BKLM331150 - Chargeable equity and liabilities: excluded equity and liabilities: Tier 1 capital and liabilities

Paragraph 30 of Schedule 19

The bank levy base excludes Tier 1 capital in order to encourage highest quality capital accumulation. This follows the IMF recommendations and complements the wider regulatory reform agenda, including moves to strengthen capital requirements.

The forms of capital that qualify for Tier 1 capital are based on regulatory terms.

Chargeable periods ending on or before 31 December 2013

For chargeable periods ending on or before 31 December 2013, the relevant terms are those which were set out in the capital resources table (see Table 2 Annex 2R Capital resources table for a bank; the FCA Handbook). These include, for example, share capital, reserves, partnership and sole trader capital, verified interim net profits, permanent interest bearing shares for building societies and, for a mutual, the initial fund plus permanent members’ accounts

The amount of Tier 1 capital allowed as excluded equity and liabilities for the purposes of bank levy is the figure (‘D’); (the total Tier 1 capital before the deductions shown in Table 2) shown in Annex 2R. This means that the figure to be excluded for bank levy purposes will be the figure before any deductions (for example for intangible assets) have been applied to those amounts.

But it should be noted that as the exclusion is from equity and liabilities only items that are included in equity and liabilities on the relevant balance sheets can be excluded.

Foreign entities were required to calculate their Tier 1 capital on the same basis, which was to calculate the amounts that would be treated under the FSA Handbook as Tier 1 capital before deductions of the entity or the group as at the end of the chargeable period.

Chargeable periods ending on or after 1 January 2014

For accounting periods ending on or after 1 January 2014 the amount of Tier 1 capital allowed as excluded equity and liabilities for the purposes of bank levy is determined by reference to Article 25 of the Capital Requirements Regulation (Regulation (EU) No 575/2013) (CRR).

The Article 25 definition of Tier 1 capital is a figure reached after deductions. This means that, for periods from 1 January 2014, the figure excluded for bank levy purposes will be the figure reached after applying the various deductions which the CRR requires.

Part 10 of the CRR contains transitional rules, including

• Grandfathering of certain capital instruments already in issue at the time the CRR took effect (1 January 2014), and
• Provisions that allow the regulator to progressively phase in certain deductions from Tier 1 capital which are made in accordance with the CRR, in a staggered manner.

In both cases, the competent authority is required to set applicable percentages which determine how gradually or quickly the relevant items are grandfathered out or phased into application. For the purposes of the bank levy, when applying the CRR, the PRA is always treated as the competent authority in relation to an entity or group (see below). The PRA has published applicable percentages in its Rulebook, in the Banking and Investment Rules for CRR Firms, on the ‘Definition of Capital’ page. This is available online at http://www.prarulebook.co.uk/rulebook/Content/Part/211285/

For the purposes of the levy, all entities and groups calculate their Tier 1 capital on the same basis, including foreign entities not regulated by the PRA. To achieve this, the CRR is treated as applying to all entities and groups as if the PRA were their competent authority, to the extent that this is not otherwise the case. This means that where, for example, the CRR gives the competent authority the power to determine applicable percentages for deduction in accordance with the transitional rules in Part 10, all entities and groups must follow the applicable percentages determined and published by the PRA. (FA11/SCH19/PARA30(3)(a))

In addition, all entities and groups are treated as if they were subject to the provisions of the PRA handbook immediately before 1 January 2014, to the extent that this was not already the case. This ensures that the transitional rules within the CRR that apply to the ‘old’ PRA handbook rules can be applied fully, including in the cases of foreign entities not regulated by the PRA. (FA11/SCH19/PARA30(3)(c))

When an entity or group applies the CRR for the purposes of the levy, the only determinations and discretions they can take into account are those that have been published by the PRA in accordance with the requirements of the CRR. Any determinations and discretions that are not published cannot be taken into account when calculating Tier 1 capital equity and liabilities. (FA11/SCH19/PARA30(3)(b))

Paragraph 30 of Schedule 19

Chargeable periods ending on or after 1 January 2021

The calculation of amounts that are excluded equity and liabilities under Paragraph 30 depends on the regulatory definition of tier one capital equity and liabilities, and the rules applied by the Prudential Regulatory Authority (PRA). Under the relevant PRA rules, tier one amounts may be reduced by certain items and those deductions may depend on whether the rules apply on a solo basis or on a consolidated basis e.g. deductions for investments in certain subsidiaries.

