UK Banking & Capital Markets Budget Alert

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1 Summer Budget 2015 UK Banking & Capital Markets Budget Alert Headlines The UK Budget announcements herald a major shift in banking tax policy, with the UK Government attempting to respond to industry concerns around the increasing impact of the bank levy on decisions regarding holding company and business location, whilst maintaining the elevated levels of taxation for the sector. The full bank levy rate will be gradually reduced over next six years, from the current 0.21% to 0.1% by From 1 January 2021, UK banks non-uk balance sheets will be excluded from the bank levy. However, an 8% supplementary tax surcharge on bank profits will be introduced from 1 January The tax will apply to banks corporation tax profit before the use of any existing carried-forward losses and group relief from non-banking companies. The tax will not apply to the first 25mn of profit within a group. More widely, another key announcement today which had not been predicted was the reduction in the corporate tax rate to 19% in 2017, and then to 18% in Further details and announcements are set out below.

2 Bank levy and bank corporation tax surcharge The Government has listened to two distinct lobbying voices in relation to the bank levy, from UK parented global banks concerned about the imposition of the levy on their global balance sheets; and from overseas parented banks with global businesses for which the levy, at current rates, represents a disincentive to maintain or grow business in the UK. The Government s response is an announcement of a gradual reduction of the levy rate from the current 0.21% to 0.18% in 2016, 0.17% in 2017, 0.16% in 2018, 0.15% in 2019, 0.14% in 2020 and 0.10% in 2021, coupled with an announcement that in 2021 the taxable base will be redefined to exclude non-uk balance sheets. However, this goes hand-in-hand with the announcement of a new bank corporation tax surcharge of 8% with effect from 1 January The combined effect is a forecast significant increase in the taxation of the sector over the period (by as much as 555mn in ), although most of that is due to the mismatch in timing between the dawn of the surcharge and the sunset of the bank levy rates. According to HM Treasury (Treasury) figures, the cuts in bank levy are intended to outweigh the corporation tax surcharge in the long term. However, this depends on the validity of the assumptions used, particularly in respect of predicting the banks profitability. In our experience, the levy rate rises in recent years have caused banks to give additional focus to making more efficient use of reliefs available under the legislation, and the Treasury costings include recognition of this trend in its assumptions. The bank corporation tax surcharge has a 25mn annual allowance to exclude many smaller banks and building societies. For those that are in scope, it is important to note that the surcharge will be charged separately from corporation tax, and the taxable profits for the purposes of the surcharge will not be capable of being reduced by pre-january 2016 losses or group-relief from non-banking companies. So for a bank with profits in 2016 (before the corporation tax begins its decline to 18%), the overall tax rate on profits will be 28%, and even if that bank has brought forward losses, the cash tax rate will still be 18% (on profits over the allowance) following the loss restrictions in Finance Act As ever with changes to bank levy policy, there will be winners and losers, although more losers especially in the short term until the 2021 change in the bank levy taxable base to UK balance sheets. In particular, the burden of elevated bank taxation will now fall more on profits rather than balance sheets, and the changes will draw in a group of banks which make significant profit in the UK but have balance sheets below the bank levy threshold. It remains to be seen whether the announcement of a reduction of the bank levy taxable base to UK balance sheets in 2021, a date notably after the next general election, will be sufficient to appease UK parented global banks who were starting to question the sustainability of the UK as a holding location. For overseas banks deciding where to locate and grow their global business, whilst some of the distortions caused by the bank levy are mitigated, they may consider that the overall package in the Budget does little to improve UK competitiveness. Above all, the sector yearns for an end to continual politically-motivated changes of bank tax policy, and will hope that these changes signal a settled and stable government policy going forward. Tackling offshore tax evasion: requiring financial intermediaries and tax advisers to notify their customers The Budget announces the introduction of legislation to give the Government the power to require financial intermediaries, tax advisers and other professionals to contact customers informing them about measures being taken to combat offshore tax evasion. These measures include: new reporting obligations under the Common Reporting Standard (CRS), a new time limited disclosure facility to be launched in 2016 to allow taxpayers to make disclosures in advance of CRS reporting, and a range of penalties for offshore evasion and a new UK Banking & Capital Markets Budget Alert 2

