UK: Financial Transaction Tax - A European Tax With A Global Reach

Last Updated: 22 May 2013
Article by Deloitte Financial Services Group

Most Read Contributor in UK, August 2017

Financial transaction taxes (FTT), also known as Tobin taxes or Robin Hood taxes, have featured increasingly in the news over the last few years. In 2011, the European Commission published a draft FTT directive applying an FTT to transactions in shares, bonds and derivatives. However, it became clear that there would not be unanimous support as not all EU member states (including the UK) were in favour of introducing an EU FTT, unless the FTT was introduced on a global basis. Since then, France and Italy have introduced their own variations of an FTT and the political momentum has continued. Earlier this year, 11 EU member states1 voted to take forward the EU FTT by way of an enhanced co-operation process (ECP) pursuant to which a minority of EU member states can implement a law. This is the first time ECP has been used to implement a new tax, and on 18 April the UK challenged the legality of the use of ECP to introduce FTT. The European Commission published a revised draft of the FTT directive on 14 February 2013, which expands the scope and reach of the EU FTT beyond the original draft. This article discusses how the EU FTT will work, what it will apply to and the key discussion points and implications of such an EU FTT.

In scope financial instruments

The EU FTT is intended to apply minimum tax rates of 0.1% to transactions in shares and bonds, and 0.01% to derivatives by notional value. The FTT would be payable by each financial institution party to a transaction where at least one of the parties is "established" in one of the 11 participating FTT zone countries. The revised draft of the EU FTT to be discussed between ECP participating countries will cover shares and similar instruments, such as American Depositary Receipts (ADRs), bonds and derivatives, as well as other financial instruments such as fund units. The UK currently taxes transactions in (broadly) UK shares, but not bonds or derivatives. Neither France nor Italy, which have introduced their own national FTTs, has sought to tax financial instruments other than equity (or similar) securities and, in the case of Italy, derivatives over equity (and similar) securities. The EU FTT, as proposed, is therefore significantly broader than the current FTTs and stamp taxes in place, and affects a wider range of market participants, such as bond traders. The potential for it to disrupt markets and impose taxes far greater than existing trading costs or margins is causing concern for market participants and end investors. Including a broad range of derivatives would expand the FTT's reach beyond the financial industry; other industries which rely upon derivatives to hedge risk, such as manufacturing, oil and gas, would also be affected.

(Extra-)Territoriality Under the revised draft, the EU FTT applies on both an issuer and residence basis. This means that FTT would apply when dealing with a party which is "established" in an FTT zone country, such as an entity with its head office in an FTT zone country, for example a German car manufacturer (residence basis).

A financial institution is deemed to be established in an FTT zone country if it deals with a counterparty that is established there; therefore a Hong Kong bank writing an interest rate derivative with a German car manufacturer would be treated as established in Germany and so liable to FTT. This contrasts markedly with the issuer basis adopted in France and Italy, where (similar to the UK's stamp duty) only securities issued in those countries are subject to the tax.

EU FTT would also apply, under the revised directive, when dealing in securities issued in an FTT zone country, such as Spanish government bonds (issuer basis). If a New York broker sells Spanish bonds to a U.S. pension fund, the broker and the pension fund is treated as being established in Spain and so liable to FTT. Financial institutions outside the FTT zone, whether in London, Hong Kong, New York or Zurich, would not therefore escape the FTT owing to an expansive definition of being "established" in an FTT zone country when dealing with counterparties or securities linked to the FTT zone. In order to counter concerns that the EU FTT might encourage dealings in financial transactions outside the FTT zone, the EU FTT has almost unprecedented extra-territorial reach. Where both financial institutions are or are treated as being established in the FTT zone, each is liable for the FTT and therefore a double charge arises.

It remains to be seen whether financial institutions can in fact bear such additional taxes themselves, especially as multiple charges are likely in a chain of financial transactions, or will have no choice but to pass the tax on to the end investor. This could result in decreased market trading volumes and greater volatility, with the discrepancy in FTT costs when dealing with an FTT zone counterparty or a non-FTT zone counterparty creating confusion and an uneven playing field in the market.

The revised draft of the EU FTT is extended to cover dealings in securities issued in an FTT zone country (or even securities such as ADRs over underlying FTT zone securities, where these have been issued "with the essential purpose of avoiding tax on transaction in the underlying security"), no matter who or where the parties are or where that security is traded. Knowing the full identity and status of trading counterparties and the place of issue of securities will therefore be paramount in order to comply with the EU FTT, even for trades taking place on the other side of the world.

The issue of double taxation does not seem to have been thought through fully by the European Commission and the participating countries, and may not be adequately covered by existing double tax treaties. For example, if a UK share is purchased by an investor in the FTT zone, this would be subject to both UK stamp duty reserve tax and the EU FTT. While countries in the FTT zone are likely to be obliged to align their existing transaction taxes to the EU FTT or even abolish any other transaction taxes which overlap with FTT, there is clearly the risk of double taxation where non-FTT zone countries impose a similar tax.

