Finance Tax: Summer Budget 2015 - E-Briefing for Banking and Finance

The Chancellor of the Exchequer gave his Summer Budget to Parliament on Wednesday 8 July.

Among the various announcements, the banking and finance sector is likely to be most interested in the announced reform of the taxation of banks and building societies and the introduction of new corporate rescue exemptions for companies in financial distress.

Generally, the industry should be happy with the reduction in the bank levy, but the dust will need to settle fully to understand the implications of the new corporation tax surcharge. The exptected addition of relieving provisions for financially distressed companies is good news and adds to the menu of existing options.

Taxation of banks and building societies

The government has announced that, as part of the Summer Budget 2015, it will be reforming the way that banks and building societies are taxed.

The announced reform will include a year-on-year rate reduction in the bank levy from 1 January 2016 until 2021. Rates in respect of the full bank levy rate (i.e. the rate for short term chargeable equity and liabilities) are expected to drop from the current 0.21% down to 0.10% in 2021 and rates in respect of the half bank levy rate (i.e. the rate for long term chargeable liabilities) are expected to drop from the current 0.105% down to 0.05% in 2021. In addition, the government is seeking to restrict the bank levy to UK operations from 1 January 2021.

However, the government has also announced the introduction of a significant new corporation tax surcharge of 8% on banking sector profits from 1 January 2016. The government has stated that the surcharge will apply to profits before certain reliefs are used. So, for example, banks will not be able to offset carried forward losses arising before 1 January 2016 against their profits for the purposes of this new surcharge. The new surcharge will, therefore, be used to counterbalance the revenue the government will lose as a result of the staged bank levy reductions.

It seems that the government has taken on board the views and concerns of the banking industry in deciding to reduce the rate of bank levy and reform its tax base. This will be welcomed by many banks and building societies, some of whom in recent months have publically stated that they are considering quitting the country, due to, amongst other things, the bank levy being a significant cost to their business. The banking industry has argued that the bank levy, which is essentially a tax on the bank’s global balance sheet position, is negatively impacting the provision of credit in the UK and is contributing to the decline in UK-based exports of financial services.

It remains to be seen whether and the extent to which the upside of this bank levy rate reduction is negated by any downside created by the bank corporation tax surcharge both from a financial and operational perspective. The impact will vary from institution to institution. It is worth noting that the government has also announced that they will reduce the corporation tax rate from 20% to 19% in 2017 and 18% in 2020. This will be welcomed and it is hoped that, overall, the net result will be that the UK will remain a competitive tax regime, where banks and building societies can conduct business and situate their global headquarters.

New corporate rescue exemptions: debt releases, modifications and replacements

The government has confirmed that it will be pushing ahead with its measures to update the rules governing the taxation of corporate debt and derivative contracts. Most of this will not be new news. One of the key changes will be the introduction of the new corporate rescue exemptions for companies in financial distress. The new corporate rescue exemptions will be included in next week’s Summer Finance Bill 2015.

At present, when unconnected debt is released, the amount credited to the debtor company’s accounts in respect of the release is generally taxable in its hands as a loan relationship credit, unless one of the existing exemptions apply (such as where the release is part of a statutory insolvency arrangement, where the debtor company meets certain insolvency conditions or the debt for equity swap exemption is utilised). The new corporate rescue exemption in respect of debt releases offers distressed debtor companies an alternative to the existing menu of options.

Further, for accounting periods on or after 1 January 2015, as a result of a changes to accounting standards to be adopted by UK debtor companies, a ‘substantial modification’ of the terms of debt may give rise to a credit for accounting purposes and, as a result, a taxable loan relationship credit in their hands. Substantial modifications will include where debt has been modified or replaced through ‘amend and extend’ arrangements, where the debtor’s contractual terms are eased. Amend and extend arrangements have been fairly common following the recession and so the relevant parties will need to understand the implications of the terms they are agreeing pursuant to such arrangements. The new rules are intended to give relief from this change, where appropriate.

Based on draft legislation released in December 2014, broadly speaking the new corporate rescue exemptions will apply where, if immediately before the relevant debt release, modification or replacement, it is reasonable to assume that, without such arrangements, there would be a material risk that the debtor company would be unable to pay its debts at some point in the following 12 months. The exemptions will apply to releases, modifications and releases on or after Royal Assent to the Summer Finance Bill 2015.

The new corporate rescue exemptions are in addition to those which already exist and provide an exemption to the debt releases, modifications and replacements noted above, which could otherwise result in a debtor company being taxed. The new corporate exemptions supplement the existing exemptions and, in the context of debt releases, are aimed at circumstances where it may not be appropriate to utilise the existing exemptions (e.g. the debt for equity swap based exemption may not be attractive to the relevant parties). However, as currently drafted the new exemptions have some shortcomings including that they do not apply to deemed releases and the requirement to determine whether there is a material risk of being unable to pay debts within 12 month is not as broad as one would have hoped. It remains to be seen whether these and other issues will be addressed by HMRC. Overall, the exemptions will be seen as a welcome addition to the existing exemptions and ultimately will assist companies in financial distress to implement a commercial debt restructuring without being saddled with an unexpected corporation tax bill.