Balancing the Regulation and Taxation of Banking

Balancing the Regulation and Taxation of Banking

Sajid M. Chaudhry, Andrew W. Mullineux and Natasha Agarwal

This concise book gives a unique overview of bank taxation as an alternative or a compliment to prudential regulation or non-revenue taxation. Existing bank taxation is reviewed with a view to eliminating distortions in the tax system, which have incentivized banks to engage in risky activities in the past. The authors analyse the taxation of financial instruments trading, as well as the taxation of banking products and services to gauge whether this could finance resolution mechanisms and also help to ensure the stability of banks.

Chapter 5: An overview of existing taxation

Sajid M. Chaudhry, Andrew W. Mullineux and Natasha Agarwal

Subjects: economics and finance, financial economics and regulation, international economics, money and banking


We next give a comprehensive overview of the existing tax regimes applied to the financial sector. Following EC (2011), we consider three areas of taxation: corporate income tax; specific anti-avoidance rules or debt bias; and labour taxation. There are two main differences between financial and non-financial corporations. This concerns the treatment of bad and doubtful loans and the non-application of thin capitalization rules to the financial sector. As far as bad and doubtful loans are concerned, the differential treatment may provide a cash-flow (liquidity) advantage, but not a tax advantage. These differences in treatment can be attributed to the structure of the business in the financial sector for which interest received and paid constitute part of the banking business and not just the financing of activities. Before the GFC, the financial sector accounted for a substantial share of corporate tax receipts. The values for the EU27 are similar to those for many non-EU G20 countries: about one-quarter in Canada, Italy and Turkey, and about a fifth in Australia, France, the UK and US (see Table 5.1 for detail). In order to reduce the tax due, companies utilize the applicable tax regime to their advantage. For example, they can choose to be funded via equity or debt. Debt financing generally brings additional tax benefits, compared with equity financing, because interest expenses are generally tax deductible (whereas dividends are distributed after tax and are not deductible).

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