Bank levies: A step toward harmonisation

Many legislators have focused on the supervision and financial stability of the banking sector which has included the desire to set aside funds to bail out banks finding themselves in financial difficulty. To raise the required funds, European legislators have mostly introduced bank levies. The financial stability levy once considered in the US never found sufficient political support.

Though bank levies have been around for decades, only in recent years since the financial crisis has there been a significant increase in the number of bank levies being implemented. Bank levies are currently being imposed at the national level, with 16 countries in Europe having introduced a bank levy.

This has led to a fragmented landscape of bank levies being imposed at the national level, leaving global banks to cope with varying requirements around the world, though mainly in Europe.

Some levies, for example in the UK, have been introduced as taxes funding the general budget, others (such as Germany) as regulatory levies feeding a fund separate from the general budget.

There is also a great variety in the scope of the national levies, including:

• Base for the levy: the base varies with respect to being based on bank deposits, capital assets, risk-weighted assets, and other calculations with respect to a bank's balance sheet.

• Tax deductible contributions (whether a particular bank levy results in a tax deduction) are decided on a national level and so differs by jurisdiction.

• The implementation date: many bank levies have implementation dates from 2011 through to 2014 and beyond, some with phased-in time periods for different components.

• Branch application: application to branches and subsidiaries of the headquarter/parent bank may differ by levy.

These variations have given rise to multiple bank levy charges for multinational banks with generally no relief being available under traditional double taxation conventions. Only recently have bilateral treaties been introduced aiming specifically at granting credit or exemption relief mitigating multiple charges. Banks normally use multi-disciplinary teams to handle the levy, which may be led out of the regulatory or the tax department.

There is only limited transparency of how much funding has been raised through bank levies against the targets set by legislators. In the case of Germany, though the target size of the restructuring fund is €70 billion ($95 billion), in the first two years of being implemented, only about €1.28 billion in total has been collected.

As far as repercussions of the bank levy on taxable income for corporate income tax purposes are concerned, there is no harmonised picture.

Some jurisdictions allow for tax deductibility of the levy, while others do not. Transfer pricing charges of national bank levies to jurisdictions outside the respective banks' home countries are very complex and seldom successful under the national legislations governing the branch or subsidiary receiving the charge.

As a consequence, implementing bank levies solely at the national level has the potential of creating competitive distortions and tensions between legislative bodies over how to resolve failing multinational banks.

On April 15 2014, three key legislative acts were adopted by the European Parliament to complete the banking union:

• The Bank Recovery and Resolution Directive (BRRD),

• The Single Resolution Mechanism (SRM), and

• The Directive on Deposit Guarantee Schemes.

According to the European Commission, the SRM, which will govern the efficient resolution of an institution, in conjunction with a Single Resolution Fund (SRF or Fund), managed by a central authority will, among others, "restore the orderly functioning of EU banking markets".

The BRRD is an EU-level single rulebook for the resolution of banks in EU member states, one component of which requires member states to establish national resolution funds with a minimum target of 1% of covered deposits. Under the SRM, a Single Resolution Fund will be established to ensure consistent application of resolution funding for all institutions covered under the Single Supervisory Mechanism (SSM), which aims at harmonised banking supervision in the Eurozone.

Contributions should begin under the BRRD in 2015. For the Euro Area, they will be transferred to the SRF in 2016 once the IGA has been ratified by all participating countries; the Eurozone plus other member states opting to participate.

However, the UK, for example, has stated it does not plan to opt-in for purposes of the SSM, and consequently, will not be covered under the SRF, which may lead to further distortion in the markets between the Eurozone and states outside the Eurozone. The UK will have to set up a resolution fund under the BRRD, but the contributions will not be transferred to the SRF.

The Fund is not meant to replace private investors absorbing losses but rather to provide temporary financial aid to ailing banks to ensure that the functions which are critical to financial stability and the overall economy are resolved with a minimal impact on the real economy.

The SRF will be financed by levies on banks covered under the SSM. To meet the financing goals of the Fund, institutions covered will need to collectively contribute roughly 12.5% of the target fund level annually for an eight-year implementation period. The Fund will initially consist of national compartments to be mutualised over a phased-in period, but accelerated with 60% over the first two years, followed by 6.7% in each of the remaining six years.

The funds will be used in a waterfall method consisting first of the use of a bank's national compartment up to a prescribed threshold, followed by the use of the mutualised portion of other national compartments, and finally by the use of any remaining funds in a bank's national compartment. Furthermore, if the previous funds are not sufficient, additional funds can be raised in the form of ex post contributions, loans from the member state, or borrowing from other national compartments.

An intergovernmental agreement (IGA) has been signed that covers the transfer of contributions raised by national authorities and the mutualisation of the funds available in the national compartments.

The level of contributions of an individual bank will be based on two factors:

1) A flat contribution calculated pro-rata based on the amount of each institution's liabilities, excluding own funds and covered deposits compared to the total liabilities, excluding own funds and covered deposits of all covered institutions; and

2) A risk-adjusted contribution based on criteria set out in the BRRD.

Thus, riskier banks will generally make higher contributions than those institutions exposed to a smaller degree of risk. However, given that the regulatory environment aims to make banks less risky, through maintaining more capital, increasing liquidity, and reducing leverage, the burden of the contributions may shift throughout the funding period along with the risk profiles of banks.

