EU CRD IV Country by country reporting - EYFile/EY-EU-CRD-IV-Country-by-country-reporting.pdf ·...

EU CRD IV Country by country reporting Insights and challenges

August 2013

Confidential — all rights reserved © EY 2013

Contents 01 Introduction 3 02 Summary of the CBCR rules 7 03 Determining the scope of the rules 10

3.1 Institutions in scope 11 3.2 Consolidated basis 14 3.3 Establishment 19 3.4 Financial Year 21 3.5 Name(s), nature of activities and geographical location 22 3.6 Turnover 23 3.7 Number of employees on a full-time equivalent basis 27 3.8 Profit or loss before tax 28 3.9 Tax on profit or loss 29 3.10 Public subsidies received 33 3.11 Format of disclosures 34

04 Appendix: list of abbreviations 36


01 Introduction


1.1 Overview of Capital Requirements Directive IV (CRD IV) The country by country reporting (CBCR) requirements are a key component of CRD IV and the Capital Requirements Regulation (CRR) reform measures. The purpose of CRD IV is to implement the requirements of Basel III into EU law and it has three key strands of regulatory measures: ► Capital and liquidity requirements and buffers ► Cap on “bankers’ bonuses” ► CBCR requirements The CBCR requirements were a last minute extension of CRD IV and link into the wider tax transparency debate taking place across governmental organizations, regulatory bodies and the commercial sector. There has been a sharp focus recently on the taxes paid by multinational companies and a desire from stakeholders, including senior political figures, for increased tax transparency. Although there are a wide range of tax transparency developments that impact the financial services sector, this document focuses on the CRD IV CBCR requirements and some of the practical implications for affected institutions. It should be noted the precise form of the rules will be determined by the law which is enacted by each of the Member States. The subject of tax transparency reporting is also a rapidly evolving area which has a natural overlap with other topical developments, such as the Action Plan on Base Erosion and Profit Shifting (19 July 2013) report published by the OECD and the possibility of an expanded EU Accounting Directive. All of these developments will need to be monitored over the coming months which will add an extra layer of challenges for financial institutions trying to prepare for this brand new financial reporting regime.

1.2 Purpose of this document The CBCR rules are intended to enhance the level of transparency related to the tax affairs of EU regulated institutions. Whilst the policy intent of the rules is clear, it is widely recognized that the rules as drafted contain little detail, being less than two pages in length. Multiple potential interpretations of those rules may therefore be possible. A cornerstone of a transparency regime which applies industry wide must be to ensure that disclosures are understood by stakeholders and, in addition, that there is comparability between institutions. This is desirable both to help stakeholders to make appropriate judgments regarding the disclosures of an institution and to ensure that institutions are not competitively advantaged or disadvantaged, by their disclosures. Whilst we recognize that the complex and differing operating models of financial services groups means that one set of interpretations may not be the most representative, and therefore transparent, in all circumstances, this document aims to provide a framework of key definitions. We also highlight the various potential interpretations of the rules and assess the practical application of those interpretations as a first step to providing a set of rules and guidance that could be applied.

Introduction

3 EU CRD IV Country by Country Reporting

01


1.3 Interaction of CBCR with other elements of the CRD IV ‘package’, such as FINREP Whilst the CBCR provisions are, to a large extent, stand alone from the rest of CRD IV and CRR, in areas where overlaps do potentially exist, reporting institutions will need to understand how the different provisions interrelate in order to ensure that their approach to applying the CRD IV package as a whole is consistent. In addition, taking a holistic view should allow institutions to identify synergies and efficiencies that may be achieved from common aspects of the different reporting frameworks. FINREP, a standardized EU-wide framework for reporting financial (accounting) data, is a key part of CRR. Under this harmonized reporting regime, institutions will be required to submit a large suite of new returns to national supervisory authorities on a quarterly basis, with granular data requirements related to the composition of the balance sheet, income statement and off balance sheet exposures. FINREP is expected to initially apply to listed credit institutions and investment firms (consolidated groups) applying IFRS from 1 July 2014. As the CBCR rules could apply to 2013 data, then these rules are actually on a more advanced timetable than FINREP.

1.4 Transposition of CRD IV into EU Member State law Like other EU directives, CRD IV is binding in its entirety on the Member States. In contrast to EU regulations, which are automatically applicable in a Member State’s domestic law immediately after entry in force, EU directives must first be transposed into domestic law by the Member States. The deadline for transposing CRD IV into the Member State domestic law is 31 December 2013. It is important to note that although the directive obliges Member States to achieve the result stipulated by the directive, there is some flexibility in how the directive is adopted which leaves open the possibility of differing interpretations at a Member State level.


Confidential — all rights reserved © EY 2013 5 EU CRD IV Country by Country Reporting

Note regarding Member State interpretations

It should be noted that the CRD IV CBCR requirements must be implemented into local EU Member State law before 31 December 2013. During the course of implementation, the Member States may elaborate on the requirements, expand their scope, or define their own interpretations of key terms. Those interpretations may not be consistent with those used in this document and therefore care should be taken to refer to rules of the applicable Member State when preparing CBCR disclosures.


02 Summary of the CBCR rules


2.1 Disclosure requirements This section summarizes the CBCR rules, which are contained in Article 89 of CRD IV. The rules require each credit institution and investment firm, as defined within the directive, which are regulated under CRD IV to “disclose annually, specifying by Member State and by third country in which it has an establishment, the following information on a consolidated basis for the financial year:” We understand the additional data requirements (items (d), (e) and (f)) in the first year of reporting in 2014 only apply to EU G-SIIs, and this data is required to be submitted to the European Commission, on a confidential basis in 2014. The Commission will review this data, consider the potential negative economic consequences of publication of such information, and report to the European Parliament and the Council on the findings of its review by 31 December 2014. Unless specific changes to the directive are enacted following the Commission’s review, then all affected institutions will need to publicly disclose all items listed in the rules on a country-by-country basis from 1 January 2015.

2.2 Timetable of provisions The CBCR rules were published in the Official Journal of the European Union (OJEU) on 27 June 2013. Therefore, assuming no Member State challenges the rules or their timing before the ECJ over the coming months, the rules will be effective from 1 January 2014 onwards. The first deadline for reporting purposes will be six months after the date of application, i.e., 1 July 2014. This applies both to the publication of items a) to c) and, for relevant G-SIIs, to the submission of items d) to f) to the Commission. For 2015 and beyond no publication deadlines are specified in the directive.

Summary of CBCR rules


02 CRD IV CBCR disclosure requirements

2014 requirements

2015 onward requirements

(a) Name(s), nature of activities and geographical location All institutions

required to publish the data requirements in (a) to (c)

Full public disclosure, items (a) to (f) will apply to all institutions from 1 January 2015

(b) Turnover

(c) Number of employees on a full time equivalent basis

(d) Profit or loss before tax

In addition, Global Systematically Important Institutions ('G-SIIs'), authorized within the European Union, provide the data required in (d) to (f) confidentially to the European Commission

(e) Tax on profit or loss

(f) Public subsidies received

EY observation There may be a degree of room for the Commission to learn from the experience of reports they receive from EU G-SIIs in 2014 and make proposals for any necessary modifications to the directive to increase the effectiveness of the CBCR rules from 2015 onward. It appears, however, that the power conferred on the Commission would only allow them to suggest changes to the rules if a negative economic consequence is identified in the Commission’s report. Proposing more general changes related to the rules may not be strictly within the Commission’s remit. Article 89 does additionally give the Commission the right to defer the requirement to publish items (d) to (f) if its review identifies significant negative effects of publication of those items. This will be an annual deferral and appears to be included in Article 89 to delay publication whilst any legislative changes to Article 89 that are proposed by the Commission are considered by the European Parliament and Council. Whilst the purpose of reporting items (d) to (f) to the Commission is to allow them to assess the macro economic impact of publishing those items in future years, some institutions have confirmed that they are already assessing the impact of the disclosures they may need to make from a reputational risk standpoint. Further, there is also a “sunset” clause in the rules (Article 89 (5)) that provides for the expiry of the CBCR provision if it is addressed in the future in alternative EU legislation, such as an updated EU Accounting Directive. However, the sunset clause will only be activated if CBCR requirements in any future EU legislation match or go beyond those stipulated in CRD IV. It is therefore important for institutions to monitor wider developments in CBCR.


