Legal Briefing

The bank levy: what is it?

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Corporate and commercial | 01 November 2011

In the run-up to the 2011 Budget, and subsequently, there have been numerous references in the media to the bank levy (the Levy). But what is it, how has it arisen and is it really relevant to in-house counsel, other than those individuals who work within banks?

 POLITICAL BACKGROUND TO THE LEVY

The political background to the introduction of the Levy was the general distress following the banking crisis. There was a feeling that the banks had been imprudent and had ‘gambled’ with their assets (the secretary of state for business, innovation and skills, Vince Cable, loves the analogy between investment banks and casinos), leaving taxpayers in various jurisdictions, including the UK, with the burden of having to bail out their banks.

The stated rationale for the Levy is to make banks contribute to the cost of the bail-out and to encourage them to move away from riskier funding. The Levy is expected to raise £2.5bn from 2012 onwards, which is paltry when compared to the level of taxpayer support for the UK banking sector. However, the government does not intend to use the proceeds of the Levy to establish a bail-out fund to meet future financial crises within the sector.

Indeed, most recently, the prime minister, David Cameron, and chancellor, George Osborne, have indicated that government strategy is to limit future exposure to the banking sector by implementing the recommendations of the Vickers Report and forcing a separation of retail and investment banking activities. However, there seems to be some debate concerning the speed of implementation in the face of bank resistance. Given the banking sector’s exposure to sovereign debt, particularly in the Eurozone, one might think that protecting retail bank solvency should be a pressing issue.

LEGISLATIVE BACKGROUND TO THE LEVY

In terms of legislative background, the Levy was announced in the 2010 Budget. During 2010 and early 2011, there was extensive consultation on its scope, application and implementation, including with the banking sector. There have been various consultation documents, culminating in the introduction of legislation in the Finance (No 3) Bill 2011.

The Levy has now been enacted as Schedule 19 Finance Act 2011, although certain other statutory provisions, particularly relating to the management and collection of tax (including, specifically, the Corporation Tax (Instalment Payments) Regulations 1998 (the Instalment Payments Regulations)) have been amended to accommodate the Levy.

WHAT IS THE LEVY?

It is a totally new tax and it is not an additional form of corporation tax applicable to banks. Paragraph 1 of Schedule 19 states that ‘There is to be a tax called “the bank levy”’. While this may not seem a particularly important feature, it could be relevant to the construction of banking documentation, particularly structured finance documents where a bank’s return is variable by reference to tax suffered by it (see below).

Although the Levy is not corporation tax, the same corporation tax administration, collection and payment mechanisms apply.

WHAT ARE THE MAIN FEATURES OF THE LEVY?

From 1 January 2011, the Levy applies to:

  • UK banking and building society groups;
  • UK subsidiaries, UK sub-groups and permanent establishments of foreign banking groups and foreign banks;
  • UK banks and UK banking sub-groups of foreign non-banking groups;
  • Standalone UK banks and building societies; and
  • UK permanent establishments of foreign standalone banks.

Broadly speaking, the Levy is based upon an entity’s ‘chargeable equity and liabilities’ at the end of a chargeable period (usually 12 months in duration). However, no Levy is chargeable where the ‘exempt entity’ test applies (broadly where 90% of a group’s trading income is derived from certain ‘exempt activities’ or 50% of the group’s trading income is derived from non-financial activities).

The legislation uses International Accounting Standards, US Generally Accepted Accounting Principles (GAAP) and UK GAAP as the methods of determining chargeable equity and liabilities, while also adopting definitions and concepts used to regulate banks by the Financial Services Authority.

In determining chargeable equity and liabilities, certain prescribed amounts are deductible including: tier 1 capital; compensation scheme liabilities; certain insurance liabilities; property revaluation reserves; tax liabilities; pension scheme liabilities; clients’ money and several other items including high-quality liquid assets. Furthermore, there are special rules where, in certain circumstances, the net position with a third party can be taken into account. To ensure that the Levy applies to equity and liabilities of lesser quality, ‘high-quality liquid assets’ (as defined by thePrudential Sourcebook for Banks, Building Societies and Investment Firms) can be deducted. The apparent intention is to encourage banks and other institutions to hold higher quality and more liquid assets and thereby have a more robust capital. While that aim is admirable, it may have the effect of discouraging lending to smaller and possibly riskier customers.

There is a general deduction of £20bn (known as the allowance). This is deductible from chargeable equity and liabilities and may help some smaller banks and institutions to avoid having to pay the Levy.

For the purposes of the Levy, a distinction is made between long and short-term equity and liabilities, with short-term equity and liabilities attracting a higher charge. The Levy on long-term equity and liabilities is set at a rate of 0.039%, while the rate applicable to short-term equity and liabilities is 0.078%.

The Levy is chargeable for all periods ending on or after 1 January 2011, with special rules for any period that straddles that date. The rate of the Levy is modified for periods covered by the calendar year 2011.

As already mentioned, the Levy is administrated and collected as if it were corporation tax and the Instalment Payments Regulations apply. Groups can appoint a representative member to administer the Levy on behalf of the group. The Levy is not a deductible item for corporation tax purposes. The legislation provides a framework to avoid double taxation where another jurisdiction imposes a similar form of tax.

Curiously, the legislation contains anti-avoidance provisions, which prescribe measures that can be taken to limit the Levy and which will not be treated as tax avoidance (eg increasing high-quality liquid assets).

Part 2 of Schedule 19 prescribes how the Levy is to be calculated. Consistent with the modern approach to drafting tax legislation, the method of calculating the Levy is expressed in a step-by-step approach that takes into account chargeable equity and liabilities, the allowance of £20bn, the relevant proportions of long and short-term equities and liabilities and the length of the relevant chargeable period.

POTENTIAL IMPACT OF THE LEVY

While the foregoing summary may all be of some interest, and may fuel discussions at cocktail parties with bankers, is it really relevant to in-house counsel in commercial organisations when dealing with their day-to-day affairs? Perhaps the answer is that it may be.

Over the last decade or so, to achieve lower funding costs, commercial organisations have been encouraged to enter into tax-based structured finance products with their banks. A typical example would be tax-based finance leasing. In many such products, a bank’s return is computed on an after-tax basis, meaning that where there is a change in the effective tax rate applicable to the bank, there will be a change in the amount required by the bank to service the funding.

If the tax burden increases on a bank as a result of the Levy, it is possible that under the relevant documentation, the bank may be entitled to increase the amounts due from the customer. Any increase is likely to depend on the precise definition of the word ‘tax’ in the relevant document. If the definition is widely drawn to include all forms of tax and levy, then presumably the bank will be able to require increased payments to service the funding. If, however, the definition of tax is limited to defined taxes, including corporation tax (which does not include the Levy), then it may be that the bank is not entitled to increase the scheduled payments and will have to bear the cost of the Levy itself.

Therefore, the Levy is an important issue, of which in-house counsel should be aware.