The Summer Budget 2015 for banking and finance lawyers

With the Chancellor’s speech still ringing in our ears, we bring together the most important features of the Summer Budget 2015 for banking and finance lawyers alongside expert analysis and industry comment.

What was relevant in the Summer Budget for banking and finance lawyers?

The bank levy rate will decrease from 0.21% to 0.18% from 1 January 2016 and will continue to decrease each calendar year thereafter until 2021. A proportionate decrease to 0.09% with effect from 1 January 2016 will be made to the half rate, with corresponding reductions being made each following calendar year until 2021. Legislation will be introduced in the Summer Finance Bill 2015 to amend the Finance Act 2011, Sch 19, paras 6, 7.

Summer Budget 2015: TIIN—Corporation Tax—modernisation of the taxation of corporate debt and derivative contracts.

The rules governing the taxation of corporate debt (known as loan relationships) and derivative contracts are updated by a new measure announced by the government at Summer Budget 2015. The measure affects companies which are subject to corporation tax, which issue or hold debt or which are party to derivative contracts.

Summer Budget 2015: TIIN—Restricting tax relief for banks compensation payments July 2015

The government has introduced a measure ensuring large compensation payments, made in relation to banks’ past misconduct and management failures, do not affect corporation tax receipts. This is to ensure the banking sector makes appropriate contributions to restoring public finances.

Summer Budget 2015—TIIN: Bank Corporation Tax surcharge

The government has announced that a surcharge of 8% is to be imposed on the profits of banking companies. The profits will be calculated on the same basis as for corporation tax, but with some reliefs added back. The surcharge will be levied on profits of banking companies in accounting periods beginning on or after 1 January 2016. Where a company’s accounting period straddles 1 January 2016, the period will be split and the surcharge will apply to the profits of the notional period commencing on 1 January 2016.

What does this mean for banking and finance lawyers?

What are the headlines for the Summer Budget for banking and finance lawyers and why?

Cathryn Vanderspar, head of tax, and Deepesh Upadhyay, senior associate, Eversheds LLP:

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. Banking and finance lawyers will need to understand the impact this will have on their clients.

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 (ie 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 (ie 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 introduction of a significant new corporation tax surcharge of 8% on banking sector profits from 1 January 2016 has also been announced. This 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.

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 which in recent months have publically stated that they are considering quitting the country due to, among 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 it 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 have 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 is not new. For banking and finance lawyers 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 change 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 finance lawyers need to understand the implications of the terms they are agreeing pursuant to such arrangements. The new rules are intended to give specific 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 (eg 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 months 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.

Charles Kerrigan, partner, Lydia Hutchinson and Mike Tanner, associates, Olswang LLP: The widely anticipated sell-off of the government’s shares in private banks, including RBS, is likely to be accelerated following a commitment in the Summer Budget to return these banks to private ownership.

There are significant changes to the bank levy and corporation tax regime for banks and large companies (see below) designed to counter accusations that retaining the bank levy long term would be a barrier to banks returning to financial health, while ensuring that the Treasury maintains tax receipts as banks return to profitability.

Reforms to the taxation of dividends from April 2016 may have a knock-on effect in terms of transaction structures, with a £5,000 annual allowance for dividends replacing the dividend tax credit and new bands for basic, higher and top rate taxpayers.

The net effect of these changes will be an increase in tax liability on dividends for taxpayers who receive significant dividend income from companies in which they have a large shareholding (typically over £140,000).

Robert Farrell, solicitor, Gordons LLP: Much of the content of the Summer Budget was focused on issues such as the UK’s welfare payments, the introduction of a new living wage and changes to personal taxation. There were, however, a number of points which will be of interest to banking and finance lawyers.

The government has agreed to reduce the rate of the current bank levy, with the first cut taking place on 1 January 2016 from 0.21% to 0.18%. The levy will then decrease each year until 2021, when the rate will be 0.10%. This will also apply to UK assets and cease to be charged on worldwide assets.