In order to be effective, the directive will require enactment in the Member State law by 31 December 2013. If a Member State fails to implement it in time, however, EU remedies exist to help ensure that implementation can take place.

2.3 Format of publication and audit requirements The rules require that, where possible, disclosures should be published as an annex to the annual/ consolidated financial statements of the reporting institution. What constitutes “disclosure” and “publication” may take on a slightly different meaning within different Member States, but is likely to relate to the concept of being made available to the general public. Where publication should be made It is not clear whether the word “annex” is intended to create a requirement that the disclosures must be published within the financial statements or whether a separate publication, for example on a company’s website but with a cross-reference within the statutory accounts, would be sufficient. Publication on a website should not, we believe, be contrary to the policy objectives of the CBCR rules. In many ways it should increase transparency since an attachment within a company’s website, so long as it can be located relatively easily, may be easier for stakeholders to locate and access than a company’s filed statutory accounts. We also note that publication as an annex is only required under Article 89 “where possible”. It is not clear in what circumstances an institution would be able to argue that publication in this way was not possible, but it is clear the directive contemplates that publication could take place in ways other than as an annex to a company’s financial statements.

Format of publication The directive does not provide any guidance or template setting out the format of the disclosures. For other areas of CRD IV, organizations such as the EBA have responsibility for providing such templates, an example being COREP and FINREP reporting templates, but it is not clear that their remit will extend to the publication of templates for Article 89. In the absence of guidance from the EU, EBA, or other authority, each institution will have to determine its own approach to disclosures. There are, however, a number of examples from other sectors that could be drawn from in determining an appropriate publication format. 1 By developing its own approach, an institution will be able to tailor its disclosures to represent the most accurate and transparent description of its tax contribution in the markets in which it operates. This form of bespoke reporting would potentially be at the expense, however, of comparability between institutions. Audit requirements It is important to note that only published information will be subject to the audit requirements stipulated by Article 89 of the directive (and audited in accordance with directive 2006/43/EC). Whilst the wording of Article 89.4 relating the audit of the disclosures allows for multiple interpretations, we consider that the information required to be submitted confidentially by the EU G-SIFIs to the European Commission in 2014 (i.e., items (d), (e) and (f) above) may not need to be subject to external audit procedures. However, beyond the first year and with the requirement for all institutions to publish all items ((a) to (f)) from 2015 onward, we expect all the items listed in Article 89.1 to be subject to audit procedures.

1. For example, Rio Tinto disclosed tax payments on a country by country basis in a separate document, which is available on Rio Tinto’s website. Vodafone included country by country tax disclosures in its Corporate and Social Responsibility report which is also available on its website.



03 Determining the scope of the rules


3.1.1 Introduction This section considers the CBCR rules highlighted in Section 2 in further detail, including alternative interpretations of the provisions of Article 89, together with key definitions and phrases used. Where areas of uncertainty arise, or terms are not clearly defined, we suggest alternative interpretations of the provisions. We conclude by providing EY’s observations on the interpretation of the CRD IV CBCR rules. The following key issues are discussed in this section: In order to set their CBCR disclosures in context for stake holders, we anticipate that some organizations may wish to voluntarily disclose additional detail or provide narrative explanation over and above the formal Article 89 requirements. If this approach is taken it will be important for institutions to engage early with the firm that will be auditing the disclosures to understand their approach to auditing this additional voluntary reporting.

EU CRD IV Country by Country Reporting 10

Determining the scope of the rules 03

Issue

3.1 Institutions

3.2 Consolidated basis

3.3 Establishment

3.4 Financial year

3.5 Name(s), nature of activities and geographical location

3.6 Turnover

3.7 Number of employees on a full-time equivalent basis

3.8 Profit or loss before tax

3.9 Tax on profit or loss

3.10 Public subsidies received

3.11 Format of the disclosures


3.1.1 Introduction One of the first steps organizations will need to undertake is to assess whether any part of their group will fall within the ambit of Article 89. The Article is triggered only where a group includes an “institution” as defined within CRD IV. Having identified in scope institutions, a group will then need to assess what further entities within its group structure it must report on, in addition to each institution’s stand-alone activities. For non-EU headquartered groups with operations in the EU, this two-step process could present a challenging exercise and careful analysis will be needed on a country by country basis. EU headquartered institutions should already understand the parts of their worldwide group subject to CRD IV regulation. In understanding the practical application of the concept of an “institution” there are various layers of complexity that need to be considered and these issues are discussed below.

3.1.2 Definitions and interpretations In many cases, terms used within Article 89 are defined within CRD IV or alternatively definitions are cross referenced from CRR or other EU legislation. “Institutions” are defined in CRR as “credit institutions” and “investment firms”. These terms are then further defined in Article 4 of CRR. Credit Institutions ► Credit institutions – “an undertaking the business of

which is to receive deposits or other repayable funds from the public and to grant credits on their own account” CRR Title I Article 4.1(1).

Investment Firms ► Investment firms – “any legal person whose regular

occupation or business is the provision of one or more investment services to third parties and/or performance of one or more investment activities on a professional basis” as defined in Article 4(1)(1) of directive 2004/39/EC (MiFID), as referenced at CRR Title I Article 4.1(2).

► The terms investment services and investment activities are then further defined within Section A, Annex I of MiFID, but we have not sought to reproduce those in detail here.

Investment firms also expressly exclude the following: ► Credit institutions – (as defined above) ► Local firms – “a firm dealing for its own account on

markets in financial futures or options or other derivatives and on cash markets for the sole purpose of hedging positions on derivatives markets, or dealing for the accounts of other members of those markets and being guaranteed by clearing members of the same markets, where responsibility for ensuring the performance of contracts entered into by such a firm is assumed by clearing members of the same markets” CRR Title I Article 4.1(4).

► Firms not authorized to provide ancillary services (referred to in directive 2004/39/EC Annex 1 Section B) on markets in financial instruments, which provide only one or more of the investment services and activities referred to in (1), (2), (4) or (5) and which are not allowed to hold money or securities belonging to their clients and which, for that reason, may not at any time place themselves in debt with those clients.

Institutions in scope


EY observation

This definition generally means that banking activities, regulated under CRD IV, fall within the scope of CBCR, including retail and commercial banking activities. It is the nature of the activities undertaken that makes an entity a “credit institution” as opposed to its legal status.


It should also be noted that various entities are specifically excluded from CRD IV. The organizations are generally explicit to a certain Member State.2

2 These are defined within CRD IV Title I Article 2.5(1) to (23), and for the UK include the National Savings Bank, the Commonwealth Development Finance Company Ltd, the Agricultural Mortgage Corporation Ltd, the Scottish Agricultural Securities Corporation Ltd and the Crown Agents for overseas government and administrations, credit unions and municipal banks.

3.1.3 EU Headquartered and non-EU Headquartered Institutions EU Headquartered institutions As noted above, the CBCR rules apply to credit institutions and investment firms that fall within the scope of CRD IV. For example, an EU headquartered credit institution and its subsidiary undertakings regulated under CRD IV will fall within the CBCR rules. Non-EU headquartered institutions For non-EU headquartered institutions, the key initial analysis to perform is to assess whether the non-EU headquartered institution is itself regulated under CRD IV or has any subsidiary institutions regulated under CRD IV. If its group contains entities that are regulated under CRD IV, then those entities will fall within the rules of CBCR. Furthermore, we expect many entities and branches under the entity regulated under CRD IV to also fall within the rules, as explained further in the “Consolidated basis” section below. The following diagram illustrates a group structure with a non-EU headquartered institution with both CRD IV and non-CRD IV regulated subsidiaries and branches:


EY observation Generally, the issue of which entities are within the scope of CBCR rules is practically a question of which entities are authorized and regulated under CRD IV. Given the wide definition of investment firms, we would expect many entities engaging in financial activities to, prima facie, be under scope of the rules, including brokers and some asset/fund managers’ activities that are regulated under CRD IV. For many investment firms in the asset management sector, however, the position is more complicated and will need detailed consideration. Many types of entities can be authorized as a credit institution or investment firm, including entities such as partnerships.