While the U.S. is thought to be opposed to such a tax applying to U.S. markets and participants, it is not impossible that it could undertake to impose a similar tax. It will be interesting to see whether other countries, such as China or India, whose financial institutions come within the scope of the EU FTT when dealing with FTT zone residents or securities, might consider imposing their own FTTs when FTT zone countries deal with one of the residents of, or deal in securities issued in, that country.

It remains unclear how the EU FTT will be collected and enforced in practice, especially outside the EU.

Exemptions

Primary market transactions, such as new issues of shares and bonds, are protected from tax by existing EU law which applies to all member states and so are not subject to EU FTT. FX spot trades are also exempt as to tax these would breach the free movement of capital within the EU's borders. Transactions with the European Central Bank (such as the repo window pursuant to which assets can be pledged in return for a loan of cash), central banks of EU member states and certain European and international bodies are exempt, as well as certain restructurings. No exemption for pension funds is currently included, but this could be something which participating member states may wish to negotiate.

It remains to be determined to what extent, if any, a market maker exemption, such as the intermediary exemption from stamp duty in the UK or the market maker exemptions from the existing FTT in France and Italy, would be available as none is included in the revised draft. Without such an exemption, the EU FTT charges on seemingly simple transactions could be multiplied, increasing the effective EU FTT rate several times over. The potential for multiple charges on the same economic transaction owing to the way in which markets are structured raises cause for concern.

For example, a typical simple broker-to-broker trade can involve securities being transferred by a broker to a clearing member of a settlement system to a central counterparty (this leg is exempt) to a clearing member of the settlement system to the buying broker. Under the original draft of the EU FTT, this could impose six charges to FTT as each transaction is chargeable at a minimum 0.1% on both the buyer and the seller if either is in the FTT zone. There could be further charges if collateral is posted to reduce risk in relation to trades.

Stock lending and sale and repurchase (repo) trades are treated as a single transaction (although still potentially subject to tax by both parties), and the taxation of collateral is unclear. Asset managers, banks, insurers and pension funds who routinely lend out securities to raise revenues could be adversely impacted if no exemption is available. Without an exemption for collateral, the EU FTT could unwittingly encourage uncollateralised risk taking by financial institutions.

Timing and the ECP vote

The revised FTT directive specifies a commencement date of 1 January 2014, although it is hard to see how this aggressive timetable can be achieved in practice, especially in view of the UK's legal challenge to the use of ECP to introduce FTT. As outlined above, several key points of the design of the EU FTT remain to be finalised and voted upon by the participating member states. All EU member states that do not support the FTT, including those such as the UK, can attend discussions concerning the design of the FTT. However, only the FTT zone countries can vote even though their choices impact other countries in Europe and globally. The 11 participating countries must unanimously vote in favour of the FTT.

Europe already operates on a multi-tiered political and economic basis. EU FTT introduces a new grouping, for example the Eurozone within the EU. The 11 participating countries are within the very centre of existing European frameworks and initiatives, notably both the Euro currency union and the Schengen borderless zone.

The FTT zone comprises an ever-smaller group of countries at the heart of Europe. The member states which abstained from the ECP vote (Czech Republic, Luxembourg, Malta and the UK) are either outside one or both of these zones or have major concerns with the proposed EU FTT.

Even once agreed under ECP, the provisions of the EU FTT directive must be implemented by each participating country under national law in each FTT zone country.

Conclusions (and predictions)

It is understood that Germany is not expecting to raise EU FTT revenues until at least 2016. Although it is likely to push for agreement on the broader EU FTT before then, this is perhaps a more realistic assessment of the likely timeframe. The 11 FTT zone countries have financial markets of differing size and importance, economically and politically, and motivations for the tax may differ from one country to another: whether to introduce an FTT to raise much needed revenues, or to introduce a broad-ranging FTT in the medium to longer term. It may be that in order to introduce an EU FTT in the near term, the first phase could cover only equities and equity derivatives (plus perhaps high frequency trading), with further financial instruments to come within scope at a later date.

No matter what the final design or timing of the EU FTT, its global reach and broad scope mean that we have entered a new stage of the taxation of the financial sector around the world. Financial institutions, markets and investors will need to take account of FTT in the future in terms of increased costs of doing business, tax differentials depending on the security and counterparty involved, cascading charges and operational compliance with the FTT. The effects of the EU FTT are likely to spill over onto the non-financial sector too, whether through increased cost of capital, increased trading and hedging costs or otherwise. One thing is clear: what started out as a European initiative to tax financial transactions is pushing towards becoming a near global tax.

Footnotes

1 Austria, Belgium, Estonia, France, Germany, Greece, Italy, Slovakia, Slovenia, Spain and Portugal.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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