Banks, tax, and offsetting losses

The Telegraph today is reporting that Lloyds will not pay corporation tax until profits hit £15bn. This has been met with outrage and taken as a further sign of injustice in favour of the banks. I must disagree. While I think the banks should be held responsible for their actions which crashed the economy, in this case they are not even using loopholes, simply doing what they are meant to do.

So what are the banks actually doing to avoid so much tax? They are offsetting their losses against future profit. Here’s how it works.

Imagine a small business that made a £10,000 profit last year. The tax on profits for a small business is 20% so they will pay £2,000 in tax.

The following year, the recession hits them and so they make a loss of ten thousand pounds. Unfortunately tax doesn’t work in reverse and they don’t get two thousand back from the taxman.

That doesn’t seem fair, does it? Well to balance things up, the rules allow a company to take that ten thousand loss and offset it against profits over the next five years until it is used up.

So, in the 3rd year of our example business, they return to profit and make £5,000. They should be liable to pay £1,000 in tax on that profit. Instead, they offset it against the £10,000 loss and pay no tax. The remaining £5,000 of the loss is carried forward for future years.

Finally, in the fourth year, our business makes £10,000 profit again. The have £5,000 of their loss remaining, and so they pay no tax on the first half of their profits, and they pay the full 20% on the second half of their profits. Their tax for that year is £1,000 instead of £2,000.

Enough about small business, what about the banks?

Lloyds and the other banks are applying exactly the same rules about losses and tax as smaller businesses do. We are outraged because of all the other loopholes that the banks use such as overseas subsidiaries and tax havens, and because we have paid money in to these banks in the form of bailouts to the tune of at least £850bn. ($2.4tn if you believe the BBC, but according to this government document no one really knows.) and yet we are not getting tax in return, and because the banks caused so many of our economic problems in the first place. The public are right to be outraged over banks paying minimal tax on their profits, but in this case the anger has been directed at the wrong thing. (For the record, I am in favour of prosecuting the banks for their actions, and have never been in favour of bailing out the banks. Let them fail.)

That is not to say that the ability to offset loss against future tax is entirely fair though. What if, for example, BP attempted to offset their losses resulting from oil spills against their UK tax? Given the environmental damage that they have inflicted and the strong likelihood that wilful negligence contributed to the failure of their equipment and structure, I am firmly of the opinion that it would not be right for them to offset. There is a good case for restricting the offsetting of losses incurred overseas too. Perhaps we should consider preventing the offsetting of losses incurred as a result of negligence or deliberate policy.

One last question to leave you with. RBS has just paid out £950m in bonuses despite incurring losses of £1.1bn. Should they be allowed to offset that £1.1bn loss against tax next year?

Thanks to Frances Coppola for the discussion which prompted this blog post, and to @Puffles2010 and @ntlk for help in finding the numbers.

Author: Latentexistence

The world is broken and I can't fix it because I am broken. I can, however, rant about it all and this is where I do that when I can get my thoughts together. Most of the time you'll find my words on Twitter rather than here though. I sometimes write for Where's The Benefit too.

5 thoughts on “Banks, tax, and offsetting losses”

  1. Good balanced blog Steve – but then I would say that, wouldn’t I! A couple of further thoughts on bonuses:
    1) Executive bonuses are paid mostly in shares rather than cash, so the value is “paper only”. This ties the executive’s remuneration to the performance of the company, gives them a personal incentive to make sure it does well! New EU rules ensure that banking exec bonuses are pretty much entirely equity shares
    2) Cash bonuses to highly-paid bank staff (e.g. traders) currently attract tax at 50%, and gains realised from bonus share sales attract capital gains tax, quite possibly at the top rate because of the amounts involved. So overall the government should encourage loss-making companies to pay bonuses, because the net tax receipts will be greater due to the fact that no corporation tax is payable by the company.

  2. I respectfully disagree with you, Frances Coppola et al on this.

    This is not the main source of anger; it’s a distracting side issue that right-wingers are seizing on to attack left-wing critics.

    As you say yourself about BP, there are cases in which offsetting losses against tax are wrong -and this is quite clearly one of them.

    1. I think the banks clearly ought to return money to the treasury. In this case, though, they are not even exploiting rules, they are following them. The rules were not made with this situation in mind.

      As you say though, this is a distracting side issue. I believe we should never have bailed out the banks in the first place, and since we have, they ought to return money given to them as soon as possible. Given that any repayment terms are not satisfactory to us, what should happen? Do we abolish tax offsetting just for the banks? Just for the banks that were bailed out? Do we specify a tax on turnover, not profit? Do we ban bonuses? Cap pay? So many possibilities, but no clear path to resolve this unfairness.

  3. As you have explained, offsetting losses is standard business practice. What isn’t fair – in my honest opinion – is the fact that my bank (The Co-operative Bank) and my building society (The Ecology Building Society) both have stict self-imposed policies on sustainability in place, and neither lend out a penny of money they don’t hold on deposit. They are fully solvent, and as very secure sustainably-based institutions, have never been able to offer some of the more attractive “competitive” rates of other, higher-risk banks. However, whilst both institutions did not need to be bailed out by the government (when you’re based on a sustainable model of lending, it means you can sustain yourself through hard times) they both had to pay significant sums to the Financial Services Compensation Scheme (FSCS) – which is fundamentally flawed in its structure as it means responsible lenders are forced to pay for the cock-ups made by higher risk organisations.

    1. Maybe the contributions to the FSCS should vary according to the risk of the behaviour of the bank.

      This reminds me, I must switch back from Natwest to Co-op. They were being a pain after our bankruptcy, but no reason not to switch back now. I still have the co-op account open, just nothing going through it so that should speed things up.

Comments are closed.