In the latest in our series explaining the Financial Times, Herbert Smith Freehills‘ Celina McGregor looks at an issue currently affecting the so-called ‘challenger banks’
The FT has reported that smaller “challenger” banks are disappointed by the Competition and Markets Authority determination that the UK government’s plan to phase out the existing bank levy and introduce a new surcharge tax on bank profits is not anti-competitive. This decision follows months of lobbying from challenger banks to change the new surcharge tax.
What is the surcharge and its background?
The background to this starts with the global financial crisis. In October 2008, the UK government announced plans for a £500bn bail-out for UK financial institutions amid fears of widespread banking collapse.
The money was used to provide a range of short term loans and guarantees for inter-bank lending as well as £50bn of direct investment in the banks themselves. It was seen by many as an unpopular but necessary decision, with commentators criticising the use of tax payer monies to bail-out the institutions they blamed for the financial crisis.
In January 2011, the UK government then introduced a “bank levy”. A tax on UK banks’ global balance sheets (assets and liabilities) above £20bn. It is payable even when a bank is unprofitable. Because of the £20 billion threshold it only affects large banks.
The bank levy is collected alongside corporation tax (which applies to all UK companies) and was designed to demonstrate to tax payers that financial institutions are contributing to the UK economy in accordance with the financial risks they present. The levy proved particularly unpopular with HSBC and Standard Chartered Bank as the majority of their business is outside the UK. Both banks have publicly considered re-domiciling (moving their headquarters) away from the UK as a result of the levy.
The government’s new plan to phase out the levy and re-focus it only on UK balance sheets by 2021 has been welcomed by the large banks. However, the plan to replace the revenue generated by this tax with an additional surcharge tax on banks’ UK profits above £25 million is very unpopular with smaller “challenger” banks, who argue the tax disproportionately affects them and discourages competition.
Where is the law?
The relevant provision for the surcharge tax is Chapter 4, Part 7A of the Corporation Tax Act 2010. It came into effect on 1 January 2016 (so is already effective) and imposes an additional 8 per cent tax on UK bank profits above £25m.
Who are the challenger banks and what are their concerns?
The “challenger” banks are small retail banks that compete with large, well-established national banks for business. They have argued that the changes to the levy and surcharge are inconsistent with the UK government’s efforts to encourage competition in the banking sector, for the benefit of consumers and small businesses.Their arguments against the introduction of the surcharge are:
- Challenger banks do not benefit from the levy reduction (because they do not meet the £20bn balance sheet threshold for the tax to apply). They also tend to be proportionately more profitable than the larger retail banks, which they say means the surcharge disproportionately increases their tax burden and impacts on their ability to lend to customers.
- The changes make entry into the banking sector and investment in challenger banks less attractive, which negatively impacts their ability to grow and compete with larger banks.
- The surcharge is designed to replace the income the UK government receives from the levy, but the challenger banks argue that this is inconsistent with the policy basis for the levy because if a challenger bank went bankrupt it would present little or no systematic risk to the economy.
What is the CMA and what were its findings?
The Competition and Markets Authority is a non-ministerial department that works to promote competition for the benefit of consumers.
Although the CMA did not endorse the surcharge, it has recently determined that it is not anti-competitive. It considered the challenger banks’ arguments, but found that there was no strong evidence to suggest that the surcharge would deter the creation of new banks or result in banks exiting.
The CMA also found that the largest retail banks would still pay higher rates of tax than the smaller banks.
What will lawyers working in this field be thinking about?
Lawyers will need to consider the additional compliance requirements as a result of the new law and be able to advise their clients as to which tax reliefs and deductions apply.
As the surcharge will result in different tax rates for banking and non-banking companies within the same corporate group of companies, lawyers will need to consider with their clients restructuring their operations and where group companies and operations are located in order to secure the best tax position for a global business. Lawyers will also be thinking about when is the best time for their clients to complete certain transactions or deals. As the levy is phased out and the surcharge introduced companies may want to plan when and how they will incur certain gains or losses.
What are the wider implications?
The CMA is an independent body responsible for promoting competition in the UK. Their view that the surcharge does not hinder the UK government’s aim to increase banking competition means it will be difficult to challenge this legislation further. The CMA’s findings are also likely to impact the government’s thinking in its next budget due in mid-March, making it less likely that any changes will be announced.
Celina McGregor is a senior associate at Herbert Smith Freehills