Non EU Bank

EU Institution

1 Non EU Branch

EU Branch

EU/Non EU Subs

EU Institution

2

KEY

Within scope

Outside scope

EU/Non EU

Branch

US Reg. Bank

Scope uncertain


A further point to consider, and already highlighted in the previous diagram, is that many non-EU headquartered institutions often have more than one institution (i.e., authorized institution or investment firm) in the EU, which may be sister entities. In the absence of a point of consolidation at the EU level, this may mean that separate disclosures related to different sub-set entities are required for each institution. Please refer to the “Consolidated basis” section for further comments. In our example above, for a US headquartered, regulated bank, branches of EU institutions regulated under CRD IV are clearly within the scope of the rules. However, the position of EU branches directly held by a non-EU institution (i.e., an institution in a third country) is less clear. Under the EU prudential consolidation rules, EU branches of third countries have typically been out of scope, but this is an evolving area of regulation so the analysis will need be considered on a case-by-case basis.

Institutions in scope (contd)



3.2.1 Introduction Article 89.1(a) requires information to be disclosed “ … on a consolidated basis for the financial year." How is “consolidated basis” defined and at what level should that consolidation take place? These are pertinent questions since the main theme of the rules is that information is reported on a country-by-country basis. As such, the basis of consolidation of this information will impact heavily on the way the final data is disclosed. We consider the different potential interpretations below.

3.2.2 Definitions and interpretations CRR Title I Article 4.1(48) defines consolidated basis as being “on the basis of consolidated situation.” “Consolidated situation” is, in turn, defined within CRR Title I Article 4.1(47), as meaning “the situation that results from applying requirements of this regulation in accordance with Part I Title II Chapter 2 (Prudential Consolidation) to one institution as if that institution formed, together with one or more other entities, one single institution.” Article 11 of Chapter 2, Section 1 of CRR, sets out the general approach to the application of “consolidated basis” to prudential consolidation. In certain circumstances where there is a regulated institution, the conditions set out in Article 11, require the parent financial holding company (PFHC) or mixed parent financial holding company (MPFHC) of the institution to be the starting point of the prudential consolidation. This often has the effect of widening the basis of the prudential consolidation by capturing group holding companies and their subsidiaries.

However, under a strict interpretation, the paragraphs within Article 11 that extend the rules to PFHCs and MPFHCs do not appear to apply for the purposes of Article 89. The fundamental issue that this creates is that where an institution is controlled by a PFHC or a MPFHC, under the strict reading of both the CBCR rules set out in Article 89 of CRD IV and the approach to the prudential consolidation set out in Article 11, Chapter 2, Section 1 of CRR, the consolidation for CBCR purposes would exclude PFHCs or MPFHCs. In other words, the consolidation would take place at the institution level rather than the holding company level, looking purely at the institution and then down through its group structure.

Consolidated basis


EY observation The inclusion of CBCR into CRD IV late in the drafting process may explain the reason for the apparent anomaly that arises when applying the strict CRR definitions to CBCR to determine the consolidated basis. However, we understand that for other late adjustments to CRD IV and CRR, the general market approach is to apply the consolidated basis methodology set out in Articles 11 and 18, Chapter 2, Section 1 of CRR to those late provisions. Under this approach, PFHCs or MPFHCs would be included in the consolidation. This approach would be preferable since it will help ensure there is consistency in the application of the consolidated basis to the other provisions in CRD IV. In the current draft of the French banking law implementing the CBCR rules, the disclosure requirement is extended to include PFHCs and MPFHCs. We believe that this represents a sensible extension to the rules and other Member States will follow suit. It is important to note that on transposition of CRD IV directive into domestic law, Member States, should they choose to do so, will have the opportunity to further clarify definition of “institutions” (similar to the action that France is proposing on transposition of CRD IV into local French law – see case study on France below).

3.The provisions within Title II Chapter 2 affect groups differently, depending on whether the parent institution is based within an EU member state and whether the parent company is a financial or mixed financial holding company.


CRD IV CBCR French CBCR EY observations

Disclosure requirements apply to: Credit institutions Investment firms

Disclosure requirements apply to: Credit institutions Investment firms Financial holding companies Mixed financial holding companies Other companies*

Insurance companies do not fall within the scope of CRD IV CBCR but may fall into the scope of the French legislation as “other companies”. However, the extension to non-banking entities in France will only be triggered if the EU introduces similar requirements.

Disclosure requirements

Name(s), Nature of activities Geographical location

Name(s), Nature of activities Geographical location

No difference

Turnover Turnover Net banking income

For banking institutions, the French rules require turnover and net banking income to be disclosed. For non-banking entities, net banking income is unlikely to be applicable. The French bill does not define these terms.

Number of employees on a full-time equivalent (FTE) basis

Number of employees on a full-time equivalent (FTE) basis

No difference

Profit or loss before tax Profit or loss before tax No difference

Tax on profit or loss Tax on profit or loss The wording of the final version of the French bill states that companies must disclose the total amount of tax on profit or loss.

Public subsidies received Public subsidies received No difference

Timetable

Implementation from 1 January 2014 and first reporting deadline of 1 July 2014

Implementation from 1 January 2014 and first reporting deadline of 1 July 2014

First-year disclosure requirements are the same under CRD IV and the French rules. The following will need to be disclosed publicly: a) Name(s), nature of activities and geographical location b) Turnover, c) Number of employees on a full time equivalent basis From 2015, all of the disclosure items listed above will need to be disclosed publicly.


Case Study: France

.

Case Study: French proposals on CBCR On 18 July 2013, the French Parliament, through the French Banking Regulation Law, adopted the final version of the provisions relating to tax transparency and CBCR. What makes the French developments interesting is that the French Parliament intends to go beyond the CRD IV CBCR when transposing the CRD IV rules into French law. For example, in addition to credit institutions and investment firms, the French CBCR rules extend the scope to non-banking entities by the inclusion of “Other companies” in its scope A further point of interest is that the French CBCR rules, as currently drafted at the time of writing, do not include provisions to transpose the early requirements for EU – GSIIs to submit items (d) to (f) to the European Commission in 2014. Although this would be a significant departure from the CRD IV CBCR provisions, we understand that the expectation in France is that these provisions should be in place by the end of 2013. Whilst our commentary in this section does not intend to provide a granular analysis of the French CBCR rules, we have set out below a brief comparison between the CRD IV CBCR and the French CBCR proposals:


Entities included in a consolidation The analysis that follows is not intended as a detailed analysis of all of the prudential consolidation rules and is intended to provide an overview only. When determining the consolidated situation for a specific group, separate advice should be taken. At a practical level though, it should not be overlooked that the test being applied here is fundamentally which businesses are regulated under CRD IV. Having identified the starting point for the prudential consolidation, Article 18 of Chapter 2, Section 1 of CRR specifies the general rules which should be applied to identify other entities that form part of the consolidated situation. Article 18.1 requires a full consolidation of all “institutions and financial institutions that are its subsidiaries.” For the purpose of Article 18, “subsidiary” takes its meaning from Article 1 of Accounting Directive 83/349/EEC and in essence means an entity that is controlled through a majority of voting rights, rights to appoint directors, or through contractual or constitutional powers related to the subsidiary entity. Additionally, Article 18.5 sets out rules regarding the consolidation of participations, meaning (in simple terms) entities where an institution holds more than 20% of the voting rights or capital undertaking but has less than a majority stake. Importantly, there is a de minimis threshold in Article 19 that applies to any “institution, financial institution or ancillary services undertaking” which is a subsidiary of the consolidating institution. The de minimis threshold applies, broadly, where the gross assets of the undertaking are less than lower of: i) Euro 10 million and ii) 1% of total assets of the parent. Although only “institutions” and “credit institutions” should be consolidated under Article 18.1, the definition of a financial institution is very widely drawn and would capture many types of entity in the financial services sector (provided the activities are those that are set out in Appendix 1 of CRD IV and/or Appendix 1 of EU Directive 2004/39/EC).

