Autumn Statement 2014 Banking & Capital Markets Tax Alert The headline Autumn Statement news for banks, building societies and other regulated entities is the restriction on the use of brought forward losses accrued before 1 April 2015 to 50% of relevant profits. These significant and unexpected changes will ensure that many banks will have a cash corporation tax liability for the first time in a number of years and historic losses realised during the financial crisis, or as a consequence of regulatory fines or the payment of compensation to customers, may take longer to utilise than anticipated. To put the point in context, last year major banks paid 2.2bn in bank levy. The Chancellor hopes to raise some 4bn over 5 years from the measures on bank losses. Therefore, the revenue effect of the measure is the same as a 36% increase in bank levy. The effect on deferred tax asset recognition will also need to be investigated, particularly given the timing of the announcement so close to the end of the accounting period for impacted entities with a 31 December year-end. That in turn may lead to consequences for banks regulatory capital positions. In better news, no announcements were made in respect of the bank levy meaning that both the rate and structure of the levy remain unchanged for the time being. This will come as welcome relief after successive periods of rate increases and reform proposals. Restriction on carried forward loss relief Entities falling within the new restriction are companies authorised for the purpose of FISMA 200 and carrying on regulated activities in the UK. There are specific exclusions from the regime for insurance companies, pension scheme managers, investment trusts, asset managers, commodities traders and spread betting companies. The rules apply to brought-forward trading losses, non-trade loan relationship deficits and excess management expenses accrued as at 1April 2015 only. Other reliefs such
as capital losses or UK property losses are not within the scope of new rules, and new losses incurred from 1 April 2015 will not be impacted by the restriction. There is an interesting point of detail in the proposals. Currently, group relief can be claimed only after carried forward losses have been used. The draft legislation implementing the measure indicates that this restriction is dis-applied where the loss restriction is in point. Therefore, in a situation where carried forward losses are restricted, a group may be may be able to claim more group relief than is currently permitted. The different permutations between the offset of current year losses, restricted carried forward losses, claims such as capital allowances, and the interaction between in-scope and out-of scope companies within the same group will require careful consideration to ensure that group-wide positions are optimised. As is to be anticipated with all new legislation, targeted anti-avoidance rules (TAAR) are included. The first is an anti-forestalling provision designed to prevent in-scope companies from accelerating profit recognition or transferring in profits from other companies before 1 April 2015. The TAAR applies where the main purpose is to secure a tax advantage by using the brought forward losses before the new restrictions apply. The second TAAR applies where, as a result of arrangements entered into, (a) profits arise in a company within the loss-restriction rules and these profits result in an increased utilisation of brought forward losses; (b) there is a corporation tax advantage that involves the use of the broughtforward losses; and (c) that advantage is expected to represent more than half of the economic benefit to the company. In addition to the potentially significant cash tax implications of the new rules, impacted entities will need to carefully consider the deferred tax and regulatory capital implications that may arise as a result of the new restrictions, with this being a matter of urgency for those companies with a 31 December year-end. Hybrid mismatch arrangements The much anticipated consultation document addressing hybrid mismatches has been published as part of the Autumn Statement package. It appears that the Government is minded to adopt the recommendations that the OECD has made as part of the Base Erosion and Profit Shifting (BEPS) project. This is to be achieved by rewriting the existing anti-arbitrage rules in line with the OECD s recommendations having regard to any amendments to those recommendations and the other BEPS Action Plans. There is to be a consultation on the proposed changes that is set to run until 11 February 2015 with responses published in Summer 2015. Draft legislation is expected thereafter, with rules expected to be in force from 1 January 2017. Although the hybrid mismatch rules would not generally apply to externally issued hybrid regulatory capital, there is concern that the rules would negatively impact those groups where such instruments have been issued intra-group due to the regulatory need (or incentive) to issue all external regulatory capital at the top holding company level and downstream this to operating subsidiaries through comparable instruments. Banks will be pleased to see that the consultation document takes this concern into account. However, the proposed method of addressing it falls short of the complete exemption for regulatory capital for which some banks were arguing. Rather, two options have been proposed to deal with the issue. The first would be to allocate hybrid regulatory capital issued by the top holding company to operating subsidiaries based on their relative proportions of intra-group issued hybrid regulatory capital (being their own issued hybrid regulatory capital minus that held in their subsidiaries). Any excess of the UK subsidiary s intra-group issued regulatory capital over the allocated external issued hybrid regulatory capital would be subject to the hybrid mismatch rules. This would require a UK bank to access information from elsewhere in the group. Therefore, under the second option the externally issued hybrid regulatory capital could instead be allocated based on the UK subsidiary s proportion of risk-weighted assets. Comment is invited on these two options and specifically on the definition of hybrid regulatory capital. HMRC also recognises that these issues will be relevant to the insurance sector and states that any such special provisions will need to accommodate both sectors. 2
