The finally agreed on compromise of the Capital Requirements Directive (CRD IV) Package includes newly introduced transparency requirements for credit institutions. Relevant data such as profit, number of employees and taxes will have to be disclosed on a country-per-country-basis.
On April 16 2013 the European Parliament adopted the fourth edition of the CRD IV. CRD IV primarily aims at transposing Basel 3 into EU law in an attempt to mitigate the risk of a future banking crisis. Simultaneously, certain tax transparency requirements have found their way into the directive. According to the commentary, transparency regarding profits made, taxes paid and subsidies received is essential for regaining the trust of EU citizens in the financial sector. CRD IV has to be transposed into national law by national legislators in the member states which are facing a tight timeline with initial disclosures expected in 2014 and further details to be published as of 2015.
Details regarding transparency requirements including tax information
According to the new Article 86a, an institution must annually disclose the following information for each country hosting an establishment of this institution on a consolidated basis:
- Name (s), nature of activities and geographical location;
- Turnover (usually not a key performance indicator used in the financial sector; likely included as the per-country tax disclosure originated outside the financial sector);
- Number of employees on a full time equivalent basis;
- Profit or loss before tax;
- Tax on profit or loss; and
- Public subsidies received.
While the information in a) to c) will have to be published in 2014, the information contained in d) to f) shall be submitted to the European Commission first on a confidential basis by all EU global systemically important institutions. The Commission will then, in consultation with the relevant European supervisory authorities, during 2014 assess potential negative economic consequences emerging from the public disclosure of this information. This includes the impact on competitiveness, investment and credit availability and financial stability. The information contained in d) to f) will have to be published from January 1 2015 onwards, only if the Commission arrives at the conclusion that significant negative effects would not be triggered. All information referred to above under a) to f) shall be audited in statutory audits of annual accounts and consolidated accounts and shall be published, where possible, as an annex to the annual financial statements or, where applicable, to the consolidated financial statement of the relevant institution. The requirements apply to deposit taking credit institutions or certain regulated investment firms, excluding, broadly speaking, institutions that do not hold client assets. There is a sunset clause which provides for the expiration of Article 86a CRD IV (probably Article 89CRD IV in the final version) if it is addressed in alternative legislation.
The political pressure for country-by-country transparency
Non-governmental organisations as well as EU representatives have argued for some time for more transparency on taxes, licences and bonuses paid by multinational corporations, especially in the extractive industries such as forestry and mining. The campaign aims at enhancing public trust in corporate behaviour and expresses concerns that companies are not paying their fair share of tax. Campaigners equally feel that current disclosures are often difficult for non-tax experts to understand. The Tax Justice Network demands country-by-country reporting for any company trading in more than one jurisdiction whether through branches or subsidiaries. There is a clear desire to further transparency of the group structure as well as to reconcile value added and labor cost in any given jurisdiction.
On April 9 2013 consensus was also reached between the European Parliament, European Commission and the European Council (Trialogue) regarding mandatory reporting for listed and other large companies in the extractive industries. It will be included in the revision of the Transparency and Accounting Directives, which is on its way.
Representatives of the affected industries point at disadvantages emerging from the new disclosure regime. These include additional cost for the reporting, competitive distortions between companies in the scope of the regulations against those outside it, as well as the difficulty to interpret the published numbers. CRD IV, in an attempt to address these concerns, now intends to assess the economic impacts resulting from the disclosure of profit, tax and subsidies until the end of 2014.
Consolidation and third country configurations
Article 86a CRD IV refers to a disclosure of information on a "consolidated basis" which is not always easy to reconcile with a country-by-country approach. CRD IV refers to the Capital Requirement Regulation (CRR) when it comes to the definition of consolidation. "Consolidated basis" therefore needs to be interpreted as a basis which is achieved after consolidating several entities of a regulated group for regulatory purposes. One of the key purposes of regulatory consolidation is to achieve capital adequacy at group level.
While regulatory consolidation rules are in some regards similar to consolidation for accounting purposes, they are by no means identical. In any event, regulatory consolidation rules may apply on a cross-border basis which could contradict the country-by-country principle.
Branches and subsidiaries
Institutions that are covered by Article 86a CRD IV have to disclose data which probably includes establishments in third countries. The term establishment is not defined in the CRR or the CRD IV, but considering the wider context and the purpose of the obligation it could include all subsidiary undertakings and branches. A branch under CRR means a place of business, which carries out activities inherent to the business of the institution and which forms a legally dependent part of an institution. Broadly speaking, EU branches of non-EU institutions are treated in the same manner as subsidiaries, when it comes to regulatory requirements. For banking groups headquartered in the EU this is likely to mean worldwide reporting.
The EU branch of a third country headquartered banking entity will, in our view, not have to disclose headquarter information but only information at branch level and below since the headquarter would be outside EU regulation.
Where a branch of a non-EU entity operates alongside a subsidiary of the same non-EU entity in the same EU country, it is unclear which establishment would have to comply with the reporting obligation. In general, the EU-branch of a third country institution and its subsidiary in the same European jurisdiction would not be consolidated for EU- regulatory purposes. In our view, particularly if the branch were regarded as controlling the subsidiary, would it be responsible for reporting and disclosure concerning the subsidiaries. This will be rather an exception, so that the branch and the subsidiary would likely be subject to several and separate disclosure obligations.