Ancillary service companies have also been brought under the consolidation by Article 18.8, provided that Article 111 of CRD IV applies. In general terms, it would appear that the only entities that are not consolidated are those that are undertaking purely non-financial commercial activities, together with insurance entities, including insurance holding companies.

Consolidated basis (contd)


EY observation Institutions are likely to be confronted by a number of policy choices when considering the issue of consolidation, and the complexity is not only at a country level, but also at a granular level when dealing with issues, such as how to deal with intra-group consolidation adjustments (both intra-country consolidation adjustments as well as cross-border consolidation adjustments). Whilst a range of views and interpretations are possible, it is important to remember that the CBCR rules seek to achieve a country-level consolidation. In our view, this is likely to mean a country report will consolidate away transactions which take place between entities established in the same country, however, transactions which take place with related parties across borders will be respected. Institutions will need to assess the most appropriate position to adopt on a case-by-case basis to help ensure a meaningful country-level consolidation is presented, which is in line with the intention of the rules. This is addressed in further detail below.


3.2



3.3.1 Introduction Article 89.1 requires “ … each institution to disclose annually, specifying by Member State and by third country in which it has an establishment the following information …” Given that the CBCR rules require institutions to report information on a country-by-country basis, the interpretation of the term “establishment” is of particular significance. This notion could have an important bearing on which locations require separate reporting, as well as the allocation of profits and taxes between jurisdictions, which may have a considerable impact on country-level disclosures. In the majority of circumstances, it will be clear in which country an entity is established but there will be significant complexity in certain areas, such as hybrid entities. 3.3.2 Definitions Definition under EU law It could be argued that, where a term within a directive is not specifically defined, that term should take its meaning from the wider body of EU law. The concept of “Freedom of Establishment” is described in the Treaty of the Functioning of the European Union. There is also a wide body of EU case law which considers the meaning of Freedom of Establishment but in the context of specific facts and circumstances, none of which easily transpose to the requirements of CBCR. Definition under Member State corporate law Alternatively, the definition could be taken to be akin to the corporate law concept of a legal seat – usually denoting a place of incorporation or legal registration of the headquarters of an entity. Applying such an interpretation could be viewed as too restrictive in the context of the CBCR rules and may not provide sufficient transparency regarding an institution’s tax contribution.

Definitions under international or Member State tax law It has been suggested that the definition of establishment should be taken from international or local Member State tax law (for example, applying some of the principles of what represents a “permanent establishment”). Given that the purpose of the CBCR proposals is primarily based on tax disclosures, using definitions from tax law may make logical sense. Whilst there is a possibility that the definition of establishment could be based on tax law, it may not necessarily be the most plausible interpretation. CRD IV is not tax legislation but part of a regulatory framework and therefore applying a tax law meaning may not lead to the correct analysis.

Establishment


EY Observation Whatever interpretation is applied by institutions, when applying the “establishment test” to operating subsidiaries or branches of an institution, the place of establishment is likely to be relatively straightforward to identify. However, large institutions will conduct operations through a more complex form of entities for commercial reasons, such as trusts, partnerships, SPVs, etc. We note that some of these structures will present challenges when trying to reach a conclusion on where they are established. For example, seeking to agree on where the allocation of profits of a partnership belong could create a tension between where the partnership is established vs. where the partners are established. In addition, there may be instances where it is difficult to align the location and entity where tax is borne with the location and entity generating profits. For example, it may be possible for the results of an entity, Entity A, not to be taxed in a country where it is established but for a different entity, Entity B, (typically the parent) to pay the “proper amount” of tax on the profits of Entity A under the relevant tax law. This might be the case either if Entity A is considered transparent under tax principles or where Entity A is considered a Controlled Foreign Company (CFC) of Entity B. These type of issues will need to be addressed in due course and the overall policy intention of the rules will need to be considered as well as how to address the complexity in public disclosures.


3.4.1 Introduction CRD IV Article 89.1 makes reference to disclosures being reported for the “financial year”. From a regulatory perspective, the term has a clear and consistent meaning as the year-end financial reporting balance sheet date. Despite a common interpretation of “financial year” being used, potential areas of uncertainty may still arise. These are considered below. Financial year vs. calendar year Many firms choose a year-end date of 31 December for financial reporting, which means the financial and calendar year coincides. Whilst CRD IV CBCR rules do not specify the first financial year that should be reported on by the deadline of 1 July 2014, we expect the rules to apply to periods ending in 2013. For example, were an institution to have a balance sheet date of 31 March, we would expect its first financial year for CBCR would be 31 March 2013 rather than 31 March 2014. Periods of less than or greater than 12 months There are potential issues relating to companies who draw up their statutory accounts for a period of less than or greater than 12 months. While this may be compatible with their local Member State company law, it is unclear what the effect for CBCR would be. We are aware that in other regulatory circumstances country regulators have insisted on a 12-month basis of preparation. Given, however, that the disclosures are intended to be annexed to financial statements where possible, it would appear more justifiable to present CBCR disclosures for the same reporting period as the accounts.

Non-coterminous accounting year-ends There are likely to be cases in practice where different subsidiaries of an institution which fall within the CBCR disclosures have a different accounting year-end from the institution. For financial accounting purposes, under many accounting frameworks, there is established guidance regarding how to consolidate the results of subsidiaries with non-coterminous year-ends. In the absence of specific CBCR guidance, companies will be required to create their own policies and may wish to draw on their applicable accounting frameworks to do so. Acquisitions and disposals of group undertakings Acquisitions and disposals of investments in other group companies, during the year, could lead to differing year-ends within the group and on a solus legal entity basis. In such situations, we would expect part of the results to be consolidated for the financial year.

Financial Year


EY observation

Despite the uncertainties highlighted above, institutions will need to assess the most appropriate position to adopt on a case-by-case basis and will need to consider the wider context and purpose of the CBCR rules. Organizations should take account of all the circumstances and ensure consistency in the disclosures. Furthermore, consideration should be given to whether the position adopted results in a less meaningful transparent result. In such sensitive cases, it would be sensible to adopt a cautious, inclusive approach.


3.5.1 Introduction All institutions within scope of the CBCR disclosures will be required to present “name(s), nature of activities and geographical location” under Article 89.1(a). Whilst our commentary and analysis below focuses on the requirements in Article 89 on this issue, institutions may also want to consider the wider OECD proposals on Base Erosion and Profit Shifting (BEPS). In particular, Action 13 of the OECD BEPS proposals, requires, amongst other things, multinationals to disclose economic activity to all relevant governments. Institutions should therefore continue to monitor the OECD developments closely.

3.5.2 Definitions and interpretations Name(s) We would expect the intention of requirements for institutions to include legal entity names. Alternatively, “name” may also be viewed as the trading name of an entity. Some commentators have advocated greater transparency of the link between the trading name and legal entity name.4 Some may therefore argue that both trading and legal entity names require disclosure. Although we consider that “name” as a legal entity name is more logical, including disclosure of the trading name may be a useful additional step. A potential issue arises for legal entities with branches in other countries since the names of those entities will need to appear more than once, i.e., in the “head office” location of the entity plus each country in which a branch exists. Nature of activities The rules do not stipulate whether the nature of activities need to be described at establishment or country level, or what level of detailed disclosure is required.

4 See for example the Tax Justice Network’s 2012 document titled Country by Country Reporting: Accounting for globalization locally.