However, what is given with one hand is taken with the other—the government has also introduced a new 8% corporation tax surcharge on bank profits, which it is estimated will raise £415m in 2016/17 and £555m in 2017/18. The surcharge is all the more relevant in the context of a further change to the taxation of banks, which was announced in March 2015 and will be included in the Summer Finance Bill. This will allow for compensation payments which banks make to their customers for past misconduct (eg mis-selling financial products) to no longer be a tax deductible expense, thus increasing their exposure to taxation. This is expected to increase tax paid by banks by £1bn over the next six years.

David Stanbridge, managing associate, Nabarro LLP: The biggest news for our banking clients is the gradual reduction of the bank levy rate (down to 0.1% by 2021) is offset by the imposition of the new 8% surcharge on bank profits (to use Harriet Harman’s phrase, ‘what the Chancellor gives with one hand, he takes with the other’).

Banks have been feeling unfairly targeted and the new surcharge may be the final straw. This could lead them to relocate some or all of their businesses outside of the UK. Only time will tell.

Outside of this, the improving economy and continued focus on investment by businesses, coupled with a further reduction in the rates of corporation tax should result in a rise in the appetite for borrowing, as businesses look to grow.

The shadow caused by the ongoing situation in Greece is looming large and could potentially have even more of an impact than the Budget on our economy and the economies of the countries within the eurozone.

Were there any surprises?

Cathryn Vanderspar and Deepesh Upadhyay: The introduction of the corporation tax surcharge for the banking sector is a surprise. Banks and building societies will need to carefully assess the impact of this surcharge. The reduction of the bank levy may come as a surprise to some, but given the industry’s lobbying around this, it should not be a surprise to those industry players pushing for reform.

Charles Kerrigan, Lydia Hutchinson and Mike Tanner: Prior to the Budget, it had been trailed that the bank levy was likely to remain for the foreseeable future—however, there are significant reforms to the bank levy and corporation tax for banks. These include:

  • the steady reduction in the bank levy over the next six years—from 0.21% now to 0.10% in 2021—and from 2021 the levy will apply to UK balance sheets only (this can be seen as a peace offering from the Treasury to HSBC, which was particularly affected by the levy applying to their global balance sheet as compared to their competitors)
  • any windfall to banks from a reduction in the bank levy is to be offset by an 8% corporation tax surcharge on bank profits—the surcharge will take effect from 1 January 2016
  • the headline rate of corporation tax will, however, drop from 20% to 19% in 2017 and 18% by 2020
  • payment dates for corporation tax will be brought forward for large companies with profits in excess of £20m (including banks)—so payments are made closer to the point when the companies earn this profit

Robert Farrell: The Summer Finance Bill will also seek to restrict individual landlords’ ability to claim tax relief on their financing costs (particularly bank fees and mortgage interest). This will be introduced gradually over a four-year period from the tax year beginning 6 April 2017. At the end of this period, landlords will only be able to claim tax relief on mortgage payments equal to the basic rate of income tax, meaning that higher-rate tax payers will be paying more in taxation on their rent profits.

Opinion was divided on whether this measure would be introduced, given the potential for it to lead to an increase in market rents. The government seems to have adopted a somewhat half-way measure by only restricting the tax relief, rather than removing it entirely, and providing a reasonably generous four-year window within which the change will be introduced. This is presumably to protect a fragile property market, the risk being that the measure could result in a large number of properties coming to market as landlords seek to offload their stock.

David Stanbridge: Not from a banking and finance perspective, but the introduction of the new national living wage was not previously expected.

What actions should banking and finance lawyers be taking as the dust settles?

Cathryn Vanderspar and Deepesh Upadhyay: As the dust settles, banking and finance lawyers will need to determine the impact of the new corporation tax surcharge on their clients and how, if at all, this new cost should be addressed in finance documents allocating risk and providing indemnity protection. It may be considered appropriate for the surcharge to be treated the same way as other taxes on net profits—ie a risk and cost which sits with the finance party rather than the borrower.

