Banks brace for tax hit to help plug UK's budget gap

British banks are bracing for a potential tax hit to their profits as the government scrambles to plug an estimated 40 billion pound ($45 billion) hole in its finances.

A source familiar with the British government's plans said new finance minister Jeremy Hunt was reviewing the current surcharge on bank profits and would confirm the level when he delivers his medium-term fiscal plan on Oct. 31.

Governments across Europe have been weighing whether to slap new taxes on banks to help pay for state support packages for citizens struggling with soaring food and fuel prices, with both Spain and Hungary proposing one-off levies.

Britain already imposes a levy on bank balance sheets and an 8% surcharge on profits above the 19% rate of corporation tax, although this surcharge was set to drop to 3% next year.

Hunt has not yet decided whether to scrap the proposed cut to the bank surcharge, the Financial Times reported on Tuesday, fuelling investor concerns about the potential tax burden on lenders.

"There is a competition angle here which is that as with all tax if you push it too far, you could lose banking activity to other markets and your tax base goes down," said Richard Milnes, bank tax partner at EY.

Shares in British lenders fell as much as 6% in early trading on Wednesday following the report.

Shares in Lloyds and NatWest fell as much as 4% and 5% respectively, while challenger Virgin Money slid 6%. The stocks later pared some of their losses but were still underperforming the wider FTSE index, which was flat on the day.

"It's a source of frustration that banks in the UK are always perceived to be an ATM by the government," said Alan Custis, head of UK equities at Lazard Asset Management.

If the surcharge were to be revised to around 5% to 8% instead of 3%, however, banks could cope, given their expected strong profits in the next few years, he said.

Senior bankers in Britain had been wary of the potential for extra taxes, although one senior industry source said they had had no dialogue so far with Hunt's new team.

"We urge the government to consider the surcharge very carefully and not put at risk the competitiveness of the UK's banking and finance industry," a spokesperson for bank lobby group UK Finance said.

($1 = 0.8893 pounds)