Financial holding companies
Since Article 86a CRD IV addresses explicitly institutions, the question has been raised, how parent entities of institutions such as non-licensed holding companies located in the EU are affected. Following a general approach in banking supervision, the reporting duties have to be fulfilled by licensed institutions only. A financial holding company therefore may not be subject to the reporting. Regardless of the responsibility for the reporting duties the financial information of a non-licensed financial holding company will have to be consolidated and included in the regulatory reporting of a financial holding group. There is a view that this concept will likely also apply to the transparency requirements following Article 86a CRD IV. This view could be supported by the Commentary to CRD IV stipulating that the supervision on a consolidated basis should include all banking groups including those where the parent entity is not an institution in the regulatory sense. The other consequence arising from this would be that parent entities of institutions would only be outside the scope of the reporting if their main activity is outside the financial sector (for example supermarket chains, car manufacturers owning a bank for the purposes of funding sales).
There are, however, also good arguments contradicting this view. The term "institution" may need to be interpreted according to the letter of the law. In other areas of CRD IV, non-licensed parent entities respectively financial holdings have been explicitly referred to. As a consequence, "consolidated" could then be interpreted such that just subsidiaries and branches of an institution would be included in the requirements of Article 86a CRD IV. It would then be irrelevant whether these branches or subsidiaries are themselves licensed for banking/financial services. Excluding the non-banking parts of banking groups organised underneath a financial holding from the reporting requirement could, however, lead to market distortions as depending on the model chosen or customary in certain jurisdictions, large parts of groups could randomly fall within or outside the scope of the reporting requirements.
The issue will have to be clarified through national legislators and regulators. At present it would seem to be a safer assumption that banking groups underneath financial holdings need to get prepared for the reporting too.
Third country parent entities
Third country parent institutions of EU based institutions will probably not be affected directly by the transparency requirements. That means they will in general not have to disclose according to Article 86a CRD IV operations in their home jurisdiction or operations worldwide. This could only become critical in cases where the subsidiary is regulatory consolidated for EU-regulatory purposes with a third country parent entity. Such a configuration would have to be examined on a case-by-case basis. However the general assumption remains that the third-country parent entity – as with a third country headquarter of a branch – would not fall under the disclosure requirements.
Further open questions
National legislators will, among others, have to clarify the following points:
- The extent of the nature of the reportable activities;
- The relevance of turnover;
- More guidance on which profit based taxes will be in scope;
- Disclosure on a cash or accounting basis;
- Treatment of intra-group trading; and
- Existence of a de-minimis threshold before the reporting duty becomes applicable.
Regarding the assessment to be conducted by the Commission in 2014 it should also be clarified, which service within the Commission will be competent for the receipt of data according to Article 86a d)-f) CRD IV.
Required activities by affected institutions: To dos
Affected institutions face challenges in various ways. Even though questions in detail are still open, it is expected that, depending on CRD IV being published before or after June 30 2013, institutions might have to disclose on a country-by-country basis data regarding name, nature of activities, the number of employees and the suitable equivalent of the turnover by June 30 2014 or by December 31 2014. The extent of additional disclosure requirements to be fulfilled from 2015 onwards is subject to the Commission's assessment in 2014.
As can be seen, there are still some fundamental uncertainties about the scope of the reporting. Affected banks should therefore seek to create transparency around these uncertainties to enable the local legislator to respond appropriately. The competitive disadvantage compared with institutions which are geographically out of scope of the regulation will need to be emphasised to ensure this will be considered by the local legislator and regulator. Differences in interpretation between the member states will need to be identified and monitored to avoid misstatements.
Institutions will also need to start getting prepared to generate the required data at short notice. Especially where the data deviates from corporate information which needs to be produced anyway, data collection and generation processes will need to be reviewed. Depending on the volume of the required data, it may be useful to introduce a tool-based approach.
There will also need to be a debate as to what extent the disclosure requirements could anticipate some of the consequences of the OECD paper on BEPS (Base Erosion and Profit Shifting) which may require a review of elements of the corporate structure.
Finally, it is already clear now that the disclosure of the profit tax position, if it was ever to be made public, will lead to significant misunderstandings in public perception. The wider public may have difficulties to appreciate the overall tax charge which a bank is subject to and which may include very significant amounts of stamp duties, irrecoverable VAT, and social security taxes. Conversely, investors may find it difficult to reconcile a cash tax position if published under CRD IV with the effective tax rate position under IFRS. As a consequence, banks will need to start considering how to communicate and explain the disclosures to the media as well as to their shareholders.
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Hans is a partner with PwC and based in Frankfurt. Since 2007 he leads the German tax financial services practice. He is a member of the German financial services and tax leadership team. In July 2012 he was announced as global tax leader for banking & capital markets.
Hans oversees 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.
Tel: +49 69 9585 6595
Jörg Schwerdtfeger is a senior manager with PwC in Frankfurt where he has specialised on banking regulatory, company and tax law. He leads projects in the area of institutions' market entries, cash management and compliance as well as banking product development.
Jörg is a qualified attorney, trained merchant clerk and holds a PhD in contract law. His clients are large and medium sized banks and financial services institutions domiciled in Germany and abroad. Furthermore he provides advice to the treasury and legal departments of industry groups and major utilities.
Before joining PwC in 1999 Jörg Schwerdtfeger worked for the financial product research department of a federal trust agency in Berlin. He is author of numerous publications in the financial services and tax sector and contributes yearly to The Treasurer's Handbook. He speaks at workshops and conventions on regulatory and compliance matters.
Tel: +44 20 7804 6750
Justin Woodhouse leads the international structuring tax team for financial services in the UK, and the UK firm's inbound territories programme. He advises global banks, insurance companies and fund management clients on tax optimising all aspects of their structures and activities, while managing tax risk and maintaining strong relationships with fiscal authorities. He led the firm's engagement on the bank payroll tax and the disguised interest rules. He has worked in New York and for five years in PwC's financial services practice in Japan. Justin became a partner in 1990 and graduated from Cambridge University in law in 1978 and became a chartered accountant in 1981.
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