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HMRC internal manual

International Manual

HM Revenue & Customs
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The attribution of capital to foreign banking permanent establishments in the UK: The approach in determining an adjustment to funding costs - STEP 1: Attributing the assets

The amount of capital required by a permanent establishment (‘PE’) will depend on the size and nature of its activities. Those activities are evidenced by the assets attributable to the PE from which it derives profits. Where the PE is responsible for the creation of a financial asset then both the asset and the related income should be attributed to that PE.

The assets attributable to the PE may not correspond to the assets shown on its balance sheet (if such exists). For example, where the PE is responsible for business where assets are held off balance sheet, those assets must be attributed to the PE. Similarly, business may be “booked” in another part of the company, while the economic reality is that the profit on the business is attributable to the UK PE’s efforts. Again the underlying assets must be attributed to the PE.

Global/trading profit splits

Where a PE has:

  • either assets that arise from activities conducted as a global trading arrangement, and/or
  • profits from assets which are dealt with as part of a profit split for profit attribution purposes (which may or may not be covered by an advance pricing agreement),

then the proportion of those assets which should be treated as assets of the PE for the purpose of attributing capital to it under CTA09/S21(2) should be consistent with the logic of the business and the profit split. For example, if the London PE of a bank is the booking centre for a global FX options book, the profits of which are split between PE’s in London, New York and Tokyo, the assets should not be treated as wholly those of the London PE since they derive in part from the activities of New York and Tokyo.

Implicit in such arrangements is that the assets belong not to the location in which they have been booked, the choice of which is usually a matter of operational and administrative convenience, but to all locations involved in the global trade. However, simply splitting the assets in proportion to the profits attributed to each centre in the profit split may not be an appropriate way of determining what capital should be attributed to the booking location PE, as that PE may be receiving part of its share of the profits in respect of its routine back office functions.

In the above example London may receive 40% of the overall profits and New York and Tokyo 30% each. However, if the additional 10& of profits allocated to London arise from its reward for the back office functions associated with the administration of booking (which may well be rewarded on a cost plus basis) then it would not be appropriate to attribute 40% of the assets to London. Assuming all three centres have an equal trading/risk management role, and this is properly reflected in the one-third share each of profits (after excluding the back office reward), then it would be appropriate to attribute one third of the assets to the London PE. A corollary to this is, of course, that the costs of funding the trading book are split between the centres on the same basis where the profit of the book is split before funding costs.

If the global trading operations are not in fact fully integrated, such that London and Tokyo have only a basic marketing role with all traders and risk management operations being based in New York, then it is most likely that all assets should be treated as New York assets regardless of where they are booked, with no capital being attributed to London in respect of those assets. In practice, London would not usually be the booking centre in such circumstances. Neither, in such a case, would a profit split necessarily be the appropriate methodology for the attribution of profits between the PE’s.