Financial Transactions Tax, Feb 2013 - Tax Authorities

The European Commission unveiled its revised proposal for a new financial transaction tax (FTT) on 14 February 2013 following the decision by ECOFIN in January to proceed with the introduction of an FTT through "enhanced cooperation". Expected by the Commission to generate €30 – €35 billion a year from 1 January 2014, the FTT as proposed will apply far beyond the borders of the 11 Member States requesting the proposal. Opposition to the FTT is strong and likely to increase as the potential implications of the revised FTT are considered. Significant hurdles also need to be overcome before the FTT can be implemented, including the potential for legal challenge to its design and scope.

In this briefing we summarise the nature, scope and potential impact of the FTT as proposed and its potential implications for Irish issuers and the Irish funds and financial services industries generally.

What is the FTT?

Proposed initially by the European Commission in September 2011, the FTT is tax on financial transactions within the FTT zone. While originally intended to comprise all 27 EU Member States, the FTT-zone will now comprise only those 11 Member States who have requested to proceed through the "enhanced cooperation" procedure: Austria, Belgium, Estonia, France, Germany, Greece, Italy, Portugal, Slovakia, Slovenia and Spain, which together account for two-thirds of EU GDP.

Initially proposed as a tax on financial transactions involving one or more financial institutions established in the FTT-zone (the "residence" or "establishment principle"), the revised proposal also applies to transactions involving securities issued within a participating Member State (the "issuance principle"). This extension was included to avoid financial institutions relocating outside the FTT-zone to avoid the tax. Thus, transactions involving German or French securities, for example, are now potentially in scope irrespective of where the parties to the transaction are located. A deemed "establishment principle" also applies so that non-FTT zone financial institutions are to be subject to the tax in respect of financial transactions with FTT-zone parties whether or not they are financial institutions.

The FTT is to be charged on financial transactions involving one or more financial institutions where (1) at least one party to the transaction is established in the FTT-zone, or (2) the transaction is in respect of financial instruments issued by an issuer established in the FTT-zone. Certain intra-group transfers are also within scope.
Financial transactions are defined broadly to include:
- the purchase, sale and exchange of financial instruments;
- certain other intra-group transfers involving the transfer of the risk associated with a financial instrument;
- derivative contracts; and
- repos, reverse-repos and securities lending and borrowing agreements.
Financial instruments are to include all manner of financial instruments such as equities, debt securities, money market instruments, options and derivatives.
Financial institution is defined broadly to include investment firms, credit institutions, insurance and reinsurance companies, most retail and private funds (including UCITS), pension funds, treasury companies of corporates and certain securitisation vehicles and SPVs.
Loans are to be excluded from the charge as well as primary market transactions (i.e. subscription and issuance) and underwriting. Thus, the issue of shares, debt securities or units in a fund will not be subject to the charge although redemptions appear likely to be caught.
Specific exemptions are also to apply for EU Member States and their central banks and other bodies entrusted with the function of managing their public debt, as well as the various European Institutions including the ECB, EFSF and ESM, and depositaries.

How and when will it apply?

The FTT is proposed to apply to financial transactions from 1 January 2014 at a harmonised minimum rate of 0.1% of the purchase price, or market value if higher. For derivatives, the rate is to be a harmonised minimum rate of 0.01% of the notional principal. Participating Member States will be free to set the rate of FTT above these minimum rates.

The FTT is to apply on all financial transactions within scope and is to be payable by each financial institution:

which is a party to the transaction either for its own account or for the account of another person,
which is acting in the name of a party to the transaction, or
where the transaction has been carried out on its account.

The FTT is to be payable to the tax authorities of the participating Member State in which the financial institution is established (or deemed to be established) and is due on completion of a financial transaction which is effected electronically or otherwise (e.g. OTC transactions) within 3 days of completion. Monthly returns are envisaged by the proposals. Where the FTT is not paid within the time limit prescribed, each party to the transaction is to be jointly and severally liable for the tax whether or not they are a financial institution.

Where two or more parties to a transaction subject to the FTT are financial institutions, each financial institution is to be liable for the tax. Unlike VAT, there is no credit for 'input' FTT; the FTT is to operate on a gross basis and is to apply separately to each stage of a financial transaction. Unlike stamp duty in Ireland and other jurisdictions, there is no exemption or relief for intermediaries. Thus, the effective rate of FTT will be significantly higher than the headline rate of FTT where a typical financial transaction is settled through a series of intermediaries.

Exchanges are to be treated as giving rise to two separate financial transactions for each taxable counterparty. However, repos, reverse-repos, securities lending and borrowing agreements are to be treated as a single financial transaction (i.e. subject to the FTT on one 'leg' only) for each taxable counterparty. There is no exemption for overnight repos in the revised proposals.

Anti-abuse provisions have also been introduced in the revised proposals which will seek to target artificial arrangements aimed at avoiding the tax. Depositary receipts or other similar securities are expressly targeted where they are aimed at avoiding the FTT on transactions in underlying securities issued in a participating Member State.

