Fri Jun 29, 2012 11:04am EDT
(Updates to add a statement from HMRC)
By Helene Durand
LONDON, June 29 (IFR) - Market participants lambasted the UK taxman this week for taking so long to come out with a release that sheds little light on the tax-treatment of hybrids, leaving the market in the lurch.
Banks are keen to find out whether instruments issued under the current legal framework, and forthcoming CDR4, will be tax-deductible.
Tax-deductibility is one of the most important considerations that borrowers take into account when looking at issuing various debt instruments, and inherently make debt issuance a more attractive financing option.
Banks that had gone to HMRC with plans to issue new-style hybrid securities ahead of the implementation of CRD4, will be disappointed. Reading the HMRC release, there were quite a number of such banks.
"UK issuers will be in limbo as to how legislation may change once CRD4 is enacted and while 2013 is the date the market is gearing itself towards, it might slip," said a hybrid banker.
"This puts prospective issuers in a difficult spot as they would want certainty on the tax treatment of any instrument they issue and HMRC has said it would provide further guidance only once CRD4 has been enacted."
Vimal Tilakapala, co-head of Allen & Overy's tax practice, said that under current UK tax law, banks cannot issue tax-deductible CRD4-compliant hybrids.
"This paper does not change that nor is it intended to - it simply addresses some additional current law issues," he said.
The release stated that under CDR4 criteria, Additional Tier 1 instruments must be truly perpetual and that HMRC remained of the view that a truly perpetual instrument could not be a debt.
"There is uncertainty in the market as to the correctness of HMRC's assertion that CRD4 compliant hybrids must be 'true perpetuals'," said Tilakapala.
HMRC draws the distinction between true perpetuals and contingent perpetuals and said it would consider these instruments on a case-by-case basis. If the sum to be repaid on the happening of the contingent event is known at the time of issue, these would be classed as contingent debt.
There are no guarantees that coupons would be tax-deductible, however, and this would be dependent on "distribution legislation" being engaged.
The release states clearly there will be no change to the tax treatment of any perpetual instrument issued prior to its publication, which market participants said was a positive, but it equally says nothing about instruments issued between now and the implementation of CRD4.
Meanwhile, HMRC has left it to UK finance ministers to determine the tax treatment of future capital instruments.
"The Finance Bill contains a power for the government to introduce new regulations to govern the tax treatment of regulatory capital instruments and draft regulations should be published once the CRD proposals are finalised," said Tilakapala.
"This is what the market is anxiously waiting for. This paper still doesn't give any clues as to what these regulations will say."
However, an HMRC spokesperson said "HMRC published this guidance to give banks and their advisors certainty about the tax treatment under current law for certain types of borrowing instruments banks are looking to issue and we wanted to make sure all aspects had been considered before publication. It is not for HMRC to decide future tax rules."
Bankers now fear that moving the issue to the political arena could be dangerous.
"Tax-deductibility of bank hybrid instruments will become a political decision," warned one. "In this context, the recent focus on tax avoidance is quite unfortunate."
Another echoed this view. "Which politician is going to want to give the banks a tax break?" he said. "This is a massive political hot potato and it could easily end quite badly."
However, others downplayed those concerns, saying that the UK would need to stay competitive from a tax perspective.
Although global regulators ideally want banks to boost their capital bases with ordinary share capital, if other jurisdictions allow their banks to issue tax-deductible capital instruments, the UK would clearly be at a disadvantage if it didn't do the same," said Tilakapala.
FEARS FOR SENIOR
Meanwhile, a number of bankers expressed concern over the wording of Clause 6 in the release and whether UK bank senior debt could be at risk of losing its tax-deductible status.
The clause suggests that instruments subject to a statutory bail-in framework might not be tax-deductible, even if there are no references to write-down or conversion to equity, either in the risk factors or the contractual terms. A strict reading of this suggests that both senior debt and subordinated capital instruments may not be tax-deductible if/when statutory bail-in powers come in.
European and UK regulators have been pushing hard to make senior debt bail-ins part of the tool kit that would help resolve failed banks. An EC Directive which will have to be transposed by EU member states is set to implement a European-wide bail-in regime for bank senior debt from 2018.
Given that in future all debt will likely be captured by statutory bail-in frameworks, bankers wonder why HMRC would make Tier 2 result-dependent (i.e. remuneration would be dependent on the performance of the bank) but not senior.
HMRC refers to AT1 and T2 as classes of debt that will become results-dependent once statutory bail-ins are introduced, but does not explicitly exclude senior.
For some, the use of the term bail-in rather than write-down, as per the European Crisis Management Directive, is a source of concern.
"This is really unhelpful," said a hybrid banker. "It could potentially now be problematic to achieve tax-deductibility even for senior debt as the HMRC views the potential for bail-in as a re-characterisation of the instrument."
This was a disappointment for some bankers who, while they knew it was always going to be difficult to achieve tax-deductibility for instruments with contractual bail-in, thought instruments captured by statutory frameworks would escape.
"Although the release refers in parts to Tier 2 and Additional Tier 1, you could see senior no longer being tax-deductible once bail-in frameworks are in place," said another banker.
However, not all were as gloomy. "While an implication of the paper is that all debt covered by a statutory bail-in regime might become results-dependant, it is hard to imagine HMRC take a position that would cause such an extreme result," said a capital solutions specialist. (Reporting by Helene Durand; editing by Alex Chambers and Philip Wright)
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