3.5.3 Interaction with FINREP regulations There is a specific FINREP template (FINREP “Table 14: Geographical breakdown”) related to the group structure, which requires entity names and entity codes, as well as the jurisdiction of incorporation of each entity forming part of the group. In FINREP, there are a number of templates that refer to the location of activities, which is defined to be the jurisdiction of incorporation of the legal entity which has recognized the corresponding asset or liability; for branches, it means the jurisdiction of residence.

Name(s), nature of activities and geographical location


EY observation Institutions may wish to consider using the general descriptions of business activities contained within the legal entity statutory accounts, where applicable. Our assessment is that the disclosures should enable an understanding of the activities undertaken by country, rather than by each establishment. Institutions using a global profit split transfer pricing methodology for allocation of their trading book profits may find it necessary to describe trading activity in all countries where trading of that nature takes place. In the absence of guidance on the “geographical location” requirement, institutions would appear to have a choice regarding what to disclose related to this item, although wider developments, such as OECD’s Action Plan on Base Erosion and Profit Shifting should be monitored closely.


3.6.1 Introduction The requirement to disclose “turnover” under Article 89.1(b) is expected to be difficult to apply in practice since credit institutions and investment firms reporting under EU adopted IFRS (and some other major GAAPs) do not typically show an amount labeled “turnover” in their profit and loss account. Institutions will therefore need to carefully consider the appropriate equivalent of turnover to include in the CBCR disclosures. The primary questions relate to whether turnover represents gross or net receipts of an institution, and which components of an institution’s income should be included within the total. Outside of the financial services sector, turnover is generally understood from an accounting perspective to refer predominantly to gross income, with little netting included. Within the financial services sector, the matter is much less clear. In its press releases related to the CBCR rules, however, the EU Commission has consistently referred to the term “net banking income” in place of turnover, which may indicate the intention behind the rules. In the analysis below, we consider some of the potential options available.

3.6.2 Definitions and interpretations CRD IV and CRR definition Whilst the concept of turnover may not exist in the financial statements of many institutions and investment firms, CRD IV Article 66.2(c), concerning the sanctions to be levied on an institution for breaches of authorization in acting as a credit institution, does make reference to “total annual net turnover” as including the gross income consisting of: ► Interest receivable and similar income ► Income from shares and other variable/fixed-yield

securities ► Commissions/fees receivable We note that the language used in Article 66 is inclusive so that other categories of income may be included in appropriate circumstances. The intention of Article 66 with regard to the inclusion of gross or net receipts is unclear since the Article uses the terms gross and net somewhat interchangeably. This is compared below with the profit and loss accounts presentation adopted by a sample of major international banks for financial reporting purposes.

Analysis of income statements of a sample of major banks The table below provides an analysis of the line items disclosed on the face of the income statements of a sample of major banks, taken from their most recent published group financial statements. We provide an analysis of EU IFRS and US GAAP reporters. While some organizations present the net balance as a sub total, others simply employ netting on the face of the income statement.

Turnover


EU IFRS

UK Bank 1 UK Bank 2 UK Bank 3

Interest Net Interest Income Interest Income

Interest Expense

Net Interest Income

Interest and Similar Income

Interest and Similar Expense

Net Interest Income

Fees and Commissions

Fee Income

Fee Expense

Net Fee Income

Fee and Commission Income

Fee and Commission Expense

Net Fee and Commission Income

Trading and Miscellaneous

Non-Interest Income Net of Claims and Benefits on Insurance Contracts

Own Credit Charge/Gain

Gains on Debt Buy-Backs

Trading Income Excluding Net Interest

Net Interest Income on Trading Activities

Net Trading Income

Net Income/Expense from Financial Instruments Designated at Fair Value

Gains/Losses from Financial Instruments

Dividend Income

Net Earned Insurance Premiums

Net Trading Income

Insurance Premium Income

Other Operating Income



Sub total Total Income Net of Insurance Claims

Total Operating Income

Total Income Net of Insurance Claims


Our analysis suggests that, whilst there is a relative degree of commonality regarding the source of income (i.e., the general categories set out in the left hand column above), there is little consensus as to whether items should be presented gross or net across any of the line items analyzed. A similar issue exists within the investment firm sector. The point of commonality is that a sub total is included in all of the accounts, which institutions may feel is the single line most aligned to the concept of “net banking income.”


US GAAP

UK Bank 4 France Bank 1 France Bank 2 Germany Bank Spain Bank US Bank 1 US Bank 2

Interest Receivable

Interest Payable

Net Interest Income

Interest Income

Interest Expense


Interest and Similar Expenses


Interest Expense

Net Interest Income

Net Interest Income Total Interest Income

Total Interest Expense

Net Interest Income

Interest Revenue

Interest Expense

Net Interest Revenue

Fees and Commissions Receivable

Fees and Commissions Payable

Commission Income

Commission Expense

Fee and Commission Income

Fee and Commission Expenses

Commissions and Fee Income

Net Fees Commissions and Fees

Income from Trading Activities

Gain on Redemption of Own Debt

Insurance Net Premium Income

Net Gain/Loss on Financial Instruments at Fair Value Through Profit or Loss

Net gain/loss on available-for-sale financial assets and other financial assets not measured at fair value

Net Gains/Losses on Financial Instruments at Fair Value Through Profit and Loss

Net Gains/Losses on Available-for-Sale Financial Assets

Net Gains on Financial Assets/Liabilities at Fair Value Through Profit or Loss

Net Gains/Losses on Financial Assets Available for Sale

Net Income/Loss from Equity Method Investments

Dividends

Income from Equity-Accounted Method

Gains/Losses on Financial Transactions

Principal Transactions

Administration and Other Fiduciary Fees

Realized Gains (Losses) on Sales of Investments, Net Other-Than-Temporary Impairment Losses on Investments


Income from Other Activities

Expenses on Other Activities

Income on Other Activities

Expenses on Other Activities

Other Income/Loss Other Operating Income/Expenses

Total Non-Interest Revenues

Insurance Premiums

Other Revenue

Total Non-Interest Revenue

Total Income Revenues Revenues Net Interest After Provision for Credit Losses

Total Non-Interest Income

Gross Income Total Revenues Net of Interest Expense After Provisions for Losses

Total Revenues, Net of Interest Expense


FINREP terminology “Turnover” is not a term that appears in the FINREP reporting templates.5 FINREP requires disclosure of the primary income statement (includes interest income, fee and commission income, trading income and other operating income). The templates require disclosure of the components on a gross basis, with no sub totals appearing with a clear equivalence to “net banking income”. Permitted GAAPs for reporting information The CBCR provisions do not stipulate which accounting standards or framework should be used for preparing the CBCR disclosures. Other regulatory reporting frameworks, such as FINREP require the information to be submitted under IFRS (which is in any event only mandatory for those preparing IFRS accounts). However, no such requirement has been imposed on the CBCR framework. The question of which GAAP to use for the purpose of the CBCR disclosure is complicated by a number of issues: i) The CBCR disclosures are to be published “as an

annex to the financial statements” of the institution, yet the GAAP in which an institution reports its results for accounting purposes will very often differ from the GAAP in which tax payments of its establishments in many countries are required to be calculated under local law.

5 CP50 ITS on reporting – Annex III to V FINREP templates (available at the following website address http://www.eba.europa.eu/documents/10180/37085/CP50-ITS-on-reporting---Annex-III,-IV,-V.pdf).

Companies will therefore need to decide whether to a) disclose turnover (and, as discussed below, pre tax profit figures) on a basis consistent with the financial statements of the reporting institution and accept that there may be a mismatch with the basis on which tax is actually calculated so that the two are not directly comparable; or b) use the relevant local GAAP figures in the CBCR disclosure and accept that these will be different from the institution’s financial statements.

ii) The CBCR rules are silent regarding the treatment of

inter-company eliminations and consolidation adjustments. There are likely to be both consolidation adjustments as well as GAAP adjustments between local subsidiary financial statements and parent head office consolidated financial statements. Institutions will need to consider, for example, how and where consolidation adjustments need to be included in the disclosures for CBCR purposes: ► Should the local country turnover be “grossed

up” to reflect the consolidation adjustment made at head office level?;

► Should consolidation adjustments continue to sit at head office level, even though they relate to a different legal entity and perhaps a different country?

