Asia-Pacific banks, in particular, need to brace themselves not only for demanding new regulations but also for significant adverse tax consequences.
Traditionally, tax considerations have been among the important drivers in strategic decisions about banks’ corporate structure and location. They have played a significant role, for example, in debates over branch structures versus subsidiarization; they have contributed to discussions of outsourcing, shared service centers and intra-group trading. The opportunity to configure operations and legal structures to derive tax efficiencies and reduce costs has brought benefits to many stakeholders. However, regulators in Asia-Pacific are now turning close attention to how banks operate and are structured; the consequences are likely to impose serious constraints on companies in future.
Regulators in the region are fully aware that many of the actions being undertaken by their counterparts in Europe and the US are designed to ensure that banks do not have to be bailed out by public funds in the future. In consequence, their priority is to protect domestic financial operations, especially retail banking. As a result, global banks have to give priority to managing constraints on their Western operations, de-emphasizing those in Asia-Pacific. Local regulators are rightly concerned.
It is clear that new regulations in the West are going to require major restructuring of big banks, and at least significant separation of retail from investment banking; the Volcker Rule in the US, the UK’s Vickers Report and most recently the EU-commissioned Liikanen Report all point in the same direction. A further factor is that many European banks are still deleveraging, disposing of assets in Asia and elsewhere and rationalizing geographical operations. In this restructuring process, Asian regulators are trying to protect their own positions, imposing their own restraints on structure, for example requiring increased subsidiarization.
Important tax consequences will follow from such decisions; Asia-Pacific banks need to understand and make the most of what freedom of maneuver they will have. Subsidiarization, for example, will imply separate taxation of one or more locally-incorporated companies. Much of the burden will be mandatory, but there will be some options which can be exploited. Some banks may be able to vary the locations where they report, or even change from one type of banking license to another.
One key issue for banks having to establish local subsidiaries is how to capitalize them most effectively and tax-efficiently. Local regulations vary, for instance, in relation to whether and to what extent hybrid instruments can qualify as Tier I capital. In many cases, there may not be much flexibility over alternatives to pure equity, but injecting capital will still present challenges. In Singapore, for example, following from developments in Basel III, the regulators have recently removed a category of capital known as “Innovative Tier 1 Capital” in assessing the capital requirements of local banking subsidiaries. Previously, the Innovative Tier 1 Capital allowed certain degree of flexibility in terms of utilizing hybrid instruments which are able to satisfy regulatory capitalization requirements and achieve tax efficiency concurrently. Following the removal of the Innovative Tier 1 Capital, certain hybrid instruments that exhibit debt-centric characteristics will be phased out. This regulatory development is expected to limit the tax-planning opportunities that may be achieved through the subsidiarization process.
Related issues include how liquidity can best be ensured. Will reliance on intra-group funding be permitted? Will regulators recognize offshore parent guarantees? What charges for liquidity will be admissible? How will debt be treated? Will historic losses be transferable into a new subsidiary, and can they be utilized in tax planning? In China, for example, one or two recent local incorporations have triggered disputes with tax authorities over the treatment of the asset cost base being carried over.
Subsidiarization also has important impacts on transfer pricing and on thin capitalization issues as rules of different countries may discriminate between the legal form of branch and subsidiary, particularly in the capital and liquidity arena. This may present Asia-Pacific banks with both opportunities and challenges in introducing capital charges, guarantees and rethinking the transfer pricing consequences following any potential changes to their booking structures as well as the organization of liquidity buffers.
Challenge and dispute
The stakes can be high when it comes to the taxation of global bank subsidiaries. So we are already beginning to see fiscal authorities challenging claims for reliefs and exemptions: these are likely to increase in future. Regulators are also imposing conditions on banks’ operational infrastructures, for example expecting locally-incorporated subsidiaries also to have local processing operations and back offices. In many cases, these requirements are not tax or cost efficient. They also raise major issues which go beyond tax and transfer pricing – into areas such as corporate governance, risk management and contingency planning. Recovery and resolution planning need to build in the impact of tax issues.
Restructuring and relocation can also stimulate challenges from tax authorities reluctant to see sources of revenue move offshore. In certain cases, companies may be required to argue the economic and business logic of particular moves, to demonstrate that they are not motivated by tax considerations. Where moves do occur, the authorities will increasingly be looking for compensatory tax measures. Double taxation disputes are likely to occur more frequently.
Within group structure, the results of reconfiguring tax and cost structures between different branches and subsidiaries can be unwelcome. Groups and teams which were profitable under one configuration and tax and regulatory framework can become unprofitable when subject to a different regime. This can have serious consequences for morale, performance and retention. If high-performance teams are to be relocated from one jurisdiction to another, special measures may be needed to preserve their value in the medium and longer term.
All of these issues impose on banks a more than normal requirement for indepth analysis, foresight and planning. As we have seen, restructuring forced by Western regulators will almost certainly have knock-on implications for Asia-Pacific structures, operations and tax results. Even if the scope to minimize adverse tax consequences may be more limited than normal, forward planning will still be important – as will the need to document the reasons for decisions to create an audit trail which records the clear strategic business analysis and commercial drivers behind specific decisions. Existing transfer pricing policies may also need to be revisited to timely reflect the regulatory considerations and changes made, in particular to verify whether commitments and guarantees provided by the Western counterparts remain fully valid and enforceable for the purposes of transfer pricing.
In many cases banks will find themselves having to make the best of a bad job. But it will be a lot better than nothing at all.
For further information, please contact:
KPMG in Hong Kong
Tel: +852 2143 8790
KPMG in Singapore
Tel: +656 213 2027
KPMG in Hong Kong
Tel: +852 2685 7457
KPMG in Hong Kong
Tel: +852 2826 7283