1. Summary of Relevant Provisions of Gramm-Leach-Bliley Act (GLB)
   
   
   1. Glass Steagall Act amendments - GLB repeals anti-affiliation restrictions of section 20 of the Glass-Steagall Act, effective March 11, 2000. These had prevented banks from affiliating with insurance companies, limited the ability of banks to affiliate with broker-dealers or engage in merchant banking, and prevented broker-dealers from owning banks.
   2. Basic policy thrust of GLB
      1. Permit freer affiliation between banks, broker-dealers, insurance companies and other financial services businesses.
      2. Expectation of substantial cross-selling of services between different types of financial services companies, subject to privacy issues and need for arm’s length relationship between banks and their affiliates.
      3. Align regulatory responsibilities with new structure of financial services industry
      4. Continue and strengthen existing barriers preventing financial institutions from affiliating with non-financial businesses.
         
   3. Two structures permitted under GLB

      1. Financial holding company (FHC) - amendments to Bank Holding Company Act of 1956

      1. Bank holding companies can elect to become FHC’s if they have a satisfactory Community Reinvestment Act (CRA) rating and are well managed and well capitalized. Foreign banks and corporations that own foreign banks can qualify as FHC’s under different standards.
      2. FHC’s can engage in activities that are "financial in nature" as determined by the Fed, along with incidental and complementary commercial activities. Newly authorized activities for FHC’s include unlimited securities underwriting, insurance underwriting, and merchant banking (e.g., owning equity in leveraged buyouts, venture capital, etc.). Some new activities are mandated by the bill; others are to be determined by the Fed in the future. Note that electronic commerce could greatly change what is viewed as a financial activity.
      3. FHC’s cannot engage in commercial or industrial activities except for merchant banking (through ownership of portfolio companies), activities that are "complementary" and "incidental" to financial activities, and certain activities covered by a limited grandfather rule.
      4. FHC merchant banking is limited to securities or insurance affiliates of banks, not banks themselves, with a prohibition on active management of portfolio companies and on ownership beyond the time necessary to enable the sale of the portfolio companies in light of their financial condition.
      5. Many large financial services companies are expected to become financial holding companies.
      6. For broker-dealers and insurance companies, a major change is that they will be able to engage in the full-service commercial banking business by using an FHC structure. Previously, they could only engage in banking through "non-bank" banks, which could not take deposits, and limited purpose institutions.
      7. For banks, a major change is that they can engage in the securities business without restriction and can enter the insurance business.
      8. Foreign financial services companies will be able to expand in the U.S. with fewer restrictions.
         

      2. Bank financial subsidiary - amendments to National Bank Act.

      1. Alternatively, a bank can create a "financial subsidiary" that can engage in a range of financial activities provided it has satisfactory CRA ratings and is well managed and well capitalized.
      2. The bank financial subsidiary’s permissible activities are regulated by the Treasury, not the Fed, but should be the same as permissible activities of FHC’s except for the exclusion of insurance underwriting, issuance of annuities, real estate development and investment, and (for at least 5 years) merchant banking.
      3. This option is potentially attractive to smaller banks, who want to engage in a limited range of nonbanking financial activity while avoiding regulation by the Federal Reserve.
         

   4. Functional regulation of financial services companies
      
      1. Regulatory responsibilities determined by function, not type of entity
      2. Under GLB, banks lose their blanket exemption from SEC regulation of their broker-dealer and investment advisor activities.
         
         1. Blanket exemption is replaced with limited exemption for a list of specified activities.
         2. Expectation that banks will move non-exempt SEC-regulated activities (e.g., debt and equity underwriting, investment advisory services and securities dealing) into a broker-dealer affiliate to keep the bank itself out of SEC regulation.
         3. Conversely, broker-dealers may move non-SEC-regulated activities (e.g., government securities) out of the broker-dealer affiliate to avoid SEC regulation of those activities.
            
      3. Insurance activities continue to be regulated by state insurance departments, and commodity activities by the Commodities Futures Trading Commission.
         
         
2. Overview of tax issues raised by Gramm-Leach-Bliley
   
   
   1. Separate entity states
      1. Existing activities will be dropped down into newly created subsidiaries to achieve regulatory objectives or meet regulatory mandates.
      2. These affiliates are likely to engage in substantial intercompany transactions, as they will share the same customer base
      3. In general, this will change tax liabilities in separate entity states in ways that may not be perceived as equitable.
         1. Possibility of losses in one entity, profits in another
         2. Possibility of non-arm’s length pricing of intercompany transactions.
         3. To the extent that separate entities are mandated by regulatory concerns, taxpayers cannot plan around inequitable tax results.
   2. Cross references to banking regulations
      1. In several states, bank tax laws include important cross-references to the banking regulatory statutes, especially the Bank Holding Company Act.
      2. The significance of those bank regulatory statutes has changed significantly, raising questions about whether the cross-references continue to serve their original policy objective.
   3. The policy rationale for separate tax regimes for banks, insurance companies and other financial services business is called into question when they can all affiliate with each other as subsidiaries of a financial holding company sharing the same customer base and engaging in substantial intercompany transactions.

