9 December 2016 Draft Finance Bill 2017 EY banking alert Taking stock of the Autumn Statement and draft Finance Bill 2017 Introduction The Government has explicitly set out its long term plans for banking taxation. As the Financial Secretary to the Treasury, Jane Ellison, explained in a speech to the City of London Corporation on Tuesday, 6 December, By 2021, banking firms will pay 25% tax on profit the lowest among G7 nations alongside a 0.1% levy on UK balance sheets. The 25% tax on profits is made up of corporation tax of 17% and the 8% banking tax surcharge, while the bank levy will be reduced from the current rate of 0.21% on worldwide balance sheets to 0.1% on UK balance sheets only. The Financial Secretary made clear that the Government continues to consider the balance between revenue and competitiveness, taking into account the implications of the UK leaving the EU. But this comment suggests that the days when banks could expect a tax rise from every fiscal statement might finally be behind us.
Detailed proposals In this alert, we have looked in a little more detail at the Government s plans, as revealed in the draft Finance Bill published on Monday, 5 December. The draft legislation is open for consultation until 1 February 2017, although the Government is only looking for comments on the detail of the proposed changes because the broad policy directions have now been set. Even though the published draft Finance Bill is almost 400 pages long, we do not yet have the complete picture: further draft legislation on major reforms such as the restrictions on interest deductions and corporate loss reform is expected in January 2017. Nonetheless, banks are now in a better position to assess the likely shape of their future tax profile than they have been for several years. Interest restrictions New rules to restrict interest deductions were confirmed in the Autumn Statement on Wednesday, 23 November. The rules are based on the recommendations in the OECD s final report on BEPS Action 4 and have effect from 1 April 2017. The draft legislation proposes restricting interest deductions based on a fixed ratio or a group ratio rule, as well as integrating a tightened worldwide debt cap into the rules. There are some areas of the rules where changes are being made as a result of representations received. For banking groups, the big news is that they are fully within the rules. Whether this is a welcome development for most groups will depend on if they have net interest receipts, and consequently should not suffer an interest restriction as a result of the regime. In contrast, if a banking group has net interest expenses, it is very likely to suffer a restriction. However, concerns about a carve out that applies to regulated entities only (which might have led to substantial interest restrictions for nonregulated entities in banking groups) have been laid to rest. Less welcome is the fact that financial services have been added to the scope of the debt cap. There is an exemption for qualifying financial services groups in the existing debt cap rules, but this has been removed from the modified debt cap being brought in as part of the new interest restriction regime. Furthermore, the modified debt cap now restricts UK interest deductions to the worldwide group s net interest expense, rather than to the worldwide gross interest expense as is the case currently. In each period, the group may elect to be subject to the fixed ratio rule, whereby interest deductions are restricted to 30% of tax earnings before interest, tax, depreciation and amortisation (EBITDA), or to a group ratio rule. Under the group ratio rule interest is restricted to a percentage of tax EBITDA equal to the worldwide net interest of the group divided by its worldwide EBITDA. However, interest deductible under the group ratio rule is restricted to 100% of UK tax EBITDA. Regardless, of whether the group elects for the fixed ratio or group ratio rule, it is subject to the modified debt cap, being an overarching restriction on net UK interest deductions equal to the worldwide net interest expense. The definition of interest is therefore crucial for banking groups. Interest expense for these purposes includes expenses related to loan relationships, derivative contracts with interest, currency or inflation as their underlying subject matter, and financing costs implicit in amounts payable under arrangements such as finance leases, debt factoring or similar transactions. Income and expenses from other derivatives (e.g. equity derivatives and, surprisingly, credit derivatives), together with other non-loan relationship items, are be included within EBITDA rather than interest calculations. Banking groups will need to work carefully through the definitions of interest and EBITDA to see exactly how the interest restrictions will affect them. It is conceivable that some business models outside of traditional retail and commercial banking could result in net interest expense as defined. The draft legislation includes provisions for carry forward of restricted interest (and capacity) to deal with net interest expense situations which may reverse over time. For regulatory capital purposes such carry forward amounts may be more beneficial compared with carried forward losses. Changes from the consultation document issued in May this year include bringing the commencement of the modified debt cap rules into line with the start date for the interest restriction rules (i.e. applying from 1 April 2017) and extending the ability to carry forward surplus capacity to five years rather than three. In addition, as EY urged in its representations on the consultation, the rules now exclude impairment losses from the definition of interest expense and introduce adjustments to EY banking alert 2