Contributions are expected to begin in 2016 to the Fund, with a target size of 1% of covered deposits, or roughly €55 billion, based on 2011 balance sheet data. There are some concerns that a €55 billion Fund is not sufficient to ensure financial stability. The 1%, however, is the minimum set by the BRRD, and thus, participating states may require higher contributions or a higher base if they choose.

Consequently, though the SRF may appear to be a harmonised bank levy for participating states, banks may still be facing a fragmented landscape.

Most notably, though, the minimum requirements for the Fund are set, participating states have the flexibility to choose to raise the minimum requirements or even the relevant base, as long as the minimum amount is met. Thus, even with a single fund, the way the charge is levied may still differ by jurisdiction.

In addition to the SRF, banks may also be subject to additional levies. First, the SRM Board (board that prepares the resolution of a bank) will be financed by a separate, independent levy than that for the Fund. Additionally, if the funds in the SRF are not sufficient to cover a bank resolution, ex post contributions can be raised, imposing an additional levy on covered banks. The ex post contributions will be allocated in the same manner as the annual contributions to the fund, however, the total amount of ex post contributions per year should not exceed three times the amount of annual contributions.

Finally, national deposit guarantee schemes must still be financed, since, in case of a bank failure, the deposit guarantee schemes will still be liable up to the amount they would have been if a bank was wound down under normal insolvency proceedings.

Most global banks have, based on publicly available figures, an effective tax rate (ETR) approximating 30%. There are exceptions to the rule, especially where banks have incurred significant tax losses. This does not greatly differ from ETRs in the real economy.

While bank levies are an above-the-line charge and, hence no component of the ETR of a bank, it is worthwhile including them hypothetically to measure their impact. For example, the UK has raised more than £5 billion from its bank levy since it was introduced in 2011 with some of the largest banks in the UK paying an effective tax rate of 40%, including the bank levy. Taking into account some extraordinary effects hitting one of the banks, the hypothetical effective tax rate of the five biggest banks in the UK was more than 71% in 2013.

Measures introduced under Basel III/CRD IV aiming at enhancing capital and liquidity while reducing leverage have, beyond the goals set by the Basel Committee, contributed to making banks less tax efficient. The same holds true for certain restrictions on the tax deductibility of hybrid debt under national legislation, and the situation will be exacerbated under the OECD BEPS (base erosion and profit shifting) concept.

While the harmonisation of the bank levy is generally a welcome step to simplify cross-border banking business, it is clear from initial estimates that the new levy will add to the financial burden of banks under existing national levies. This burden is running counter to the regulators' goal to strengthen banks' capital bases, as it will limit each bank's ability to set aside retained earnings to build capital. This will adversely impact the Eurozone (plus opting member states) banks' competitiveness from at least two perspectives:

• Their main competitors in the US are not subject to a similar levy and are unlikely to become so any time soon.

• Given that banks have less ability to build capital from retained earnings, they will have to tap capital markets for further capital. Bank levy costs will add to banks offering less attractive earning per shares and other KPIs making it more expensive for them to raise capital than for their European peers in the real economy.

The degree of a banks' suffering from the levy will also depend on its tax treatment. Based on the bank levies in place now, more than half are tax deductible. Should national governments make different decisions regarding the tax deductibility of the levy, this could lead to competitive distortion among the markets.

Additionally, transfer pricing of the new levy continues to be a complicated topic because of the potential deviation of actual implementation approaches from country to country, especially with respect to tax deductibility and the use of calculation basis. Banking institutions may need to implement a transfer pricing strategy to deal with the new levy, which could be linked to the strategy for any existing levies. Furthermore, since the bank levy is a balance sheet driven and regulatory driven cost, a bank group might want to review how efficiently it has deployed its balance sheet, for example in terms of debt and equity mix.

Thus, while a harmonised bank levy is a step toward simplifying cross-border banking, banks may still be subject to a fragmented landscape and left addressing various regulations with different objectives.

Hans-Ulrich Lauermann PwC Direct: +49 69 9585 6174 hansulrich.lauermann@de.pwc.com www.pwc.de Hans is a partner with PwC and based in Frankfurt. Since 2007 he has led the German tax financial services practice. He is a member of the German financial services and tax leadership team. In May 2014 he was announced as co-leader global FS tax. Hans overseas tax and regulatory advice to banks, insurance companies and asset managers. His broad range of experience includes international structuring, coordination of transactions, and compliance projects for financial services companies. Before joining PwC Frankfurt, Hans worked for several years as a director in the London-based global financial services tax team of PwC. He is a regular speaker at conferences on financial services matters. Hans-Ulrich Lauermann is a German attorney and certified tax adviser. He holds a PhD in securities law.

Kathryn Struve PwC Direct: +49 69 9585 2972 kathryn.struve@de.pwc.com www.pwc.de Kathryn Struve is a manager with PwC in the financial services tax team in Frankfurt, Germany. Before moving to Germany in March 2012, Kathryn worked in the PwC New York office where she worked in the asset management team focusing on advising hedge funds and private equity funds. Since moving to Frankfurt, Kathryn has focused on FATCA and has supported multiple engagements in both banking and asset management. Kathryn is a certified public accountant (CPA) in New York and is a member of the American Institute of Certified Public Accountants.