Consideration will also need to be given to other types of head office adjustments, such as “purchase accounting adjustments” that are often booked at head office level but often relate to multiple entities in a group. Institutions will need to assess whether, for CBCR purposes, an accurate and transparent picture emerges from the inclusion of these adjustments at head office level.

Turnover (contd)


EY observation

From a comparability perspective, it would be preferable if guidance were provided either at EU or country level regarding the implementation of this term. On the basis of our preliminary analysis above, and the reference to “net banking income” in the Commission’s press releases, we would suggest that disclosure is made at the “sub total” level, although we note that both FINREP and Article 66 are valid arguments for inclusion of gross amounts.


Permitted reporting currency The CBCR rules do not stipulate the reporting currency that should be adopted in the disclosures. The use of different currencies could limit the comparability of data between institutions, however, from a practical perspective the currency used by the institution for the presentation of its accounts would appear to be a pragmatic choice as the basis for disclosures. This would mean that any foreign operations would need to be converted to the institution’s reporting currency. A potential problematic consequence of this approach is that CBCR disclosures will not tie directly with the local statutory accounts of subsidiaries, although we do not foresee this being a major concern for most groups. Allocation of turnover (and profits/losses) to branches/partnerships Institutions will need to consider how turnover (and profits) should be allocated to branches and partnerships under the CBCR rules. Will, for example, income attributed to these types of entities for the purposes of preparing local tax returns represent an accurate and transparent position that can be used for CBCR purposes? Such allocations will often involve the use of transfer pricing to arrive at a local taxable income figure. This basis may be different, for example, from the basis used for internal management accounts.

Institutions will also need to ensure that turnover/profits are not duplicated for branches/partnerships/joint ventures and so on, where the information is reflected both at the local country level as well as at the head office country level.

3.6.3 Interaction with FINREP regulations FINREP requires disclosure of the income statement, split between domestic and non-domestic activities. As previously highlighted, the “location” is determined by the jurisdiction of incorporation of the legal entity and for branches it pertains to the jurisdiction of residence. Currently, there is no disclosure requirement under FINREP to produce the income statement on a country-by-country basis. However, institutions are likely to carry out this granular analysis on a country-by-country basis, in order to collect the information to split their income statement between domestic and non-domestic. To reduce implementation effort, the key will be to consider the extent to which policies, which are developed in response to the issues in Section 3.6.2 above, can be aligned with the FINREP data definition model.


EY observation

When considering how to deal with the detailed implementation choices set out in this section, “one size” is not likely to fit all. It would be challenging for standard setters to prescribe a standardized method of dealing with such adjustments without impacting on transparency of the disclosures made by some institutions. This is an area where it may be most appropriate for institutions to determine their own policy for dealing with such adjustments in order to provide the most transparent analysis. This would, of course, to an extent, limit the comparability of the CBCR disclosures between institutions.

EY observation

Apart from establishing the most appropriate equivalent of turnover, institutions will need to grapple with a range of other challenges, including intra-group trading, carving out figures for branches and permanent establishments, treatment of consolidation adjustments, and concluding on which GAAP to use for CBCR. Institutions will need to pay particular attention to reconciliation of data in the CBCR disclosures, as well as ensuring robust reconciliations to other publicly available data.


3.7.1 Introduction The “number of employees on a full time equivalent basis” under Article 89.1(c) is required to be disclosed by all institutions in scope for the purposes of CBCR. We understand the intention was for the average number of full time equivalent employees during the year to be disclosed.

3.7.2 Definitions and interpretations It appears most likely that the term “employees” will take its normal legal meaning. Full-time employees If the definition of “full-time employees” takes its normal legal form, it suggests that contractors, outsourced staff and group shared service center staff which are not employed by the institution or one of the subsidiary entities included within the CBCR consolidation would be excluded. Allocation of employees between multiple jurisdictions and contracts Institutions will need to consider how to allocate any dual-contract or international secondee employees to a particular entity and country. For example, the practical method may be to allocate them on the basis of payroll/human resources data or on a simple average. However, international secondees may be registered and paid in one country but could be working in a different country. This could lead to complications around which country the employees should be shown in for CBCR.

Once again, institutions will need to consider whether the disclosures are in line with the intended aims of CBCR, and if there is uncertainty then a prudent approach should be adopted.

Number of employees on a full-time equivalent basis


EY observation Data sources for employee location may require review to ensure that the governance in place around their use and maintenance is a reliable and auditable basis for the CBCR disclosures. For example, they will need to reconcile to other public disclosures, such as details regarding employees in subsidiary statutory accounts. Furthermore, with wider EU banking reform, banking structures are changing and this could affect where employees “sit” within an organizations structure. If employees are divided into separate service companies there is a possibility, particularly for inbound groups, that many employees may be employed outside of the CBCR group and this may require explanation as part of the public disclosures. Finally, the disclosures may need to be considered in light of issues, such as previous assessments of “permanent establishment” risks and of the group’s transfer pricing models. It is possible that fiscal authorities will begin to use a review of the CBCR disclosures to target PE related tax audits.


3.8.1 Introduction “Profit or loss before tax” is required to be disclosed in line with Article 89.1(d). Given the motivation of the CBCR proposals, the country-by-country breakdown of this metric will be important as stakeholders often quote taxes paid or accrued by entities with reference to profit or loss before tax. Many of the issues highlighted in the turnover section, Section 3.6, above (for example, intra-group transactions, allocation of income to branches and consolidation adjustments) are also relevant for profit or loss before tax. To avoid duplication, we have not revisited those issues in this section.

3.8.2 Definitions and interpretations Again, “profit or loss before tax” is not explicitly defined within CRD IV or CRR. Therefore, it appears both appropriate and reasonable that institutions should use the profit or loss before tax figures in line with their financial statements. The issues likely to arise when determining the definition of “profit or loss before tax” may include, but not be limited to: the choice of which GAAP(s) to use, reporting currencies, the method for dealing with intercompany transactions and allocation of profits between branches/partnerships. Clearly, a consistent approach with that adopted for the purpose of the “turnover” disclosure will need to be applied.

Profit or loss before tax



3.9.1 Introduction Article 89.1(e) of the CBCR rules requires the disclosure of “tax on profit or loss” (although the recitals to CRD IV refer to “taxes paid” and this is discussed below). This is clearly one of the significant components of the CBCR disclosures. In a climate of greater scrutiny of the taxes paid by organizations and heightened debate around tax transparency, the CBCR tax disclosures that institutions make could have far reaching implications. There are a number of reasons why the disclosure of taxes poses unique interpretational challenges that have been discussed in more detail in the following sections: ► There are open questions regarding the range of

taxes in scope and whether tax should be presented on an accruals basis, consistent with the disclosures of turnover and pretax profit, or on a cash paid basis. A cash paid basis would make attempts to analyze the effective tax rate implied by the CBCR disclosures for a given country much more difficult.

► The interaction between tax accounting and tax disclosures in the financial statements and actual tax return filings is a complex area and likely to lead to potential issues when considering CBCR disclosures. For example, in some cases tax is payable on items which are not recorded in the income statement at all, but are instead recorded through Other Comprehensive Income (OCI) for accounting purposes.

► For all of the reasons set out in this paper, disclosure of raw country-by-country data without appropriate narrative and context may lead stakeholders to misunderstand the disclosures.

Whichever approach and methodology an institution decides to adopt for CBCR tax disclosures, it will be important that the approach is fully explained in the disclosures, together with a list of definitions to assist stakeholders and auditors to understand what the disclosures “say” about the business.

3.9.2 Definitions and interpretations Type of taxes included Many argue that the term “tax on profit or loss”, implies that the CBCR rules are referring to taxes based on net income. This is consistent with IAS 12 (Income Taxes), ASC 740 (Income Taxes) and would be consistent with the approach taken in FINREP.

