This is one of a  series of guides  on issues connected to ring-fencing and banking reform faced by banks. Other guides cover issues such as asset transfers, employment, issues for directors, real estate, pensions, litigation, third party contracts and competition considerations.

This guide was last updated in May 2014

The imposition of a ring fenced retail business will cause profound changes in the legal structure and day to day functioning of the banking business, so it is inevitable that there will be significant tax impact. The precise nature and scope of this impact will only become clear closer to its implementation in 2019. However, in the interim, some early issues around VAT and Transfer Pricing have been identified.

Many banks use VAT grouping between the legal entities to eliminate VAT arising on intercompany charges and allocations, such as those for IT, premises and shared service centres. The UK’s current rules around VAT grouping require each member of the VAT group to be jointly and severally liable for the debts of the whole group.

From a ring fence perspective, the concern is that this liability could breach the ring fence and expose the retail banking operation to VAT liabilities and losses arising in the non ring fenced business. As such, it is currently suggested that the concept of a ring fence is incompatible with the usual VAT grouping undertaken by the banks.

It may become necessary to break the current VAT group to meet the requirements of the ring fence. Such an outcome would expose the group as a whole to incremental VAT cost arising on intercompany charges. In such circumstances it may be prudent to consider where support functions are placed and how they best interact with the business as a whole.

The issue was highlighted in HM Treasury's paper in June 2012. In that paper it was suggested that other members of the VAT group place security with the ring-fenced bank. However, in a later paper on October 2012 it was stated that the issue was being considered with any modifications to be introduced in the Finance Bill rather than the Banking Reform Act. There has, as of yet, been no further measures introduced to address the issue. HM Treasury is believed to still be consulting with businesses on the issue.

Any changes to the legal entity structure and variation in the functions undertaken, assets employed and risks assumed will, of necessity, require consideration of the transfer pricing position. The requirements of the ring fence require that the retail bank is fully insulated from exposure to the non ring fenced business. As such, it is likely that there will be additional scrutiny by the regulator of the pricing to ensure that the arm’s length requirement is firmly adhered to. This is likely to entail significant work to undertake fresh functional and economic analysis of the ring fenced operating model.

There could be alterations required to the standard transfer pricing framework to ensure that intercompany debts are settled as soon as possible to avoid significant, on-going, exposures between entities either side of the ring fence.

The customer impact

Tax has become a key battleground in a political battle over 'fairness', with arrangements coming under severe media and public scrutiny. Getting the tax position right will be essential to remaining competitive and keeping customers on-side.