3 minute read 16 Apr 2018
American President Statue

How to make the most of US tax reforms

Authors

EY FS Insights

Minds Made for Financial Services

Thomas Brotzer

EY EMEIA Insurance Tax Leader

Passionate tax and regulatory advisor. Transformation leader in insurance. Lecturer. Sailor. Husband and father.

3 minute read 16 Apr 2018
Related topics Tax Financial Services EMEIA

Will businesses fall into the trap of focusing on the short-term effects of US tax reform, while underestimating the longer-term impact? 

The reforms: “America first”

The President has been clear that the aim of these tax reforms is to revitalize the US economy by eliminating what he perceived to be anti-competitive elements in US tax law and preventing the ease with which companies were able to erode the US tax base. To that end, the provisions create several new incentives and deterrents. However, their complexity means they affect each industry in unpredictable and potentially distorting ways.

On the one hand, rules offering preferential rates for moving intellectual property back to the US will likely have little impact on financial services but could have a significant effect on manufacturing and technology. On the other hand, provisions like “BEAT” (the base erosion and anti-abuse tax) and “GILTI” (global intangible low-taxed income) are expected to have a major impact on financial services, where they could well erode the benefit of the lower corporate tax rate.

Reforms at a glance

  • Headline corporate tax rate reduced from 35% to 21% from 1 January 2018. 
  • Creation of a broader tax base which, among other things, limits net interest deductions to 30% of EBITDA (restricted to EBIT beginning 2022) applying to both related and unrelated party debt. 
  • One-time transition tax charge arising in the 2017 tax year on historic earnings that have not previously been taxed, payable over eight years. 
  • Participation exemption granted for dividends received from 10%–owned non-US subsidiaries, facilitating the efficient movement of funds back to US owners. 
  • Base erosion and anti-avoidance tax (BEAT), liability for which is determined on a tax base that does not allow a US deduction on foreign related-party payments, with potential long-term effects on supply chains, booking models, and inter-group service arrangements. 
  • Global intangible low-taxed income (GILTI), which taxes a US parent immediately on non-US subsidiary profits not associated with a routine return on tangible fixed assets — expected to disproportionately affect industries with low levels of tangible assets (such as financial services). 
  • Foreign derived intangible income (FDII), which taxes export income not associated with tangible assets at a beneficial tax rate, incentivizing the export of services from the US (note that financial services income is excluded).

At first sight, the reforms could well achieve the President’s ambitions of favoring doing business in the US, but only up to a point. For example, an entirely domestic US enterprise might receive the full benefit of the lower corporation tax rate, while avoiding the more punitive measures like BEAT. However, global businesses, and particularly global financial institutions, will always want to retain a global presence. They cannot therefore avoid grappling with the complexities and potential inefficiencies of the longer-term impact of the reforms.

So, what might the consequences be for financial institutions? There are three key questions:

  1. Will global financial institutions increase investment in the US?
  2. What is tte likely impact on capital and corporate structures?
  3. Are we in for a tax trade war?

Key findings from the EY-Chartis research:

  • About Global Trader Surveillance Survey

    As part of our research and analysis, this report includes the results of a 2017 global survey conducted by Chartis Research. It surveyed 35 FIs about their use of trader surveillance, and the challenges they faced in implementing it. Of the respondents surveyed: 

    • 37% were from Europe
    • 23% were from North America 
    • 20% were from Asia-Pacific. 
    • 20% were from the Rest of the World 
    • 20% were Tier 1 organizations (more than $100 billion in assets)
    • 23% were Tier 2 organizations (between $10 billion and $100 billion in assets) 
    • 57% were Tier 3 organizations (less than $10 billion in assets) Additional insight for this report comes from roundtable discussions and interviews with EY subject matter advisors.

Change in the air 

The need for effective trader surveillance systems is becoming more pressing. So far, the default position for FIs has been to use systems designed primarily to meet the requirements of regulators. While regulations allow for a certain degree of flexibility when addressing trader surveillance, FIs are wary of distinguishing themselves too much from their peers – there is safety in being part of a group of institutions that all manage risk in the same way. As a result, there has been only modest technical advancement in this space.

