The EU Financial Transaction TaxOctober 28, 2013
On 14 February 2013, the European Commission (EC) published a revised proposal for a broad-based financial transaction tax (FTT) to be applied by 11 EU member states (the EU 11).
The EU FTT is commonly referred to as an indirect tax, because it applies to transactions, not income or profits. However, unlike value-added taxes (VATs), the EU FTT would (under the current proposal) apply throughout a chain of transactions without any recovery mechanism, meaning that it is a cascading tax.
If an EU FTT along the lines proposed by the EC were to be introduced into law, this would have enormous repercussions for global financial markets. It would have an impact not just on financial institutions, but also on multinational corporations in other industries; and its impact would also extend beyond the limits of the EU 11 into businesses worldwide.
Even a scaled-down version of the tax, which looks increasingly likely, will still have a potentially significant effect on financial markets. A scaled-down version may make it more likely that the tax will be agreed to by the EU 11 and introduced in 2015.
A brief history of the FTT
In September 2011, the EC set out in a draft directive its proposal for an FTT across all 27 EU member states. However, the proposal could be introduced into law only if all member states were in agreement. It became obvious during the first half of 2012 that not all member states would agree.
In the autumn of 2012, the EU 11 – led by France and Germany – asked the EC to take forward an FTT proposal to be introduced only by those countries, under a little-known procedure called “enhanced cooperation.” This procedure effectively enables a “coalition of the willing” to sidestep the need for unanimity among all EU member states.
On 22 January 2013, the European Council authorized the enhanced cooperation process with respect to the EU FTT, and on 14 February 2013, the EC adopted a proposal for a directive implementing the enhanced cooperation.
Separately, over the course of 2012, both France and Italy announced the introduction of an FTT that applies to equities. In August 2012, France went live with the new tax, and Italy followed in 2013.
The policy drivers underpinning the EC’s proposal are to:
- Harmonize transaction taxes within the EU
- Ensure the financial sector pays a fair and appropriate amount of tax in this respect
- Penalize transactions that are perceived to increase financial stability risks
The EC estimates that the FTT (introduced by the EU 11) would raise approximately €31b, even allowing for a 15% reduction and 75% reduction in the volume of equities and bonds trading and derivatives trading, respectively.
The FTT is seen as an important potential source of own revenue for the EU. The EC has also said that it sees a successful EU 11 FTT as a precursor to a global FTT.
Proposed EU FTT: basic structure
The EC’s draft directive is very similar to the original EU FTT proposal of September 2011. The EC’s expressed wish is to apply the tax to “all actors, all instruments and all markets.”
Under the current proposal, FTT is due where three conditions are met:
- A financial institution must enter into the transaction.
- It must be in regards to a financial instrument.
- There needs to be some sort of nexus with the EU.
Let’s consider these criteria in more detail:
- Financial institution: The EU FTT applies to all financial institutions (FIs) that are party to a transaction. The definition of an FI is very wide and covers banks, insurance companies, asset managers, funds, brokers and, potentially, commodity traders. It also includes pension funds and, potentially, treasury and holding companies of nonfinancial groups. Where both parties to a transaction qualify as a financial institution, EU FTT is likely to be due from both parties to a transaction.
- Financial instrument: The EU FTT applies to all secondary market transfers of equities, bonds and entry into all derivatives, as well as stock loans and repos. It also applies to intragroup transfers of risk with respect to such instruments. “Material modifications” of in-scope instruments are also treated as taxable transactions.
- EU 11 nexus: The EU FTT applies only to FIs “established” in an EU 11 jurisdiction. An FI is established within the FTT zone, broadly, if it is authorized and has a registered seat, permanent address or branch in any one of the EU 11 member states.
Furthermore, an FI is also treated as so established if it meets either of the following conditions:
- It is party (or acting for a party) to a financial transaction with another person established in that member state pursuant to the above points (the “counterparty” rule).
- It is party (or acting for a party) to a financial transaction over (broadly) bonds or shares issued, or an exchange traded derivative treated as issued, within the territory of an EU 11 Member State (the “issuance” rule).
The inclusion of both the “counterparty” rule and the “issuance” rule is particularly controversial. Examples of this include:
- Gross basis of tax: The EU FTT applies on a gross basis; the tax base is not capable of being reduced by set-off, netting, etc. It is this aspect of the tax that may lead to tax cascading.
- Exemptions: The EU FTT has practically no exemptions. In particular, there are no exemptions for market makers, brokers or other intermediaries, for investors such as pension funds, or for short-term/financing transactions such as repos or stock loans. There is no exemption for intragroup transactions. There is no blanket exemption for “agents.” There is only a limited exemption where one FI acts as agent for another FI. This lack of exemptions accounts for the cascading effect of the tax as noted above.
- Rates: The EU FTT does not harmonize tax rates. It only provides for minimum rates to be applied by the participating member states: 10 basis points for bonds and shares and 1 basis point for derivative contracts.
The full version of this article was published in EY´s Indirect Tax Briefing, issue 8 (PDF, 3.28 MB).
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