B&O tax exemption for gross receipts of international banking facilities

Purpose

The Legislature did not state a public policy objective when passing this preference.

Certain banking institutions do not pay B&O tax on their earnings

The preference exempts international banking facilities (IBFs) from paying business & occupation (B&O) taxes on their gross receipts.

An IBF is a separate set of deposit and loan accounts established by certain banking institutions in the U.S. to accept deposits from and extend credit to primarily foreign institutional customers.  These customers include:

• Foreign entities such as governments, corporations, and other banks.
• U.S. offices of the IBF’s parent institution.
• Other IBFs.

International banking facilities are maintained separately from a bank’s other accounts and records.  Although the term “facility” implies an independent location, many IBFs are located within an existing bank branch.

The following types of banking institutions may establish IBFs in Washington and benefit from the preference:

• A commercial bank with its principal office in Washington—these are banks incorporated and doing business under the laws of the United States or the state of Washington.
• A U.S. branch or agency of a foreign bank.
• An Edge Act corporation—banks with a special charter from the U.S. Federal Reserve to conduct international banking operations.
• An Agreement corporation—banks chartered by a state to engage in international banking.  The bank limits its activities to those allowed by an Edge Act corporation.

There is no expiration date for the preference.

Soon after Federal Reserve authorized IBFs, Legislature passed B&O tax preference

1981: Federal government authorizes IBFs

On June 18, 1981, the Federal Reserve Board of Governors approved the establishment of international banking facilities (IBFs) beginning December 3, 1981.

After the Federal Reserve authorized IBFs, state legislatures began to consider whether to revise state laws to determine how to tax these newly created entities.

1982: Legislature exempts IBFs from B&O tax

The Legislature passed this preference, exempting IBFs from paying B&O taxes on their gross receipts.  The bill’s sponsor testified that the preference would help bring several Washington banks operating offshore financial centers back to the United States.  The sponsor indicated that other states had enacted similar preferences in order to attract IBFs to their states.

2010: Changes to state apportionment laws reduce amount of income IBFs would apportion to Washington

The 2010 Legislature revised Washington’s laws governing how service businesses apportion their income.

The apportionment changes did not affect the tax liability of Washington’s IBFs because their gross receipts were already exempt due to the preference.  However, the changes would reduce the amount of an IBF’s gross receipts that would become subject to B&O tax if the preference were to end.

IBFs allow banks to operate under less regulation and compete with offshore financial centers without leaving U.S.

Offshore financial centers provide similar services to IBFs

In the 1960s and 1970s, governments attempted to control capital flows and monetary policy through restrictive domestic regulations.  International banks shifted deposits and borrowing to less-regulated offshore financial centers.  The offshore centers could operate more freely in markets where banks borrow and lend currency outside of the country where it is legal tender.

IBFs allow banks to compete with offshore financial centers without leaving U.S.

U.S. banks can operate international banking facilities (IBFs) in a regulatory environment similar to their offshore competitors without having to leave the country.  IBFs allow financial institutions in the U.S. to take deposits and extend credit to foreign customers without being subject to all of the U.S. banking regulations that apply to domestic banks, such as reserve requirements, interest rate ceilings and deposit insurance assessments.

Federal Reserve places some limits on IBF business transactions

The Federal Reserve established rules specific to IBFs.  For example:

• Extensions of credit can only be made to foreign customers, other IBFs, or the U.S. offices of the IBF parent bank.
• Nonbank customer deposits or withdrawals must be at least $100,000.
• Deposits received may only be used to support the IBF’s non-U.S. operations.
• Extensions of credit may only be used to finance a customer’s non-U.S. operations.

JLARC staff infer public policy objective is to encourage IBFs in Washington

The Legislature did not state a public policy objective when passing this preference.

JLARC staff infer the objective is to encourage the establishment of international banking facilities in Washington.

JLARC staff identified one IBF currently in Washington; influence of tax preference is unknown

JLARC staff identified one IBF currently in Washington based on data from the Washington Department of Financial Institutions and the Federal Reserve Board.

There were no IBFs in Washington prior to 1982.  IBFs were not authorized to exist anywhere in the U.S. until December 1981.

The majority of IBF assets are located in New York and California.  These states are home to 98 percent of the $126 billion in IBF assets of U.S. branches and agencies of foreign banks at the end of 2016.

It is unclear if the IBF in Washington would have located in the state without the preference.  Given the changes to apportionment rules, the benefit IBFs realize from the preference may be minimal.

International banking facilities benefit from the preference

Beneficiaries are international banking facilities in Washington and the financial institutions that establish them. 