    

3. Cross references to bank regulatory statutes
   
   
   1. To become an FHC, a corporation must generally first register as a bank holding company under the Bank Holding Company Act of 1956. In many states, registration as a bank holding company changes applicable tax rules.
   2. New York State and City
      
      1. Under the NY Tax Law and applicable regulations, corporations are taxed under the Bank Tax if they are -
         1. Engaged in a banking business,
         2. A NY corporation authorized to do a banking business, or
         3. 65% or more owned or controlled, directly or indirectly, by a bank or a bank holding company and are principally engaged (under a gross receipts test) in a business which

            1. May lawfully be conducted by a bank under various state or federal banking statutes, or
            2. Is so closely related to banking "as to be a proper incident thereto" under section 4(c)(8) of the Bank Holding Company Act of 1956, as is elaborated in Federal Reserve Regulation Y listing specific activities and in individual orders issued by the Fed to specific banks, which are now codified in 4(c)(8).

      2. It is the "65%" rule that causes broker-dealer or other non-bank affiliates of banks potentially to be taxed under the Bank Tax.

         1. Various activities typically conducted by broker-dealers and other entities that are generally not associated with banking are listed in the Reg. Y laundry list (now codified by the Act).
         2. Other activities typically engaged in by broker-dealers may also lawfully be engaged in by banks
         3. If the Reg Y activities or lawful bank activities amount to more than 50% of the broker-dealer affiliate’s gross receipts, the affiliate would be taxed under the Bank Tax.
         4. This test is applied separately to each affiliate in an affiliated group and is applied separately every year. Thus, an affiliate could easily flip-flop between the general corporation tax and the Bank Tax each year, leaving and entering the broker-dealer combined group (or the bank combined group), creating problems by triggering of deferred intercompany gain, modifying net operating losses, investment tax credits, etc.

      3. Under NY tax law, bank holding companies are taxed under the Bank Tax if they file combined reports with banks. (Under the general rules, they would generally be general corporate taxpayers because they merely receive dividends.)
      4. The purpose of these rules in NY tax law was to enable banks and their related businesses to file under the Bank Tax. There was never an expectation that the rules would be applied to a typical broker-dealer.
      5. Bank tax potentially quite different from tax on ordinary business corporations.
         
      6. NYS and NYC response
         1. Transition legislation included in recently enacted budget
            1. Corporations freeze their status as general business corporations or banks through 2000.
            2. Non banking corporations newly becoming NYS or NYC taxpayers are taxed in 2000 based on how they would have been taxed had they been taxpayers in 1999.
            3. Newly formed nonbanking corporations of FHC’s engaged in financial activities or newly formed bank financial subsidiaries are given an election to be taxed as banks or as general business corporations in 2000
            4. The State and City are prevented from forcing combined reporting of FHC’s which first become bank holding companies in 2000 with bank affiliates.
         2. Business/government working group formed to study throughgoing reform of NYS and NYC taxation of financial services industry. The task force is expected to consider both patches to existing law to deal with the problematic cross-references, along with more far-reaching proposals to tax financial institutions under a single Article of the Tax Law.

1. Illinois’s taxation of a non-banking financial institution would change if the taxpayer used the FHC structure to buy a bank
   
   1. Broker dealers, for example, are presently taxed under rules applicable to general business corporations, which source receipts on the basis of cost of performance.
   2. However, if a broker-dealer uses an FHC structure to buy a bank, it would become a bank holding company, in which case all affiliates that are part of the unitary group would be taxed under rules for financial services companies. These rules involve greater customer-based sourcing of receipts than the rules applicable to broker-dealers.
2. Other states with references to Bank Holding Company Act
   1. Alabama - bank holding companies use different apportionment formula.
   2. Arkansas - bank holding companies do not use a double weighted sales factor in apportionment formula
   3. Florida - bank holding companies taxed under financial institutions tax, but rules are generally similar to rules applicable to ordinary business corporations.
   4. Hawaii - bank holding companies and subsidiaries doing reg Y activities are defined as financial institutions subject to a higher tax rate.
   5. Indiana - bank holding companies and subsidiaries doing reg Y activities are subject to financial institutions tax regime with different tax rate, single-factor apportionment and exemption from gross income tax. Indiana’s cross-references Bank Holding Company Act of 1956 as it existed in 1990.
   6. Maine - bank holding companies and subsidiaries are subject to financial institutions tax based on income and assets, not to the net income tax applicable to ordinary business corporations
   7. Michigan - bank holding companies treated as financial corporations which include interest income and expense in their single business tax base.
   8. Minnesota - bank holding companies use different apportionment formula
   9. Nebraska - bank holding companies and subsidiaries are subject to financial institutions tax based on deposits.
   10. New Hampshire - bank holding companies taxed as financial institutions subject to different apportionment formula.
   11. North Dakota - bank holding companies and certain subsidiaries are subject to financial institutions tax with lower tax rate and different apportionment formula.
   12. Tennessee - bank holding companies and their subsidiaries performing activities authorized by regulatory authorities (based on a gross receipts test) subject to different apportionment formula and combined reporting rules.

    

IV. Level playing field issues

1. Historically, states have maintained separate taxing regimes for banks, insurance companies, and broker-dealers and other financial services companies.
   1. Bank taxation has evolved separately from the taxation of general business corporations on account of now-repealed restrictions on state taxation of national banks. Many states still use separate accounting for bank taxation.
   2. Insurance company taxation has emphasized premium taxation in light of the difficulties in measuring net income of mutual insurance companies. The industry’s exemption from the Commerce Clause has engendered an idiosyncratic system of retaliatory taxation to deter states from enacting discriminatory taxes on out-of-state insurance companies.
   3. Broker-dealers and other financial service providers are generally taxed as ordinary business corporations.
2. As the financial services industry evolves into FHC’s engaging in a variety of financial activities, with the various affiliates entering into intercompany transactions, do these separate tax regimes continue to make sense?