Changes to the definition of bank: the evolution of taxation in the financial sector

HMRC has updated the UK tax definition of a ‘banking company’ in line with the Finance Conduct Authorities’ (FCA’s) regulatory definitions. Although presented as a routine update, the changes widen the range of financial services companies that will need to consider the tax definition of a bank. Operators of Organised Trading Facilities (OTF’s) that have previously fallen outside the UK tax definition of a bank will need to look again to determine whether or not UK banking tax rules apply to their businesses.

Banking Article 1920X1080 Jul 22
Steven Fearnley
Published: 03 Oct 2022 Updated: 03 Oct 2022

There have been several changes to the specific tax rules that impact the banking sector, meaning there are significant additional criteria to consider for companies that are taxed as banks:

Bank Levy

The Bank Levy was introduced in 2011 but has evolved to include several iterations since its inception. It applies to banks with a chargeable equity and liability of £20 billion or more.

Bank Surcharge

The bank surcharge, originally introduced in 2015, increased the tax rate charged on profits over £25m by 8% (over the standard corporation tax rate). In 2021 the Government confirmed plans to reduce the surcharge to 3% (in response to the planned increase in UK corporation tax to 25%) and increase the profit threshold to £100m. Following the September 2022 Mini Budget, the decision was taken to retain the 8% rate, in line with the retention of the main corporation tax rate at 19%. However, the increase in the profit threshold to £100m is being maintained to support growth in smaller challenger banks.

Bank Loss Relief Restrictions

From 1 April 2015, the proportion of participating banks’ taxable profits that can be offset by carried-forward losses was restricted to 50% for pre-April 2015 losses and then further reduced to 25%.

Bank compensation payment restrictions

Legislation introduced in 2015 in response to growing PPI claims and corresponding accounting accruals can restrict relief for bank compensation payments.

Code of Practice on Taxation for Banks

The Code of Practice on Taxation for banks was introduced in Finance Act 2014. Although a voluntary code, companies falling within the tax definition of a bank are compelled to adopt the code or be disclosed on a publicly published list of non-adopters.

Expansion of tax definition of bank

The most recent iteration in the evolution of the taxation of banks include amendments to the definition of ‘banking company’. By aligning with the FCA’s regulatory definitions, the scope of companies that are taxed as a bank is extended to include the operations of OTFs. These regulations came into force on 5 April 2022 and apply from 1 January 2022.

Who defines what is a bank?

UK tax legislation relies on the definitions of the Prudential Regulatory Authority, which supervises banks, building societies and the largest investment firms, and the FCA, which supervises all other investment firms, to define what should be taxed as a bank.

Revisions to the Markets in Financial Instruments Directive (MiFID II) introduced the concept of Multilateral Trading Facility and Organised Trading Facility venues – known as MTFs and OTFs. These venues offer multiple third parties a platform to execute trading contracts.

Previously, operators of these venues were outside the tax definition of a bank. The recent change to align the UK tax definitions to the FCA’s regulations widens the scope of relevant regulated activities that need to be considered when reviewing the tax definition of what is a bank.

What this means

Companies found to be banks should consider the bank-specific taxes noted above. Although allowances and de-minimis carve outs for these taxes may mitigate any cash tax cost, companies subject to the rules taxing banks will still need to consider whether or not to subscribe to the Code of Practice. As such, the revised definition will result in additional legislation for many financial service firms to consider and could result in increased scrutiny from HMRC.

Next steps and how we can help

While the rules may only apply to a limited number of financial service companies, the change is a significant expansion of the definition of banking company that may require brokerage businesses and trading platforms to reassess whether or not these rules could apply.

The heightened focus on compliance and risk management mean financial service companies should pro-actively examine these rule changes to determine whether they apply and if not, document why they are outside the rules should HMRC seek to apply them.

Whether or not your business needs support reviewing the definition of bank for the first time, or assistance in evaluating the appropriateness of existing tax risk management processes, our team of experts would be pleased to arrange an initial call.

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By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication.

Tax legislation

Tax legislation is that prevailing at the time, is subject to change without notice and depends on individual circumstances. You should always seek appropriate tax advice before making decisions. HMRC Tax Year 2023/24.