Other points to note are: HMRC has proposed not to extend the scope of the rules to payments that are deemed to be made for tax purposes (such as notional interest deductions). Issues such as stock lending and repo transactions are still subject to refinement by the OECD in September 2015. Certain entities such as unit trusts, openended investment companies, investment trusts and charities should be exempt from the rules (with appropriate anti-abuse clauses) Mismatches involving tax rate arbitrage are not within the scope of the provisions The dual resident investing company rules will be amended to deny deductions claimed by a dual resident company unless they are specifically the subject of an agreement between the competent authorities of both jurisdictions. If there is no treaty, this exception will not apply. A deduction would also be allowable if offset against income which is taxable in both jurisdictions of residence. These rules would apply regardless of whether a deduction is claimed in the other resident jurisdiction. Code of Practice on Taxation for banks The Autumn Statement did not contain any new announcements on the Code of Practice on Taxation for Banks (Code). However, it is worth noting that HMRC is conducting an informal consultation on proposed guidance in relation to the operation of the Code. The draft guidance includes statements of HMRC s views on how to ascertain the intentions of Parliament for the purposes of complying with those aspects of the Code that deal with banks own tax planning. Late-paid interest rules As had been rumoured, the Autumn Statement contained draft legislation repealing certain of the late-paid interest rules. This action is to prevent groups using the rules to time the intended realisation of interest deductions so maximise their ability to use their tax losses. Parallel rules which apply to deeply discounted securities have also been repealed. The repeals will apply to new loans entered into on or after 3 December 2014, and existing arrangements will be grandfathered until 1 January 2016 unless material changes are made to the terms or the creditor before this date. Care should therefore be taken to ensure that the implications of these rule changes are fully understood prior to any intra-group debt restructuring taking place before 31 December 2015. R&D tax credits The Chancellor has announced that the government will increase the rate of the above the line R&D tax credit from 10% to 11% from 1 April 2015. This should provide an additional incentive for banks to revisit whether all potential R&D expenditure is being captured in their claims. Bad Debt Relief In his speech, the Chancellor announced (alongside the new carried-forward losses rules) that there would be a form of restriction on bad debt relief for banks, which may include a delay in the timing of the provision of relief. At the time of going to press, no further detail is available. It may be that the point of this change is to restrict banks ability to deduct the higher provisions for bad debts that are expected with the introduction of IFRS9. Clearly banks and other lenders should monitor the position, and additional EY updates will be published in due course. Diverted Profits Tax It is proposed that a 25% rate of diverted profits tax will apply to profits of a multinational enterprise that have been diverted from the UK through artificial arrangements. They are expected to apply from April 2015. EY is not expecting further detail on the new tax to be published until 10 December. This is potentially a significant announcement. While it does not appear to be targeted at the banking industry, clearly the rules should be reviewed in detail in order to ensure that their impact is fully understood across all sectors. 3
Withholding tax exemption for private placements The government will provide for a new exemption from withholding tax on interest on qualifying private placements to help unlock new finance for businesses and infrastructure projects. Legislation is expected to be included in Finance Bill 2015. Direct Recovery of Debts The Autumn Statement did not add to the information contained in the consultation response document published by HMRC on 21 November. However, this remains a significant issue for banks to get to grips with. A significant number of safeguards were announced, and legislation is expected in Finance Bill 2015, but not until after the General Election. legislation will be repealed although the unallowable purposes rule will be retained. Changes are likely to the regime applicable to loan relationships held by connected companies. Those changes are highly technical but are broadly designed to align the tax measure of profit with the accounting measure in circumstances where the debt in question is hedged with a derivative. An update to the loan relationship rules effecting partnerships is likely to be discussed further in 2015, for inclusion in the Finance Bill 2016. The Government's announcement does not explicitly address the banking sector's concerns about associated costs for banks and building societies and other deposit holders. Instead the Government has only committed to work with the sector to minimise the administrative impact and make sure communications are clear that the debtor should contact HMRC not the bank. This means that banks will now need to begin to focus on how they might build the systems they need to implement the proposals. Loan relationships and derivative contracts The full detail of changes to the loan relationship and derivative contract regimes will not be known until draft legislation is available. However, the following changes are likely to feature: The new regime will compute taxable income by reference primarily to amounts recognised in the profit and loss account. Amounts recognised in other accounting statements would typically not become taxable unless and until recycled into the profit and loss account. A general anti-avoidance rule (in the form of a TAAR) is to be introduced to counteract tax advantages that would otherwise arise under the loan relationship or derivative contracts regime. As a consequence, a number of specific anti-avoidance 4
EY Assurance Tax Transactions Advisory Further information For further information, please contact one of the following or your usual EY contact: Anna Anthony AAnthony@uk.ey.com 020 7951 4165 Andrew Bailey ABailey@uk.ey.com 020 7951 8565 Mark Bennett MBennett2@uk.ey.com 020 7806 9257 Richard Clough RClough@uk.ey.com 020 7951 7601 Dan Cooper DCooper@uk.ey.com 020 7951 5381 Oliver Davidson ODavidson@uk.ey.com 020 7951 1571 Lynne Ed LEd@uk.ey.com 020 7951 2893 George Hardy GHardy@uk.ey.com 020 7951 0124 Neil Harrison NHarrison@uk.ey.com 0113 298 2596 Stephanie Lamb SLamb@uk.ey.com 020 7951 1700 Andy Martyn AMartyn@uk.ey.com 020 7951 9539 Kevin Paterson KPaterson@uk.ey.com 020 7951 1347 Mark Persoff MPersoff@uk.ey.com 020 7951 9400 Jonathan Richards JRichards@uk.ey.com 020 7951 6428 Rod Roman RRoman@uk.ey.com 020 7951 1549 Julian Skingley JSkingley@uk.ey.com 020 7951 7911 Ben Smith BSmith5@uk.ey.com 020 7951 8144 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 OC300001 and is a member firm of Ernst & Young Global Limited. Ernst & Young LLP, 1 More London Place, London, SE1 2AF. 2014 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 5