Prior to the rescope, the determination of a UK-parented group’s equity and liabilities on a consolidated financial statements basis aligned with prudential supervision on a consolidated basis. Following the rescope, the determination of the equity and liabilities of a UK sub-group may depend on whether the UK sub-group has members that are non-UK resident or designated FPE entities, and whether the sub-group has made an entity-by-entity election. In such situations the equity and liabilities of the UK parent entity of that UK sub-group may be determined by reference to the parent’s solus financial statements or by reference to consolidated financial statements of a residual UK sub-group (see BKLM315500), rather than by reference to the actual consolidated financial statements of the UK parent entity. Therefore, following the rescope, it is possible that whilst consolidated prudential supervision is permissible in relation to the parent, the determination of equity and liabilities for Bank Levy purposes is made on a different basis.

For UK sub-groups that do not include non-UK resident subsidiaries or designated FPE entities and that have not made an entity-by-entity election, HMRC considers that in calculating the excluded equity and liabilities under Paragraph 30, any deductions from tier one should be based on the PRA rules for consolidated supervision of the UK sub-group. This is because in such circumstances the prudential supervision of the UK parent entity on a consolidated basis and the determination of the parent’s equity and liabilities on the basis of the consolidated financial statements should align.

For UK sub-groups with non-UK subsidiaries or designated FPE entities, HMRC accepts that deductions from tier one may likewise be based on deductions under permissible consolidated prudential supervision.

HMRC also accepts that deductions from tier one may be based on the permissible consolidated regulatory position, where an entity-by-entity election has been made in relation to the UK sub-group.

The following examples show how the Tier one calculation applies in a simplified group scenario. Any impact of relevant thresholds for regulatory deductions is ignored.

Example 1

UK1 is the parent holding company of UK2, which is a banking subsidiary in the UK1 group. UK1 and UK2 are in a UK sub-group that has made an entity by entity election. PRA supervision on a consolidated basis of the UK1 group is permissible.

UK2’s solo Tier one capital consists of 100 of equity issued to UK1. UK1 has issued Tier one equity of 120 (i.e. 100 in relation to its holding in UK2, and 20 of its own Tier one requirement).

On a solo regulatory basis, UK1 has issued 20 of Tier one, and on a consolidated regulatory basis the UK1 group has issued Tier one of 120.

If UK1 were to use a solo basis for Bank Levy purposes then UK1 has chargeable equity of 100 (i.e. 120 less 20) due to the regulatory deduction from Tier one for UK1’s holding in UK2, and the amount of excluded equity for Tier one is only 20 for UK1.

As consolidated regulatory supervision is permissible for the UK1 group, the amount of excluded equity for Tier one is 120 for UK1 i.e. chargeable equity of nil.

Example 2

Starting with the entities in example 1, UK1 has another banking subsidiary, UK3, in respect of which it has made a foreign permanent establishment (FPE) election. UK3 has issued 100 of equity to UK1. UK1 has issued a total of 220 equity (i.e. 120 from example 1 and a further 100 in respect of its investment in UK3).

UK1’s excluded equity for Tier one is 220, the same as UK1 group’s Tier one calculated on a consolidated regulatory basis.

Example 3

Starting again with the entities in example 1, UK1 also has two foreign subsidiaries, F1 and F2. F1 is a bank and has issued 100 of equity to UK1. F2 is an ancillary services entity and has issued 10 of equity to UK1. UK1 has issued a total of 230 equity (i.e. 120 from example 1 and a further 110 in respect of its investments in F1 and F2).

The consolidated tier one capital amount used for regulatory purposes (230) must be reduced by UK1’s investment in F1 (100) and F2 (10) to give excluded equity for Tier one for UK1 of 120.

Relief for UK1’s holding in F1 should be available under step 3 of the calculation prescribed by Paragraph 15N (see BKLM315620). As F2 is a non-banking entity relief is not available under step 3 for UK1’s holding in F2.