BKM504750 - The Code commitments – tax planning: examples

Examples 1 and 2 – Bank Levy, High Quality Liquid Assets “HQLA”

The bank levy was introduced in 2011 and is an annual levy on the chargeable equity and liabilities of the largest UK and foreign owned banking groups operating in the UK. FA11/SCH19/PART4 sets out detailed rules for identifying chargeable equity and liabilities with the final step being to reduce the amount otherwise chargeable by high quality liquid assets (HQLA).

HMRC became aware that the definition of HQLA had, in some cases, been interpreted to include assets which would not qualify for the regulator’s liquid assets buffer. In particular, this alternative interpretation included assets which had been provided as collateral to a third party and were therefore encumbered.

The intentions of Parliament with regard to the HQLA deduction in determining a bank’s bank levy liability could be discerned from the government’s bank levy consultation response document published on 21st October 2010, in particular at paragraphs 3.12 – 3.14. This made it clear that a deduction for HQLA was included within the bank levy rules because the government did not want to disincentivise the holding of assets that were eligible for the regulatory liquid assets buffer, by bringing the funding for these relatively low yielding assets into the bank levy base.

Tax planning based on an interpretation of HQLA which allowed assets that were not eligible for the regulatory liquid assets buffer to be deducted for bank levy purposes, did not meet the express policy objective of the deduction and was thus clearly not within the intentions of Parliament. Any arrangement undertaken with the purpose of exploiting this interpretation would clearly be a Code Red transaction.

Example 1

Bank 1 is aware of Parliament’s intention regarding the interpretation of the definition of HQLA and is considering undertaking a number of transactions to take advantage of the bank’s alternative interpretation and reduce its bank levy charge.

This tax planning and the structuring of the proposed transactions are contrary to the intentions of Parliament so would be Code Red.

Example 2

Bank 2 carries out its normal commercial transactions without any tax planning in respect of the bank levy. After the end of an accounting period the bank’s lawyers suggest applying a different interpretation to the HQLA deduction from that set out in the government’s response to the consultation document. The bank completes its tax return on this basis as it believes this is the correct interpretation.

In example 2 there is no tax planning, therefore it is not necessary to consider whether the tax result is contrary to the intentions of Parliament. This is consequently Code Green. HMRC would expect banks to approach HMRC under the Code if it intends to interpret legislation differently to that publicly stated (see the second paragraph in part 4 of the Code).

In 2013 the definition of HQLA was amended with retrospective effect to make it clear that only HQLA which were eligible for the regulatory liquid assets buffer could be deducted in arriving at chargeable equity and liabilities.

Example 3 – Factoring of business receipts

Factoring of business receipts involves a company borrowing money against a future income stream. Where the company obtains finance by way of a loan it normally gets tax relief for the interest shown in its accounts but not for the principal.

In the early to mid-2000s a number of companies entered into structured transactions with banks in which they borrowed money against future income streams but claimed a deduction for both interest and principal. These included transactions by companies that were looking to obtain finance for development projects and involved transferring the right to income on an existing development to a tax transparent entity.

Anti-avoidance legislation was introduced in CTA10/PART16/CHAPTER2 to tax these structured finance transactions on the basis of their economics i.e. following the accounts, rather than the legal form of the transaction.

The relevant Explanatory Note states “This Chapter… stops a number of schemes which are intended to enable taxpayers to borrow money and obtain effective tax relief for both interest and repayment of principal.”

A bank that had adopted the Code considered entering into an innovative factoring transaction with a client, with the bank receiving a share of the expected tax advantage. The transaction circumvented the structured finance anti-avoidance rules by adding an additional step to change the accounting treatment. The bank’s technical analysis showed this would result in tax relief for both interest and repayment of principal.

In this case the introduction of anti-avoidance legislation and the wording of the Explanatory Note made clear Ministers’ and Parliament’s intention that businesses that factor their business receipts should not get tax relief for both interest and repayment of principal.

These arrangements would give a tax result for the client that is contrary to the intentions of Parliament and so would be Code Red.

Example 4 – Tax credit schemes

A bank considers a scheme seeking to exploit certain tax provisions to generate a repayment of tax that has never been paid. The scheme requires the bank to invest a sum of money in an authorised investment fund (AIF) for a few months. In return the bank receives interest on the sum invested and a tax credit which it uses to offset other liabilities, providing the bank with a return well above that it would receive by investing the same sum on normal commercial terms. The AIF has not and will not pay any UK tax.

Such a scheme clearly gives a tax result that is inconsistent with the underlying economic consequences. Unless there is specific legislation designed to give such a result the bank will need to consider if the transaction gives it a tax result which is contrary to the intentions of Parliament.

The proposed transaction follows earlier similar transactions that sought to produce repayable tax credits where no tax has been paid (tax generators). The government had introduced legislation to prevent similar schemes and the following document clearly set out Parliament’s intention at the time this anti-avoidance legislation was introduced:

Budget Press Notice 3 of June 2010 states “The government today announces, with immediate effect, an anti-avoidance measure to prevent corporate investors using Authorised Investment Funds for avoidance schemes designed to create a credit for UK tax where no UK tax has been paid.”

In this case there is clear documentary evidence that the tax result of the proposed transaction – a corporate investor using an AIF designed to create a credit for UK tax - is expressly contrary to the intentions of Parliament. Therefore, this is Code Red.