CFM90840 - Debt cap: financial services groups: qualification affected by losses on activities normally reported on a net basis
This guidance applies to worldwide group periods of account ending before or straddling 1 April 2017.
TIOPA10/S266 (1) (b) relaxes the qualification for a financial services group where the trading income condition is not met because of losses on a business activity reported on a net basis
A group is a qualifying financial services group if it meets the trading income condition for a period of account of the group. The trading income condition is tested by establishing how much of the group’s worldwide trading income (or if the test is made by reference to the relevant group companies, the UK trading income) is made up of income derived from qualifying activities.
In calculating the worldwide (or UK) trading income, the income taken into account is the gross income, unless the accounting standards under which the financial statements are prepared require the income to be reported on a net basis. CFM90940 and CFM90950 provide more detail on calculating the worldwide trading income and UK trading income respectively.
Financial services groups such as banks usually have specific accounting standards that govern how their financial statements are drawn up. IFRS 7 Financial Instruments: Disclosures requires an entity to disclose in the income statement the net gains or losses on particular financial assets, financial liabilities, investments, and loans and receivables. The buying and selling of financial instruments is reported by reference to the margins made, not on the absolute sale value of those instruments. When the markets are volatile, a group may incur significant losses on the sale of these instruments. However, the fact that losses are made does not detract from the fact that this particular business activity relies on debt to fund the business. Gain or loss, debt is still required for the underlying business activity of buying and selling the financial instruments.
If losses are made, this reduces the worldwide or UK trading income, and more importantly reduces the amount of trading income that is derived from qualifying activities. Consider the following two examples where the only difference is the net trading income
| - | Example 1 | Example 2 |
|---|---|---|
| Interest income | 100,000 | 100,000 |
| Interest expense | - 95,000 | - 95,000 |
| Net interest income | 5,000 | 5,000 |
| Fee & commission income | 5,000 | 5,000 |
| Fee & commission expenses | -3 ,000 | - 3,000 |
| Net fees & commission | 2,000 | 2,000 |
| Net trading income | 10,000 | - 40,000 |
| Other income | 2,000 | 3,000 |
| Total income | 19,000 | - 30,000 |
| Trading income | 117,000 | 68,000 |
| Income from qualifying activities | 110,000 | 60,000 |
In both of these examples the fee and commission income does not arise from qualifying activities. In Example 1, the net trading income shows a profit and overall substantially all the trading income is derived from qualifying activities. The trading income is the total of the gross interest income £100,000, gross fee and commission income £5,000, net trading income £10,000 and other income £2,000. By contrast in Example 2, the net trading income shows a loss and overall the income from qualifying activities does not represent substantially all of the trading income. The trading income is the total of the gross interest income £100,000, gross fee and commission income £5,000, the net trading income (£40,000) and the other income £3,000.
Where the trading income condition is not met, solely because income that arises from an activity that is a qualifying activity and is reported on a net basis, shows a loss,TIOPA10/S266(1)(b) treats the worldwide group as a qualifying financial services group for the period of account of the worldwide group. There are no set criteria by which to judge whether a group satisfies this sub-section; it is up to the group to be able demonstrate that without the losses it would have met the trading income condition for a period of account.
The reference in S266 (1)(b) to financial statements prepared in accordance with IAS provides a common frame of reference for deciding whether particular income is reported on a net basis or not. Irrespective of the accounting standards under which the financial statements are prepared, the question of whether income is reported net or not is dependent on whether the income is reported on a net basis in accordance with IAS, which in effect means in accordance with IFRS 7.