6 August 2010 by

Different taxation regime for banks and finance companies?

Currently banks are taxed on the basis that interest which they pay in respect of the so-called "pool of funds" is deductible. In other words, the argument is that a bank has to accept deposits on the basis that its general intention is to generate income from these deposits. To the extent that it may receive exempt income (such as dividends), it is regarded to be incidental and all of the interest payable by the bank in respect of the pool of funds is deductible. 

It has been announced in the budget tax proposals that financial institutions are perceived to be deducting interest beyond what should be allowed according to tax principles. Measures will thus be introduced to ensure that interest expenses are allocated proportionately amongst various financial assets based on taxable income/gross receipts and accruals formula. In other words, the deduction of funding costs would rather be determined with reference to the percentage of taxable income to gross receipts and accruals as opposed to interest being deductible in view of the fact that a bank generally borrows money in order to lend money on a large scale and to the public.

It is expected that this announcement may have a substantial impact upon the taxation regime of financial entities, especially with reference to the scenario of how financial assets are to be allocated. Up to now it has been argued that the interest arising in respect of the pool of funds was deductible in total given the general intention of a financial institution to generate income. This position may now change depending on the extent to which a financial institution may receive exempt income such as dividends.

Emil Brincker, Director, Tax

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