Based on data from the Washington Department of Financial Institutions and publicly available data from the Federal Reserve Board, JLARC staff estimate that there is one international banking facility (IBF) in Washington as of March 31, 2017.  The IBF is established by Taiwan Cooperative Bank, Ltd., a U.S. branch of a foreign bank.

Beneficiary savings based on estimates of IBF assets; actual savings may be lower due to changes in apportionment rules

JLARC staff estimated beneficiary savings using publicly available information on the total amount of assets for Washington financial institutions that have established international banking facilities (IBFs).  The estimates assume that the share of total assets attributable to the IBFs is the same share as California’s IBFs (37 percent).  JLARC staff also estimated the future growth of those assets, and the interest rate they earn.

Tax return data cannot be used to estimate the beneficiary savings because there is no specific tax reporting line for this exemption.

Beneficiary savings may be lower than estimate if IBF income is from customers outside of Washington

The estimated beneficiary savings are not adjusted to reflect Washington’s apportionment rules.  For financial institutions, 2010 changes to apportionment rules shifted from a three-factor apportionment formula to a single-factor formula:

• Three-factor: Prior to the 2010 changes a financial institution’s income was generally apportioned to Washington based on the average share of the institution’s total property and payroll in Washington, and earnings from Washington sources.
• Single-factor: After the 2010 changes a financial institution’s income is generally apportioned to Washington based only on the share of the institution’s earnings that is from Washington sources.

Bank earnings from extending credit to customers located outside of Washington are not apportioned to Washington for tax purposes.  Because IBFs serve primarily foreign customers, a large portion of an IBF’s earnings would not be apportioned to Washington, and would therefore not be subject to B&O tax absent the preference.  If the preference were terminated, IBFs would be subject to the B&O tax on gross receipts attributable to Washington.

Two states have the majority of IBFs and provide some tax relief

Ninety-eight percent of international banking facility (IBF) assets of U.S. offices of foreign banks are located in New York and California.  JLARC staff reviewed the statutes of these states, and found that both provide beneficial tax treatment to IBFs.

• New York – New York tax law allows IBFs to exclude income attributable to foreign persons from income taxation.
• California – No IBF assets or revenues are taxed in California.  The portion of a bank's worldwide income subject to California taxation is determined by an apportionment formula that takes into account the ratio of California-based business to worldwide assets, revenues, and payroll.  California treats IBF intangible personal property and sales as if they were located outside California for purposes of this formula.

RCW 82.04.315

Exemptions—International banking facilities.

This chapter shall not apply to the gross receipts of an international banking facility.

As used in this section, an "international banking facility" means a facility represented by a set of asset and liability accounts segregated on the books and records of a commercial bank, the principal office of which is located in this state, and which is incorporated and doing business under the laws of the United States or of this state, a United States branch or agency of a foreign bank, an Edge corporation organized under Section 25(a) of the Federal Reserve Act, 12 United States Code 611-631, or an Agreement corporation having an agreement or undertaking with the Board of Governors of the Federal Reserve System under Section 25 of the Federal Reserve Act, 12 United States Code 601-604(a), that includes only international banking facility time deposits (as defined in subsection (a)(2) of Section 204.8 of Regulation D (12 C.F.R. Part 204), as promulgated by the Board of Governors of the Federal Reserve System), and international banking facility extensions of credit (as defined in subsection (a)(3) of Section 204.8 of Regulation D).

[ 1982 c 95 § 7.]

NOTES:

Effective date—1982 c 95: See note following RCW 30A.42.0730A

Legislative Auditor recommends reviewing and clarifying the preference

The Legislature should review and clarify the B&O tax exemption for international banking facilities (IBFs) to provide an explicit public policy objective and metrics to determine if the objective has been achieved.  The Legislature may also want to review the relevance of the preference given changes to Washington’s apportionment laws.

• Public policy objective: The Legislature did not state a public policy objective for this preference.  JLARC staff infer that the objective is to encourage the establishment of IBFs in Washington. It is unclear if the one IBF in Washington would have located in the state without the preference.
• Changes to apportionment laws: The 2010 legislative changes to the apportionment formula may have diminished the value of this preference.  The apportionment formula is based only on the institutions’ earnings from Washington sources.  The majority of IBFs customers are likely located outside of Washington and earnings from those customers would not be taxed, even without the preference.

  The preference continues to benefit IBFs when they generate earnings from Washington sources.

Legislation required: Yes (preference has no expiration date).

Fiscal impact: Depends on legislative action.

The Commission endorses the Legislative Auditor’s recommendation without comment.