Who will be affected? How will it affect Irish issuers and Irish funds?

The FTT will potentially impact a wide range of parties including those located outside the FTT-zone. Financial institutions established in participating Member States will be affected on their worldwide financial transactions, including those conducted through their non-FTT-zone branches. Depending on the location of their customer base, the FTT may encourage financial institutions to leave the FTT-zone altogether.

However, financial institutions established outside the FTTzone (for example, in Dublin, London or New York) will also be subject to the FTT on their financial transactions with parties established in the FTT-zone as well as in respect of securities issued by FTT-zone issuers. Those financial institutions will be accountable for the tax by being deemed to be established in the relevant participating Member State. The administrative impact of this extra-territorial effect alone, not to mention the cost of the tax, could act as a real deterrent to overseas financial institutions doing business in Continental European markets. Residents of the FTT-zone who are not financial institutions themselves may also suffer as they could be held to be liable for the unpaid tax on their dealings with non-FTT-zone financial institutions that refuse or fail to pay the tax on time.

The FTT could also have a significant impact on funds. Investors purchasing units in funds on the secondary market, such as those secondary investors in ETFs, may be subject to the FTT on acquisition if they or the funds are located in the FTT-zone. While Ireland is not a participating Member State and is not within the FTT-zone, the sale and purchase of units in Irish funds on the secondary market would be subject to the FTT as proposed where a resident of a participating Member State is a party to the transaction or the sale is effected by or through a financial institution in the FTT-zone. In addition, the fund itself may be subject to the FTT when it buys and sells certain securities, and if it engages in repo or securities lending transactions. Uncertainty exists as to how collateral would be treated. Irish funds, including in particular money market funds, could also be subject to the FTT where they engage in financial transactions in respect of the securities of FTTzone issuers.

While depositaries will not be subject to the FTT in respect of their core functions, they are to be subject to reporting obligations in respect of the tax and may be liable where their counterparties fail to pay the FTT on time.

What are the arguments in favour of an FTT?

The main objectives of the FTT are three-fold:

to harmonise legislation concerning indirect taxes on financial transactions to avoid the fragmentation of the Single Market that uncoordinated national financial transaction taxes could create;
to ensure that financial institutions make a "fair and substantial" contribution to covering the costs of the recent global and economic financial crisis and to create a level playing field with other sectors which are more heavily taxed; and
to create "appropriate disincentives" for transactions that do not enhance the efficiency of financial markets.

The proponents of the FTT argue that the FTT should not lead to any job losses and that the revenues generated by the FTT could be recycled back into the economy to improve overall GDP. They also counter criticisms of the tax by pointing to the low rate of the FTT, the fact that day-to-day financial activities of ordinary citizens and businesses (e.g. insurance contracts, mortgage and business lending, deposits etc.) will be unaffected thus protecting the real economy, and that the tax will not apply to traditional investment banking activities such as the raising of capital (i.e. primary issuances of shares and bonds) or to restructuring operations.

Commenting on the release of the Commission's revised proposal for the FTT, Algirdas `emeta, European Commissioner responsible for Taxation and Customs Union, Audit and Anti-Fraud said: "With today's proposal, everything is in place to enable a common Financial Transaction Tax to be become a reality in the EU. On the table is an unquestionably fair and technically sound tax, which will strengthen our Single Market and temper irresponsible trading. Eleven Member States called for this proposal, so that they can proceed with the FTT through enhanced cooperation. I now call on those same Member States to push ahead with ambition – to drive, decide and deliver on the world's first regional FTT."¹

What are the arguments against the FTT?

Critics of the FTT warn that it will be harmful to the European financial sector and is likely to damage growth and disrupt markets. They argue that despite the objectives of the tax, it would shrink those parts of the financial markets which did not contribute to the financial crisis. Furthermore, those who would carry the economic burden of the tax would not be the banks but workers and consumers in general.² Member States outside of the FTTarea have also questioned the legality of the territorial reach of the revised proposals and warn that the plan may breach EU treaties.

Another argument against the introduction of the FTT as proposed is the potential compounding effect of the tax. By applying at each stage of a financial transaction and to each financial institution that is a party to the transaction, the effective rate of the FTT could be significantly higher than the headline rate suggests.

When will it come into force?

The proposals envisage the FTT applying from 1 January 2014, with the participating Member States expected to adopt implementing legislation by 30 September 2013 at the latest. Whether this ambitious timetable will be met will depend on the resolve of the participating Member States over the coming months in finalising, agreeing and enacting the Directive. The approval of at least 9 Member States is required to implement the Directive under the "enhanced cooperation" procedure. It is possible that other Member States may also choose to join the current group of participating Member States while others may leave.

Footnotes

¹ ^{http://ec.europa/eu/commission_2010-2014/semeta/headlines/news/2013/02/20130214_en.htm}

^{2 The Case Against a Financial Transactions Tax, Worstall,
Tim; November 2011, IEA Current Controversies Paper No.
33}

This article contains a general summary of developments and is not a complete or definitive statement of the law. Specific legal advice should be obtained where appropriate.