3 criminal offence for failing to declare offshore income and gains. The Budget commits the Government to consulting with financial institutions to establish a costeffective and targeted approach to communications. The wording suggested indicates that this will be a permanent power which could be reused by HMRC in the future. Whilst banks will have updated their terms and conditions to reflect the fact that they will be required to report certain information to HMRC, this measure requires them to undertake broader communication to customers. The commitment to consultation to establish a practical approach to these communications is welcome. Greater taxpayer awareness of information sharing, the offshore penalty regime and associated civil and criminal offences should change behaviours and ultimately reduce customer tax risk faced by banks. Bank compensation payments With effect from today, certain compensation payments incurred by banking groups and building societies will be treated as non-deductible for corporation tax purposes. This follows an announcement in the March 2015 Budget and a consultation process which closed on 29 May Two of the critical issues debated during the course of the consultation were the definition of expenditure to be disallowed and whether associated costs would also be in scope of the disallowance. The announcement today refers to compensation payments made to customers in relation to a relevant issue which is expected to be defined by reference to the relevant regulatory standards (DISP from the FCA Disputes Handbook). There will be an exclusion from this for payments relating to administrative issues (essentially intended to capture payments not arising from misconduct). A clear message from industry during the consultation process was that the workability of these new rules is critical. It will be important to analyse the legislation and guidance when published to determine how closely the tax rules follow the regulatory standards and, therefore, how much existing complaints handling systems can be leveraged both to capture the appropriate compensation payments and also to identify any excluded amounts. In respect of costs associated with redress programs, it appears that due to concerns around the different approaches to the classification of expenses, the disallowance of associated costs will be calculated by reference to a percentage uplift to the total non-deductible compensation payments. These new rules have effect from today and provisions covering this period will need to be apportioned on a just and reasonable basis. This will require an analysis of the elements that make up an accounting provision for customer compensation. Interestingly, HMRC expects this measure to raise nearly 1bn over the next five years which suggests they expect banks and building societies will continue to face conduct issues for the foreseeable future. Restriction on using losses against controlled foreign company (CFC) charges Groups will no longer be able to use their UK losses or group relief to offset set a CFC charge. Broadly, a CFC charge arises in the UK where profits are diverted from the UK to a CFC in a low tax jurisdiction. Where they apply, the rules impute a charge to UK corporation tax on the CFC profits to any UK company that holds a relevant interest in the CFC. From 8 July 2015, the CFC charge cannot be relieved by losses of the UK company to which the charge is imputed, whether the losses are brought forward or from the current year, or by losses surrendered as group relief from elsewhere in the group. For CFCs with an accounting period that straddles 8 July 2015, the rules will apply to CFC profits treated as accruing from that date on a just and reasonable apportionment basis. In addition, the rules introduced in Finance Act 2015 which restricted losses in cases involving tax avoidance will be amended to make it clear that they also apply to transactions involving CFCs. UK Banking & Capital Markets Budget Alert 3

4 Loan relationship and derivative contract reform The Government has confirmed that it will include in the summer Finance Bill changes to the loan relationships and derivative contract rules which follow on from the consultation launched by HMRC in the summer of The key purpose of the changes is to align the tax treatment of corporate debt and derivatives more closely to the amounts going through companies' profit and loss accounts. Unlike the current rules, amounts will only be taxed when they are recognised in profit and loss account, and not when they are recognised in other financial statements (such as the statements of other comprehensive income or changes in equity). Also, the override of the accounting treatment where it does not fairly represent profits and losses will be removed. The majority of changes will have effect from accounting periods commencing on or after 1 January However, there are two exceptions to this commencement date: Firstly, new 'principles-based' targeted antiavoidance rules, seeking to counter arrangements that are entered into with a main purpose of achieving a tax advantage under the loan relationship or derivative contract rules, will be introduced for arrangements entered into on or after the date that the summer Finance Bill receives Royal Assent. The introduction of this rule, called the Regime TAAR, will enable the repeal of some of the existing detailed anti-avoidance rules on loan relationships and derivative contracts from the same date. However, the current rules disallowing deductions in relation to an 'unallowable purpose' will remain. Secondly, new rules enhancing the tax reliefs available on the restructuring of debts of a company which is in financial distress are also to be introduced from the date that the summer Finance Bill receives Royal Assent. Change to definition of banking company The definition of banking company used in bank levy and bank loss restriction legislation is to be updated to be aligned with those now used by the Prudential Regulatory Authority and the Financial Conduct Authority. This change will apply from 1 January 2014 in respect of Schedule 19 Finance Act 2011 (the bank levy legislation) and from 1 April 2015 in respect of Part 7A of the Corporation Tax Act 2010 (the bank loss restriction legislation). Until now the definition of banking company used in the bank levy and bank loss restriction legislation referenced to the old definitions from the Prudential Sourcebook for Banks, Building Societies and Investment Firms (BIPRU) which was replaced by the EU Capital Requirement Regulations (CRR) on 1 January This is a technical change to the wording of the legislation and we understand there is no intended change to the policy, with the relevant legislation intended to apply to the same population and continue to operate in the same manner. It is expected that the new bank corporation tax surcharge is likely to use the same definition. Direct recovery of debts It was confirmed that legislation will be introduced in summer Finance Bill 2015 to provide HMRC with new powers to recover tax and tax credit debts directly from bank and building society accounts (including Individual savings accounts) of debtors. This follows on from the draft legislation published on 10 December 2014, which included strengthened safeguards relating to the use of the direct recovery of debts power, in response to concerns raised in response to the original proposals. The implementation of these rules is likely to present significant operational challenges for banks, which do not appear to have been factored into HMRC s impact assessment. UK Banking & Capital Markets Budget Alert 4

5 EY Assurance Tax Transactions Advisory Further information For further information, please contact one of the following or your usual EY contact: Anna Anthony Andrew Bailey Richard Clough Dan Cooper Oliver Davidson George Hardy Neil Harrison Stephanie Lamb Andy Martyn Richard Milnes Kevin Paterson About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization and may refer to one or more of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com. Ernst & Young LLP The UK firm Ernst & Young LLP is a limited liability partnership registered in England and Wales with registered number OC and is a member firm of Ernst & Young Global Limited. Ernst & Young LLP, 1 More London Place, London, SE1 2AF Ernst & Young LLP. Published in the UK. All Rights Reserved. ED None In line with EY s commitment to minimise its impact on the environment, this document has been printed on paper with a high recycled content. Information in this publication is intended to provide only a general outline of the subjects covered. It should neither be regarded as comprehensive nor sufficient for making decisions, nor should it be used in place of professional advice. Ernst & Young LLP accepts no responsibility for any loss arising from any action taken or not taken by anyone using this material. ey.com/uk Mark Persoff MPersoff@uk.ey.com Julian Skingley JSkingley@uk.ey.com UK Banking & Capital Markets Budget Alert 5