the calculations of group interest and group-ebitda to align these more closely with UK tax rules. For many banking groups, the main effect of the new rules will be to increase their UK tax compliance burden. While groups which are net interest recipients in the UK will not suffer any restriction to deductions, they will still need to analyse their position in detail. Restrictions are most likely to arise where a bank is a worldwide net recipient of interest, but due to local conditions, finds that it is paying net interest in the UK. In this case, no UK deduction for net interest would be available. This may be a particular concern for overseas banking groups whose UK branches have net interest expense allocated to them. Draft legislation on various outstanding areas is due in the New Year. This includes definitions needed for the group ratio rule, rules concerning related parties and the Public Benefit Infrastructure Exemption, as well as issues such as leasing, Real Estate Investment Trusts and securitisations. For more details on the interest restriction rules, please see our detailed alert. Bank levy reform Draft legislation for the reduction in scope of bank levy from the worldwide to the UK balance sheets of banks based in the UK is expected in Finance Bill 2018. However, the Government has published a detailed response to representations it received on its consultation on re-scoping the bank levy. It may be possible to detect a signal towards a more generous approach to banking tax policy in this response. As previously announced, the Government has confirmed that the bank levy, which, in the case of UK-based banks, is based on their worldwide balance sheets, will be calculated only in respect of UK liabilities from 1 January 2021. This means that the bank levy with apply only to the equity and liabilities of UK entities and relevant UK sub-groups, excluding non-uk resident entities, as well as the UK allocated equity and liabilities of a non-uk resident bank with a UK permanent establishment. UK banking groups will be allowed to elect to calculate their liabilities on a top-down consolidation minus approach or a bottom-up approach similar to that currently used by foreign banking groups. A welcome response to the consultation was a recommendation that a measure of the equity and liabilities associated with foreign branches of UK banks should be excluded. This was not originally suggested in the consultation document, but the Government was persuaded to include it in any case. Furthermore, relief for liabilities on the UK balance sheet that relate to overseas subsidiaries will be given by allowing a deduction against chargeable equity and liabilities for investments that UK entities hold in loss absorbing instruments issued by their overseas subsidiaries. The Government has committed to continued consultation on other issues that arise from bank levy applying to UK balance sheets only, such as intracompany trading balances and the netting rules. Corporate loss reform The draft Finance Bill legislation includes a substantial part of the rules for reforming corporate losses. Under the new rules: Groups will be able to set off a wider range of profits against brought forward losses incurred on or after 1 April 2017, including an extended form of group relief Only 50% of profits incurred on or after 1 April 2017 can be relieved against brought forward losses (after a 5 million allowance per group) In its response to the consultation on corporate losses published this week, the Government set out a number of modifications to its initial proposals. These include: Companies will have flexibility to choose how to allocate current year losses against trading and non-trading profits It will now be possible to use post-april 2017 in preference to pre-april 2017 losses in certain circumstances Anti-avoidance on loss buying and loss refreshing rules will be widened and there will be additional anti-avoidance to deal with when a trade ceases or becomes small or negligible The Government has also confirmed that it will legislate to ensure that, while losses generated from EY banking alert 3
entities not subject to the banking tax surcharge can be used against profits that are subject to the surcharge, relief will be restricted to the corporation tax rate A particular complexity of the rules for banks is the interaction between the 50% loss restriction for all companies from 1 April 2017, and the 25% bank loss restriction (BLR) applying to losses which arose before 1 April 2015. The Government s response to the consultation suggests that the rules should interact as follows: Once all in-year reliefs (including group relief) have been claimed, a group can allocate amongst its members a 5 million allowance against which brought forward losses (but not BLR losses) can be offset before the 50% limitation is applied. The most efficient way to allocate in-year reliefs and the allowance will depend on the precise circumstances of the group in question. Next, where a bank has BLR losses, it can set off 25% of profits remaining after in-year loss relief and any allocation of the 5 million allowance. If the bank also has non-blr losses, it can then use these to top up relief to 50% of profits after in-year loss relief and the allowance. For example, a bank with profits of 105 million