The range of taxes accounted for as income taxes under these standards is extremely varied across the globe and it is not possible to provide an exhaustive list here. In general, however, we would expect income taxes to include, but not be limited to, the following: ► Corporate income taxes including alternative

minimum taxes ► Cantonal or state taxes ► Withholding taxes suffered by the institution on

income it receives It would seem logical to limit the scope of “tax on profit or loss” to these items, since this should ensure consistency with the statutory accounts. In addition, it would allow for a comparison with the pre tax profit or loss figure (discussed above) and with national headline corporate income tax rates. A contrasting argument, however, is that the purpose of the rules is to help stakeholders judge the tax contribution of an institution in each market where it operates, so that merely disclosing taxes based on net income does not provide the transparency the rules are looking to achieve. After all, many institutions pay many different taxes across the globe, including employment taxes, VAT and indirect taxes that they suffer and do not charge on to customers, bank levies and so on. None of these items are accounted for as income taxes under IAS 12 or ASC 740. Looking at Article 89 as drafted, it does not appear that the language used would prevent this wider interpretation from being applied. The argument would be that each of these items is tax incurred in arriving at the institution’s operating profits or losses and that, if the drafts people had wished to limit the range of taxes to income taxes, this could have been done by cross referring in the Article to accounting standards definitions. A third view may be to include all taxes borne and collected. This would expand the interpretation above to include taxes where institutions perform important “collect and pay” functions on behalf of others. For example, this might include withholding taxes on interest on individuals’ bank accounts and employee taxes that are not the liability of the company.

Tax on profit or loss



Cash tax payments vs. accrued basis The CBCR rules do not clarify whether cash tax payments made are required to be disclosed or whether the Article requires disclosure of taxes accrued in the period for accounting purposes. In many jurisdictions, entities are not required to pay their tax or file a tax return during the year in which the accounting profit or loss arises. As such, cash taxes paid in a given year are unlikely to relate to the accounting profit or loss recognized for that period. In the UK, for example, some companies pay their corporate income tax liabilities nine months after the year end, and for large companies 50% of the tax liability is paid during the year and the remaining 50% after the period has ended. To illustrate, say a company has pre tax income in its 2013 accounts of £100m, implying its tax liability is, say £24m. £12m of the tax liability will be payable during 2013 (representing 50%) and the remaining 50%, £12m, in the following year.

If the CBCR disclosures show pretax income of £100m and that tax paid in the year is £12m, stakeholders may read this as a sign the institution has somehow avoided 50% of its tax liabilities, when this is clearly not the case. We note that the recitals to CRD IV (CRD IV paragraph 52) refers to “taxes paid” as follows: “Increased transparency regarding the activities of institutions, and in particular regarding profits made, taxes paid and subsidies received, is essential for regaining the trust of citizens of the Union in the financial sector.’’ The reference to taxes paid in the commentary is in common with other tax transparency regimes. Disclosure based on cash taxes paid in a financial year is valuable information in its own right but, for the reason set out above, it would be potentially misleading to include that disclosure alongside disclosure of the accounting profit or loss before tax for the same year, since the two figures will frequently not be related. Others argue that disclosing based on amounts companies “expect to pay”, i.e., on an accruals basis, may be less transparent since those amounts may never in fact be paid, or not be paid for some time.


EY observation We understand that the European Commission’s view is that the CBCR’s intended scope was the disclosure of taxes on net income, i.e., corporate income taxes as defined for accounting purposes. However, in practice, many institutions may consider that this narrow interpretation does not enable them to reflect their full contribution to society that the CBCR rules were intended to highlight. Institutions may, accordingly, want to consider including the disclosure of additional taxes (beyond corporate income taxes) in their CBCR disclosures. This could potentially be done through a separate sub-analysis in order to ensure that corporate income tax disclosures can still be separately identified. Experience of CBCR from other sectors, such as the extractive sector, suggests that the country by country disclosures include all key taxes related information to give a full picture of the contribution made to society. EY observation

Without further clarification in local law or guidance, the choice between disclosure of cash taxes paid or taxes accrued is likely to be a significant policy choice for many institutions. Both of the approaches outlined above carry weight for different reasons and we do not see that one approach is inherently more appropriate than the other. We consider that maximum disclosure could only be achieved by showing both taxes accrued and cash taxes paid. This would, however, introduce significant additional effort and cost to comply with the rules, and companies will need to assess the cost or benefit in selecting which approach is most appropriate. An obvious example of where additional disclosure may be required is for institutions with significant brought forward losses arising from the financial crisis. Those institutions may now have returned to profit but could be paying no corporate income taxes due to tax law requirements that brought forward losses should be offset against the institution’s current year tax liability.


Additional considerations if an “accruals basis” is applied: prior year adjustments One of the key items included within tax disclosure in the financial statements of entities is prior year adjustments (PYAs). PYAs generally arise where the tax liability differs between the amount accrued in the previous year’s financial statements and the amount finally reflected in the entity’s tax return filing. This is a regular adjustment which companies make since their tax return is not generally completed or is due to be filed until after the end of the accounting year and they must therefore make an estimate of their final tax liability for the purpose of their financial statements. Consequently, a PYA is necessary in the following year’s financial statements to “true up” the tax liability shown in the accounts to reflect the final tax liability for the previous period. If the accruals basis for tax disclosure is used, the issue that arises for CBCR is whether and how PYAs should be included in the CBCR disclosures. Their inclusion would distort the true picture of taxes paid based on the profit or loss before tax for the current year, but if they are not disclosed at all, then significant tax payments or refunds may fall out of disclosure altogether since they would, by definition, not have been disclosed in the previous year’s CBCR report. Note that if “tax on profit or loss” is interpreted to mean cash taxes paid in the year, then the payments should represent the amount of tax actually paid based on the final submitted tax return and PYAs should not generally be relevant.

Additional considerations if an “accruals basis” is applied: deferred tax Broadly, under many accounting frameworks, deferred tax assets and liabilities may be included in the financial statements of an entity due to the differences between the accounting carrying value of an asset or liability and its underlying tax base. A deferred tax asset suggests that a company may pay less tax in the future on its profits due to a tax deduction that it expects to receive. A deferred tax liability indicates that a company is likely to pay more tax in the future than it otherwise would, perhaps because it has already deducted tax relief for an item that will not be expensed for accounting purposes until the following period. Whilst the inclusion of deferred tax is a very broad interpretation of “tax on profit and loss,” aimed at reconciling amounts disclosed under the CBCR rules with amounts disclosed for accounting and for FINREP purposes, it seems unlikely that the legislator intended this interpretation to apply. The broad spirit of the CBCR rules is to highlight the taxes paid by institutions and many would therefore argue that deferred taxes, although an important component of the overall tax charge of an institution in its financial statements, should be excluded. Those who hold this position argue that including deferred taxes is contrary to the statement of intent in the CBCR press release issued by the Commission, creating considerable complexity and the inclusion of further judgment in the amounts disclosed. As a consequence of this, it is argued the approach would reduce transparency.

Tax on profit or loss (contd)


EY observation Where an accruals basis is used to ensure that the CBCR tax disclosures can be fully reconciled to the tax disclosures in the financial statements, and to accurately represent the final amount of taxes paid on profits, we would expect PYAs to be included as part of the “tax on profit or loss” amount. This would, however, re-introduce the distortion between the disclosed “profit or loss before tax” and “tax on profits” figures that using an accruals basis, rather than a cash paid basis, was seeking to avoid.

EY observation We do not feel that the CBCR rules are intended to require disclosure of deferred taxes. However, institutions may find, should they wish to ensure that CBCR tax disclosures fully reconcile to the income statement within the financial statements, that it is necessary to reference deferred taxes within the CBCR disclosures. We note that “current tax” will typically be separately disclosed either directly on the face of the income statement or in the footnotes, and reconciliation could therefore be presented to those current tax amounts if desired, without including the additional complication of deferred tax.