Yet this picture is changing rapidly. Increasingly, rather than matching their trader surveillance capabilities to those of the bodies that regulate them, or even their peers, FIs are looking to establish their own leading practices. But why? And why now? 

The key drivers of change are: 

  • Regulators’ desire for more ‘semantic’ information around trades. This has been driven largely by the Market Abuse Regulation (MAR). But it is emerging as good market practice, driving a more holistic approach to surveillance that encompasses electronic communications (e-comms) and trade monitoring. 
  • At the same time, regulators and market drivers are pushing many FIs to expand the remit of their surveillance to cover a broader range of asset classes, such as fixed-income, commodities, and other Over-the-Counter (OTC) products. 

    Meanwhile, new trading venues such as Organized Trading Facilities (OTFs) must be catered for. Across these new assets and venues, systems originally designed for more traditional, ‘regulated’ asset classes (such as equities) are struggling under the weight of an increasing number of trades, idiosyncratic reporting requirements, and the sheer volume, variety and velocity of the data involved.
  • Trader surveillance systems are also generating thousands of alerts per day, more than FIs’ compliance teams can feasibly monitor. This is pushing up costs, as FIs expand their compliance departments with additional Full-Time Employees (FTEs) to keep pace. Not surprisingly, FIs want to increase the quality of their alerts, and speed up how they process them.

Future of trader surveillance 

Most of the increase in spending in the sector is likely to remain tactical, focused on extending existing point solutions – including enhanced analytics and out-of-the-box reporting – or buying new ones. At the same time, there is also likely to be a low volume of very high-value transformational projects. These are likely to be undertaken by organizations in the upper-Tier 2/Tier 1 levels, which are seeking economies of scale.

These solutions will be complex, and the future of trader surveillance – with integrated conduct risk, advanced analytics, extensible databases, and integrated e-comms and trade monitoring – might seem complicated and difficult to implement. Nevertheless, FIs can develop a path toward the future by prioritizing certain elements and identifying specific solutions. 

A target trader surveillance architecture should be able to deliver unified trade monitoring and e-comms monitoring data to the first and second lines of defense. This can be developed through phased, modular enhancements, beginning with basic data integrity and control processes. A system covering each of these areas can then provide a centralized data repository to manage additional related data, including conduct risk data, HR data, and P&L data.

Conclusion 

As our survey shows, firms struggle to provide effective monitoring of all business lines and requirements, and cultural and governance processes form a vital part of a successful system. The scale and scope of FIs’ requirements are expanding quickly, and the need to refresh their technology has become more pertinent in recent years. 

Trader surveillance budgets and expenditure may have expanded, but there is no guarantee that their systems will address systemic deficiencies. FIs should work to the ABCD principles to deliver broader, more effective and more efficient surveillance. Their systems should continue to evolve, covering more areas, detecting more breaches of compliance, and generating better alerts. 

Ultimately, by linking all the elements and integrating sources of information to leverage more insight, FIs can break down the barriers between the different types of surveillance. They will know their traders, understand their employees, and recognize how they make their profits. Better monitoring will enable FIs to use highly skilled resources more effectively, by delivering more high-quality alerts to individuals. 

Today, trader surveillance is a complex area of an FI’s operations. But by addressing the ABCD of surveillance, and adopting the right balance of people, processes and technology, FIs can emerge from the confusion and bring new insight – and value – to the way they work.

Summary

The US reforms, and particularly the unprecedented overnight 14% reduction in the US corporate tax rate, will have both an immediate effect and a longer-term dynamic impact. They will create significant upsides for many US businesses and, more broadly, on the global stage, there is likely to be a strategic rethink of capital deployment to and from businesses in the US. Download the full report (PDF)

About this article

Authors

EY FS Insights

Minds Made for Financial Services

Thomas Brotzer

EY EMEIA Insurance Tax Leader

Passionate tax and regulatory advisor. Transformation leader in insurance. Lecturer. Sailor. Husband and father.

Related topics Tax Financial Services EMEIA