On 13 July 2010, HM Treasury published a consultation document on the scope and detail of the proposed UK bank levy (the “Levy”) which was announced in the UK Emergency Budget on 22 June 2010. The Levy is to be introduced from 1 January 2011. The genesis of the Levy as described in the consultation document is very clear and originates from the design of the Government to encourage the UK banking sector to “move away from riskier funding models”1, reduce systemic risk in the sector and increase institutional resilience. Allied to these objectives is the stated intention to ensure that banks make a “fair contribution in respect of the potential risks they pose to the UK financial system and the wider economy”.2
These objectives have not changed materially from those we reported on in the Cadwalader Clients & Friends Memorandum published on 23 June 2010 following the UK Emergency Budget, although they must also be placed in the context that the Levy is expected to raise an amount of £2.5 billion annually. The combination of these objectives, and the prominence given in the consultation document to the aim of encouraging the use of certain lending models within the UK banking sector, distinguishes the Levy from being primarily focused on financial reparation for the costs of governmental support during the recent financial crisis. Although the main features of the Levy are broadly as announced in the Emergency Budget, we have briefly set these features out below together with some further thoughts and questions regarding the issues which will now need to be faced by the Government and the UK banking sector regarding the detailed operation of the Levy.
(1) The Levy will apply to:
(a) the global consolidated balance sheet prepared under IFRS of UK banking groups and building societies;
(b) the aggregated UK subsidiary and branch balance sheets of foreign banks and banking groups operating in the UK; and
(c) the balance sheet of UK banks in non-banking groups.
Owing to the application of the Levy to bank consolidated balance sheets, questions may well arise concerning the extent to which accounting reform, such as the IASB’s project to replace IAS 39, may affect the valuation of liabilities under the Levy. Banking institutions and groups will only be liable for the Levy where their relevant aggregate liabilities which are subject to the Levy amount to £20 billion or more, a move calculated to catch only larger banking institutions. The consultation document confirms that the calculation of branch liabilities and Tier 1 capital for the purposes of the Levy will be based upon the existing capital attribution methodology already employed for corporation tax purposes. However, there remain a number of questions regarding whether calculation of branch liabilities under the existing capital attribution methodology will most optimally reflect the policy aim of the Levy in focussing on the funding profile of the overall bank business and risk profile (rather than just the risks located in the branch itself).
(2) The consultation document proposes for the definition of a “bank” for the purposes of the Levy to follow the definition in paragraph 43, Schedule 3, FA 2010 (for bank payroll tax purposes). The Government has also proposed to use the bank payroll tax definition of “banking group”, albeit with suitable amendments to reflect the fact that the Levy is based on accounting group concepts and not the definitions of tax grouping used in bank payroll tax. Some of the tensions and difficulties experienced in the bank payroll tax relating to which institutions fell within that tax may therefore be translated into the Levy, although the £20 billion threshold for banks should alleviate many of the problems which relate to certain funds falling within the definition of a “bank”.
(3) As described in the Emergency Budget, the Levy will be based on total liabilities and equity, excluding:
(a) Tier 1 capital,
(b) insured retail deposits,
(c) repos secured on sovereign debt; and
(d) policy holder liabilities of retail insurance business with banking groups.
Derivatives would be included on a net liability basis. Some questions will be inevitable regarding the definitions of retail funding and deposit insurance, and there will be challenges to align the exempt liabilities from the Levy with equivalent provisions in other banking levies to be introduced by France, German and the United States. The excluded liabilities identified all serve to reinforce the objectives of the Levy in encouraging banks to strengthen their capital base and promote certain forms of funding which are perceived to be safer and “relatively stable”3 bearing in mind the lessons of the financial crisis.
(4) The Levy will be imposed annually at a rate of 0.07 per cent. HM Treasury estimates that this will raise around £2.5 billion annually. A lower rate of 0.04 per cent. will be set for 2011. There will be a reduced rate for longer-maturity wholesale funding (with more than one year remaining until maturity) to be set at 0.02 per cent. rising to 0.035 per cent. This reflects the stated policy objective of encouraging the UK banking sector towards longer term funding. The consultation document makes it clear that there is no intention to utilise the revenue generated by the Levy as a bail-out or insurance fund for the UK banking sector.
(5) The relative expense of wholesale funding (relative to Tier 1 capital, insured retail deposits and sovereign debt repos) will be increased on an after-tax basis owing to the UK bank levy not being deductible for UK corporation tax purposes. A “targeted” anti-avoidance rule will also be introduced to prevent Banks mitigating their liability to the Levy.
(6) The processing, administration and collection of the Levy will be the responsibility of HMRC, with banking companies self assessing their liability. Payment of the Levy will be the joint and several liability of all members of a banking group, with a single group member being appointed as a “responsible company” for Levy administration purposes.
There remain a number of key issues relating to the introduction of the Levy, perhaps the main being the risk of double taxation. The consultation document acknowledges that liabilities under the Levy will not constitute “tax” for the purposes of the UK’s double taxation treaties, raising the risk that a foreign jurisdiction might not give relief under an existing treaty for the amount of the Levy payable by the UK branch of a bank in that foreign jurisdiction. This problem is also relevant to any bank balance sheet levies imposed by foreign jurisdictions which are not assessed on income or gains and which would be borne by the foreign subsidiaries and branches of UK banks. In the event that such bank levies are not eligible for foreign tax credits or relief under double tax treaties or domestic legislation, the cost to multinational financial institutions may well be very substantial. Resolving the issues in this area will clearly be a priority for the Government4, not least because press reports of banks contemplating the location of their headquarters have already started to emerge in the UK media5. While the Levy is just one of a large number of taxation and commercial aspects a bank would consider in reviewing the location of a headquarters in the UK, the Government will be aware of the particular sensitivities relating to the taxation of banks in the wake of other Government initiatives including the Code of Practice on Taxation for Banks, the proposals for a general antiavoidance rule and other legislative initiatives regarding financial instruments6. Whether the combined effect of such initiatives and the Levy will be sufficient for UK headquartered banks to seriously consider a corporate inversion and an exit from the UK marketplace remains to be seen, and will no doubt be closely monitored by the Government and HM Treasury.