could use 5 million of its brought forward non-blr losses against 5 million of profits. It could then use BLR losses against another 25 million of the remaining 100 million of profits. Finally, it could use 25 million of non-blr losses against a further 25 million of profits. This gives the bank maximum loss relief of 5 million plus 50% of the remaining profits, resulting in total loss relief of 55 million. We note that the draft legislation is very complex and groups will need to consider carefully how losses can best be utilised. The new anti-avoidance rules will also need to be taken into account when buying or selling companies or trades with realised or unrealised losses, as well as when determining the effect of intragroup transactions. Legislation in a number of areas, including antiavoidance measures, is still to be published. Draft clauses are expected by the end of January 2017. However, with only four months to go before the reforms take effect, groups will wish to start modelling their impact. For more details on the reform of corporate loss relief, please see our detailed alert. Substantial shareholding exemption As expected, the draft Finance Bill contains a relaxation of some of the conditions for the application of the substantial shareholdings exemption (SSE). The changes have effect for disposals of substantial shareholdings on or after 1 April 2017. The first change removes the requirement for the company making the disposal to be a sole trading company or a member of a trading group at any time before or after the disposal. It also extends the period during which the investing company can satisfy the substantial shareholding requirement from 12 months within the two years before the disposal to 12 months within the six years before the disposal. The second change introduces a new third subsidiary exemption within SSE for companies that are wholly or partly owned by certain institutional investors. For more details, please see our detailed alert on the changes to SSE. Amendments to the anti-hybrid rules On the same day as the draft Finance Bill, the Government released a technical note on two changes to the anti-hybrid rules to be included in Finance Bill 2017, but these have not been included in the draft clauses published so far. The change with the most relevance to banks concerns mismatches which represent timing differences. The anti-hybrid regime allows mismatches to be disregarded if corresponding amounts are brought into account within a certain time period where that is just and reasonable. However, it has been recognised that the claim requirement contained in the legislation brings with it a potentially sizeable compliance burden. Accordingly, the requirement to make a formal claim for each mismatch involving a financial instrument will be removed. Nevertheless considerable uncertainty and a significant compliance burden remain in relation to the anti-hybrid rules which now come into force in a matter of days. Particular uncertainties for banks relate to potential mismatches from intra-group trading transactions in the ordinary course of business; changes to the rules relating to the taxation of branches; and third party transactions.. EY banking alert 4
EY Assurance Tax Transactions Advisory Draft HMRC guidance in relation to these points and on the anti-hybrid rules more broadly has been published today. Penalties for enablers of defeated tax avoidance The draft Finance Bill includes a new penalty which HMRC can impose on any person who enables the use of tax avoidance arrangements which are later defeated. Enablers include financial enablers, which could include banks, where it is reasonable to suppose they should have known that they were providing financing for avoidance arrangements. The definition of tax avoidance arrangements for the purposes of the rules is based on the general anti-avoidance rule, that is, it applies to arrangements which cannot reasonably be regarded as a reasonable course of action. This is narrower than was proposed in the Government s earlier consultation. Arrangements are defeated either in the Courts or the Tribunal or where otherwise counteracted. The penalty charged will usually equal the fees the enabler earned from the scheme. HMRC will also have the option of naming and shaming enablers who have been subject to a penalty over a fixed amount How we can help The interest restriction rules and reform of corporate losses, in particular, represent major changes to the UK tax regime which will have significant and long term effects for banking groups. Many of the rules in the draft clauses come into effect on 1 April 2017. Even though the proposals are still in draft and not all the relevant draft legislation has even been published, it is important to consider the impact of the proposals now and determine what actions are required. We can help model the impact of the new provisions and compare the various strategies that may be available to enable groups to make full use of interest and loss relief going forward. Further information For further information, please contact one of the following or your usual EY contact: 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. 2016 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 Neil Harrison nharrison@uk.ey.com +44 113 298 2596 Richard Milnes rmilnes@uk.ey.com +44 20 7951 7750 Mark Persoff mpersoff@uk.ey.com +44 20 7951 9400 Daniel Lucas dlucas@uk.ey.com +44 20 7951 7206 Tom Passingham tpassingham@uk.ey.com +44 20 7951 2846 James Hannam jhannam@uk.ey.com +44 20 7951 2686 EY banking alert 5