Additional considerations if an “accruals basis” is applied: tax contingencies (Uncertain Tax Positions) The term “Uncertain Tax Position” (UTP) is widely used by financial accountants to refer to an income tax item, the tax treatment of which is unclear, or is a matter of unresolved dispute between the reporting entity and the relevant tax authority. A UTP will usually arise as a result of uncertainty as to the meaning or application of the law to a specific set of facts. UTPs generally relate to current tax, although there are circumstances where UTPs affect the tax base of an asset or liability and can affect deferred tax. Organizations are required, under a number of accounting frameworks, including US GAAP and IFRS, to include a provision for UTPs in their financial statements in certain circumstances and generally this falls within the disclosures for “current tax”. UTPs are part of the accruals approach to tax accounting. Organizations that present taxes actually paid in their CBCR disclosure will not need to consider UTPs.


EY observation This is likely to be an area of considerable sensitivity since it is not clear that the legislation was intended to capture such items within the CBCR rules. If an accruals presentation is selected, however, then under some accounting frameworks, and in particular IFRS, it may be difficult to justify not including UTPs within the current tax disclosed. This is because IAS 12 does not differentiate between UTPs and other liabilities, it simply requires income tax to be recorded based on the amount of tax the entity “expects to pay”.


3.10.1 Introduction Article 89.1(f) requires institutions to report any “subsidies received.” Although, prima facie, institutions in the financial sector may not typically be in receipt of public subsidies, institutions will need to consider all potential incentives that they may be receiving from public bodies.

3.10.2 Definitions and interpretations The concept of “subsidies” is likely to take on a broad definition from general usage, though the term is also defined in the EC statute. (A) EC statutory definition (taken from Regulation 597/2009, Article 3) Financial contribution The EC statutory definition of a “national subsidy” is a “financial contribution” that may take different forms: ► A direct or potential transfer of funds (e.g., grants,

loans, equity injection or loan guarantees) ► Government revenues (which are otherwise due)

foregone or not collected (e.g., tax credits) ► Government provision of goods and services (other

than general infrastructure) ► Government purchase of goods ► Any of the above functions performed by a private

body (e.g., a bank) on the instruction of the government.

(B) General usage definition Government assistance As highlighted above, one interpretation of “subsidies” may simply relate to any grants or other financial assistance that an institution has received from a supranational or national government body. For example, this may include offering monetary incentives to move into a particular area with high unemployment. In the UK, this would typically take the form of enterprise zones, which provide favorable treatment to companies, such as tax holidays and reduced business rates.

Tax deductions However, others may argue that “subsidies” in fact may also relate to enhanced tax deductions that the entity may receive. For example, in the UK, this may include enhanced capital allowances on energy saving plant and corporation tax deductions for R&D expenditure. Difficulties that can be faced in this area include data granularity and complexities in terms of deductions deemed to be “subsidies” from tax law. In the UK, consideration should also be given to the Private Finance Initiative (PFI) and whether any additional disclosures would be required. A significant majority of institutions in the UK are involved with PFI and therefore, this stands to be an important issue. Cash vs. accrued subsidies It is currently unclear as to whether the proposals will relate to cash or accrued subsidies. The complexities of a cash vs. accruals concepts was discussed in Section 4.9.2 above.

Public subsidies received


EY observation Due to its potentially wide definition, identification of potential subsidy items, determining whether they fall within the CBCR definition, and formulating suitable disclosure may, in practice, be one of the most time-consuming elements of the rules. It may also be one of the areas where the approach taken and policy choices made varies most widely between institutions. One reason for this is that we have not so far been able to establish where this data may already by collated by institutions for any other reporting purpose and so many institutions may find that they are gathering data of this type for the first time.


3.11.1 Introduction There is limited guidance on the format of the CBCR disclosures in the directive. Institutions will need to consider how and where to publish the CBCR disclosures.

3.11.2 Definitions and interpretations Article 89.4 states “the information … shall be published, where possible, as an annex to their (the institution’s) annual financial statements, or where applicable, to the consolidated financial statements.” Group vs. Solus financial statements The CBCR requirements appear to suggest that the CBCR disclosures should be included as an annex to the financial statements or, where relevant, consolidated financial statements of the institution. Where the institution does not prepare consolidated financial statements, but a parent company does (whether an EU parent or a third country parent), the requirement is nevertheless that the disclosure for the institution and its “establishments” are annexed to the solus financial statements where possible. On the basis of a strict reading of the rules, where a group has more than one institution, each institution must annex a separate disclosure report in its annual financial statements. Format of reporting In contrast to FINREP reporting requirements, no standardized format or template currently exists for CBCR disclosures. We consider that institutions would be advised to develop their own templates, which are compatible with their own systems. We further consider that it would be in institutions’ best interests to ensure they build-in the required flexibility to cope with a form of template that the EBA may issue at a later stage.


Format of disclosures

EY observation

The inclusion of CBCR disclosures as an annex to the financial statements is likely to give rise to the following issues:

► The data required for CBCR may not be ready at the time that the financial statements are finalized. Waiting for this data could lead to a delay in the finalization of the financial statements. Many institutions will be keen to avoid this scenario but it is not clear what exceptions are contemplated by the phrase “where possible”.

► Increased complexity of financial statements that are already considered by many stakeholders to be excessively lengthy.

Another option might be to publish CBCR data on the group’s website, perhaps either as a separate document or within the Corporate Social Responsibility report, with a reference made in the financial statements. This may have the added advantage of being easily accessed by many stakeholders but it is not clear that this approach would meet the condition of being an annex under the rules. Whichever method of publication is selected, institutions will wish to ensure that the information they publish is capable of being reconciled to other public sources if required, whether or not such reconciliation is made publicly available. Finally, we would add that it is not entirely clear that there is a requirement in Article 89 that the disclosures are presented in a format that “reconciles” back to the figures shown in the institution’s consolidated financial statements. (if the institution prepares consolidated financial statements). A reconciliation of this type is likely to be difficult to prepare and complex to explain in a transparent way that is useful to stakeholders.


04 Appendix: list of abbreviations


Many of the specific abbreviations and definitions have been discussed within this document. This section provides a list of the main abbreviations and EU Articles referred to in this document.


Appendix: list of abbreviations 04 Accounting Directive Accounting Directive 83/349/EEC

Article 11 CRR Article 11 of Chapter 2 Section 1 (prudential consolidation)

Article 18 CRR Article 18 of Chapter 2 Section 2 (methods for prudential consolidation)

Article 19 CRR Article 19 of Chapter 2 Section 3 (entities excluded for the purposes of prudential consolidation)

Article 66 CRD IV Article 66 (administrative penalties and other administrative measures for breaches of authorization requirements and requirements for acquisitions of qualifying holdings)

Article 89 CRD IV Article 89 (country by country reporting)

ASC 740 Accounting Standards Codification Topic 740 – Income Taxes (US GAAP)

CBCR Country by country reporting

COREP Common Reporting framework

CRD IV EU Capital Requirements Directive IV

CRR EU Capital Requirements Regulation

EBA European Banking Authority

EC European Commission

EU G-SIFI EU Global Systemically Important Financial Institution

EU G-SII EU Global Systemically Important Institution

FINREP Financial Reporting framework

GAAP Generally Accepted Accounting Principles

IAS 12 International Accounting Standards – Income Taxes (IFRS)

IFRS International Financial Reporting Standards

LLPs Limited Liability Partnerships

MiFID Markets in Financial Instruments Directive 2004/39/EC

PFI Private Finance Initiative

PYAs Prior Year Adjustments

SPEs Special Purpose Entities

UTP Uncertain Tax Positions


Contacts

Name Neil Harrison

Direct Tel +44 113 298 2596

Email [email protected]

Name Dan Cooper

Direct Tel +44 20 7951 5381


Name Tara Kengla

Direct Tel +44 20 7951 3045


Name Silvain Niekel

Direct Tel +31 88 407 1675


Name Michael Berberich

Direct Tel +49 6196 996 27206


Name Vincent Natier

Direct Tel + 33 1 55 61 12 61



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