In our article, The future of tax: The impact on new business models, we described how the business models in banking, insurance and asset management are changing, and set out some of the headline tax issues arising from this change. This article delves further into the detail of the models in banking and some of the challenges that organisations will need to deal with.

The capital markets' IT landscape has changed dramatically in recent years due to a combination of next generation technology and the transformation of IT operating models. Some of the models we see in banking include:

  • Next generation IT operations: Traditionally, technology ownership was in-house, with IT operations covering data centres, operating systems and vendor software solutions. This model has been reinvented and the role of IT has fundamentally changed as a result.
  • As a service providers: The tier 1 banks are able to invest in technology at levels which cannot be matched by smaller players. They are now looking at how they can monetize this investment, offering services to the rest of the market.
  • Aggregated service model delivery: New entrants often focus on just a slice of business operations, competing with traditional banks that offer an end-to-end business solution. Traditional banks are therefore looking at alliances to build scale and capability.
  • Full-scale digital retail banking: Banks are exploring how they take digital retail banking to the next level, heavily focused on the customer, building highly customized models, and driving demand for 'client-for-life' ecosystems to support with major life events.

These new models present a number of conundrums for tax departments as they grapple with how tax authorities will deal with the taxation of the changes in the way banks are operating.

These new models present a number of conundrums for tax departments as they grapple with how tax authorities will deal with the taxation of the changes in the way banks are operating.

A focus on corporate tax

As operating models change, tax departments in traditional banks may need to broaden their horizons to consider a number of different areas as follows:

  • Incentive regimes: Many of these new models require organizations to innovate to stay relevant, be it in the design of a new digital banking platform or the integration of aggregated services into the existing infrastructure of the bank. This will potentially give rise to opportunities to make use of different countries' incentive regimes, such as research and development credits, or preferential rates for patented items or innovation-based activities.
  • Digital services taxes: This is currently a contentious area, particularly with France and the UK having introduced digital services taxes (DSTs) in a targeted manner, and whether other countries will retaliate with reciprocal policy changes. While it is not expected that the current DSTs will have a material impact on these new businesses, as other countries introduce their own unilateral measures in relation to digital business models (for example, Spain, Austria and Italy are currently considering the possibility), the new measures need to be monitored, to ensure these models are not inadvertently caught by proposals that do not have effective carve-outs for financial services.
  • Location of taxable profits: Digital business models in general are under significant scrutiny from tax authorities around the world, given the considerable complexity that these can bring on a cross-border basis, particularly when there may be no physical presence involved. Tax authorities are also starting to introduce anti-tax avoidance rules (such as the UK's Diverted Profits Tax) that focus on whether companies are artificially stripping profits out of a particular country, although it would be reasonable to expect that commercial operations of the nature set out above should not be caught by these rules.

A focus on transfer pricing

Any change in operating models will usually lead to consideration of the transfer pricing issues related to the change. Some of the key issues to be considered are as follows:

  • A possible new value chain: It is critical, when building a new digital business model, to understand the value creation in the new business and how it is similar/different compared to the traditional business.  For example, it will be key to understand the role of technology and brand intangibles, as well as data, synergies and network effects and whether they are market differentiators creating significant value.  These concepts may be familiar territory for technology companies, but perhaps less so in financial services where the value chain typically centres around capital and people functions. Digital business models may therefore require a fresh look at value creation, the value chain, and associated transfer pricing for many financial services institutions.
  • BEPS: The OECD's Base Erosion and Profit Shifting project has demanded a careful look and focus on DEMPE (development, enhancement, maintenance, protection and exploitation) functions, as well as the control of risk functions.  This is particularly important where a new business model contains a high degree of use of non-routine valuable intellectual property.
  • Fintech driving revenue: Where new financial technology is a key driver of revenue generation and increased profits, the transfer pricing policies used may need to be modified to incorporate a reward for the contribution of technology; such as when residual profit split or revenue/profit sharing approaches are employed.  Depending on the fact pattern, one may also need to consider pricing based on royalties for the use of intellectual property.

It is critical, when building a new digital business model to understand the value creation in the new business and how it is similar/different compared to the traditional business.

A focus on indirect tax

Similar to transfer pricing, whenever operating models change, there needs to be a focus on indirect taxes, and the implications on cash-flows in the business, particularly where these transcend borders. Some of the key issues that need to be considered with digital business models are as follows:

  • VAT liability of transactions: transformation of business models invariably results in new transactions being undertaken such as outsourcing the IT build or indeed outsourcing the banking operations to bank utilities providing highly sophisticated banking platforms.  The critical question from a VAT perspective will always be to determine the liability of such outsourced services.  Clearly, there is benefit in such services being exempt given that banks (especially retail banks) have very low recovery VAT rates.  The eligibility for exemption will be driven largely by the terms of the contracts and the economic reality.  Structuring the contracts in such a way to maximise exemption is often well worthwhile.
  • Single vs. multiple supply: There is the age-old issue of determining the extent to which a bundle of services being provided should be treated as part of a single supply or as separate supplies.  This is critical in outsourcing contracts where there is scope for VAT exemption as poor structuring of contracts and the economic reality may result in services which should be treated as part of a single exempt supply becoming taxable.  Typical examples of areas to focus on would be project management work, IT build, onboarding customers and variations to original contracts.
  • Engaging with the tax authorities: Where the structuring is complex or the VAT consequences are unclear, it is often best to engage with the tax authorities up-front to avoid an unanticipated and perhaps costly VAT challenge at a later stage.  The key to success in this regard is a good and clear explanation of the commercial model to the tax authorities and not only an explanation of what reliefs are available.  It is, of course, equally important to anticipate the objections and counter-arguments that may be raised by the tax authorities.


These new business models are evolving, and evolving fast. There will be new areas of technical knowledge that tax departments will need to engage on, and a thorough understanding of the business models that are being implemented is key to getting to the right answer from a tax perspective. The challenge of a tax department in any large financial services organisation is to ensure they are sufficiently connected with the business to remain ahead of the developments, so that tax considerations can be factored in early as the business is set up.

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