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.