In Tax Plan's Fine Print, Banks Find a Problem

By Telis DemosFeaturesDow Jones Newswires

As the U.S. Congress attempts to hammer out a final tax plan, Wall Street is fighting to limit the scope of a provision meant to discourage companies from sending money overseas to avoid taxes.

Banks' beef: The way the provision is written in the Senate version of the tax bill could make some key bank businesses much more expensive. These include transactions in the $2 trillion repurchase obligation, or "repo," market, as well as the business of lending out stock that banks and other firms hold on behalf of customers. Foreign banks, too, say the tax provision will make their U.S. operations more expensive and reduce their ability to lend in the U.S.

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Repos are a big business and major funding mechanism for banks, which make money by lending out securities they or their customers own, such as U.S. Treasurys. They often involve transfers of cash between different arms of a bank in different countries.

This and other business activities are at risk of being specially taxed under the tax-code provision known as the base erosion anti-abuse tax, banks and their industry groups say.

The provision is intended to limit companies' ability to shield money from U.S. taxes that they send to their overseas arms. It would ensure that companies pay a minimum level of tax on transactions involving affiliated foreign entities.

All companies are potentially affected, but banks are especially concerned because many of their businesses involve moving money back and forth between their U.S. and foreign arms to secure funding and facilitate transactions.

Currently, payments to overseas affiliates are deducted from firms' U.S. tax obligations. Under the Senate version of the tax-code overhaul, banks and securities dealers would as of Jan. 1 potentially owe a special, minimum 11% tax on those deducted amounts.

The Senate bill exempts some types of derivative transactions from the tax. But in exchange, banks would pay a higher overall rate in terms of the base-erosion tax. Non-banks would only owe a 10% tax on these deductible payments.

For years, many countries have been seeking ways to stop companies from so-called "stripping" earnings to reduce their domestic-tax bills with foreign payments. The U.S. Senate will have to decide how punitive it wants to be on such activities.

"There is an argument that this is an over-inclusive proposal, because it's arguably applicable to nontax motivated transactions," said Rebecca Kysar, a professor at Brooklyn Law School who studies international taxation and tax treaties.

In one example laid out by banking groups to senators, and based on a 10% rate, a U.S. bank entering a "repo" transaction could end up owing $10,000 in taxes on a trade that makes just a $1,000 profit, according to people familiar with the discussions. That is because there is a $100,000 payment passing between the bank's U.S. arm and U.K. arm on behalf of a client, for which the bank earns a $1,000 spread. That $100,000 would still be deductible for U.S. tax purposes, but it would also be subjected to the new, special minimum tax. The result would be a $10,000 tax bill, the banks argued.

Foreign banks fear the provisions could drive up the cost of funding their U.S. operations. That is because a U.S. arm that normally deducts the interest it pays on loans from its foreign parent would now owe the special tax on that amount.

Concerns about the provision are another example of how big companies, despite getting a major cut to their overall tax rates, may still be squeezed by parts of the plan, such as the corporate alternative minimum tax rate.

It isn't yet clear if banks will succeed in convincing lawmakers to alter the language. Even lawmakers sympathetic to banks' arguments may have trouble taking away revenue that is needed to offset popular cuts elsewhere in the tax overhaul.

The revenues generated from taxing these payments could be substantial. The Joint Committee on Taxation reported that the foreign affiliate base-erosion provisions in the Senate bill would generate some $140 billion in revenue over 10 years, versus $94.5 billion in the House version for the same period. The latter bill doesn't impose a higher tax on banks and more broadly excludes transactions.

Efforts to protect banks from these taxes have had mixed results. The House version of the tax bill broadly excluded transactions that involve the sale of a security from the base-erosion provisions. Several bank lobbyists said the language is vague, but preferable to the more limited language in the Senate bill.

An early version of the Senate bill didn't offer any exemption for banking activities. Groups including the Securities Industry and Financial Markets Association sent letters detailing their concerns about the tax applying to everyday movements of money to foreign affiliates that aren't intended to hide income abroad in lower-tax countries, according to people familiar with the discussions.

The final version of the Senate bill added an exemption on payments related to derivatives. But it didn't cover other banking activities that involve intercompany payments.

The Institute of International Bankers, a group that represents large foreign banks in the U.S., sent a letter to lawmakers asking them to find ways to exempt intercompany interest payments. Some European regulators have also proposed excluding payments made by U.S. arms of foreign banks on debt related to regulatory capital provided by their parent bank.

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(END) Dow Jones Newswires

December 13, 2017 05:44 ET (10:44 GMT)