It is likely that banking and finance lawyers, alongside their tax colleagues, will need to review the new corporate rescue exemptions to be able to determine their practical use and availability.

Charles Kerrigan, Lydia Hutchinson and Mike Tanner: There are a few considerations for banking and finance lawyers. Where ongoing operational costs are relevant, the increase in the insurance premium tax rate from 6% to 9.5% from November 2015 should be considered—this could have an effect on financial covenant modelling for businesses with significant insurance costs.

Previously announced policies tightening the tax rules in relation to controlled foreign companies and ‘carried interest’ have been confirmed. As well as the corporation tax reforms outlined above, there is an increased focus on tax compliance for large businesses with profits over £20m, with HMRC set to be given new powers and a £750m budget to tackle both avoidance and non-compliance—as a result, banks and large companies can expect increased scrutiny.

Robert Farrell: Many of the bank-related measures are not strictly legal in nature, so I would not expect them to result in any significant changes in current practice for transactional lawyers, although clearly the changes are relevant to regulatory lawyers and tax specialists. However, the apparent net increase in taxation on banks which begins in January 2016 may clearly have implications for the terms offered by banks to their customers and their risk appetite.

Landlords who currently borrow from banks may also wish to check whether the changes to their taxation will have any bearing on their compliance with their loan terms, particularly financial covenants, although this is perhaps unlikely as many are tested on a gross rental-income basis.

What has been the reaction from the banking and finance industry?

Anthony Browne, chief executive, British Banking Association: ‘We welcome the Chancellor’s decision to amend the bank levy to reduce the damage it does to Britain’s biggest export industry.

‘But introducing yet another new bank-specific tax will reinforce fears that Britain is becoming a less attractive place for banks to do business. This is the fifth new bank-specific tax measure in as many years following fast on the heels of the big rise in March and will increase banks’ tax burden by nearly £2bn. We believe these moves will also undermine competition in the industry by making it harder for smaller players to break through and challenge larger banks.

‘We still believe that the government should conduct a strategic review of the way banks are taxed to ensure that the UK remains a competitive place for banks to do business.’

Jim Meakin, head of tax, Baker Tilly: ‘The Chancellor’s ‘Security First’ Budget was far more significant than expected. He has shown real creativity in navigating around the triple lock, finding a number of areas for generating additional revenues while announcing some eye-catching measures such as the new living wage, designed to generate a feel-good factor about progress in the economy.

‘There will also be a wholesale review of how dividends are taxed, the outcome of which seems likely to be that most recipients will be no worse off, and may be better off. However recipients of large dividends from private businesses and holders of large investment portfolios may well lose out.’

Paul Smee, director general, Council of Mortgage Lenders: ‘The most significant Budget announcement for the mortgage market is the fundamental change to Support for Mortgage Interest, which will change from a benefit to a loan in 2018.

‘This is a radical change and we will need time to consider it and work through the practicalities and logistics. The systems and risk challenges for our members arising from such a change are potentially huge.

‘Our members already go to significant lengths to support customers through temporary periods of difficulty, and will continue to do so. We will do our utmost, whatever the landscape of State provision, to keep in their homes customers whose problems are temporary and whose circumstances will allow them to get back on track over a reasonable timeframe. But this is a change that could have wide implications.

‘Other notable announcements for the mortgage lending industry include the four-year phased reduction of higher rate tax relief on buy-to-let mortgage interest payments. The phasing is important. We will need to understand whether this will have a behavioural impact on higher-rate buy-to-let landlords, but a four-year timetable does at least reduce the risk of sudden market shocks.’

John Cridland, director general of the Corporation of British Industry: ‘By phasing out the bank levy, the Chancellor has tackled an issue that was making the UK uncompetitive for global banks headquartered here. But the proposed new banking profits surcharge will need careful examination to avoid unintended consequences and ensure it doesn’t stifle choice in the banking sector.’

The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.

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Filed Under: News/Updates , Tax

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