be repaid or otherwise met during the 12 month period starting from the balance sheet date. The legislation does not indicate whether this will exclude repayment falling due as a result of a default.

Deposits made otherwise than by financial entities will be regarded as long term.

Intra-group liabilities will only be regarded as being long term if an officer of HMRC is satisfied that the liabilities are funded by equity, excluded liabilities to non group entities or liabilities which themselves meet the long term test. It is likely that this limb of the test will give rise to some concerns, as it is not thought correct that HMRC should be the sole arbiter of the position.

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What constitutes insured retail deposits?

This covers the insured element of deposits covered by a statutory or State run guarantee or insurance scheme. For example, in the UK the first £50,000 of a deposit with a banking group is protected by the Government.

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Are there other items which can be disregarded in the calculation?

  • So-called “high quality liquid assets” can in certain cases be deducted in determining the tax base (although they must be deducted first from long term equity and liabilities before reducing short term liabilities), provided they are not held specifically to cover any item which has already been excluded in determining the tax base. “High quality liquid assets” are assets within section BIF RU 12.7.2(1)-(4) of the FSA Handbook – ie, broadly, high quality debt securities issued by a government or central bank; securities issued by a designated multilateral development bank; certain central bank deposits and in some cases investments in a designated money market fund.
  • Where certain tests are met, netting can be applied to determine the liabilities owed to a particular counterparty for the purposes of the tax base. For this to apply, the counterparty must not be a member of the same group, the bank entity must have assets which correspond to the liabilities to the counterparty and there must be an agreement which applies for a single net settlement of the liabilities and assets between the two parties in the case of termination or default. Banks will need to review their relevant documentation to see if the test is satisfied.
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How is the levy payable?

The levy will be payable on quarterly basis along with the corporation tax liability. Returns setting out how the bank has calculated the tax base will be required along with the main corporation tax return. Details of which entity in the group will be the person liable to account are not yet included in the draft legislation; the original proposal was that it should be the top company in the group, but this may give rise to issues in relation to the need to ensure that the levy is borne within the group by the relevant entity (in order to avoid the need for intra-group recharges) and also in relation to whether it is possible to pass the cost to the bank’s customers.

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Is the levy tax-deductible?

The levy (or any intra-group recharge of it) will not be deductible in determining corporation tax in the UK.

It is not yet clear whether other jurisdictions will treat the levy (or intra-group charges which pass on the cost of the levy) as a creditable tax in computing the tax due in that jurisdiction – the HMRC view is that they will not be required to do so under the UK current tax treaties.

The draft legislation contains powers to enable secondary legislation to be introduced providing for double tax relief in relation to the levy, but it is not yet known the extent to which countries which do not intend to introduce a levy will wish to enter into treaty negotiations in relation to it.

It is also not yet clear how the levy will be treated for accounts purposes – will it be an above or below the line charge?

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Are there anti-avoidance rules?

Provisions will be included ensuring banks cannot minimise the levy by entering into arrangements which have the main purpose or a main purpose of reducing the levy. Where such arrangements are entered into they will be disregarded in computing the levy, except to the extent that an HMRC officer is satisfied that the arrangements reduce the reliance on funding from sources which are not excluded or short term, and increase reliance on funding which is excluded or long term. Again, whether it is appropriate for the HMRC to be the sole arbiter of this is questionable.

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Can the levy be recovered from customers under tax indemnity or increased costs clauses in current loan documents?

For current transactions, this will need to be considered on a case by case basis. For the future, it seems likely that affected lenders will seek to factor the levy into their margins, thereby diminishing their competitiveness.

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Are other EU jurisdictions considering additional bank taxes?

France and Germany have both said they will introduce a bank levy. Details of the French proposal have not yet been released. The German regime seems limited to German incorporated banks, and the tax base and the rate is different to the UK proposal.

In addition, the EU continues to consider the introduction of a financial transactions tax (FTT) and/or a financial activities tax (FAT). The second of these is levied on a bank’s profits plus some or all of its staff costs.

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