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The Financial Transaction Tax proposals

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On 28 September, the European Commission published proposals for the introduction of a Financial Transactions Tax (FTT). Under the proposals, the charge would be imposed on financial transactions where a financial institution ‘established in’ a Member State is a party to the transaction. The tax would take effect from 1 January 2014, with enabling legislation in Member States due by end 2013. The minimum rate is 0.01% for derivatives calculated on the notional amount and 0.1% for other transactions, calculated on the consideration or the market price in the case of related party transactions, in both bases before netting. Tax must be paid ‘at the moment when the tax becomes chargeable’ for electronic transactions’ and within three working days for other transactions, with ancillary provisions for the filing of monthly returns. HM Treasury has already indicated the UK will use its veto to block the proposals.

The European Commission proposals for the introduction of Financial Transactions Tax (FTT), published on 28 September, had been widely leaked but still caused serious concern in London, including public comment by Michael Spencer, Chief Executive of Icap, that if FTT were introduced Icap would move its main operations from the UK.

Policy issues

The FTT has been widely, and misleadingly, referred to as a Tobin tax.

In fact Tobin tax was conceived with a very clear policy objective – to discourage currency speculation, and was intended to be confined to spot forex transactions.

Ironically, this is one of the relatively narrow range of ‘dealing’ transactions to which the FTT is not proposed to apply.

The policy objectives behind the FTT are at best vague.

Comments by President Barroso indicated little more than that many financial institutions are seen as a soft target in a difficult climate of austerity and higher personal tax burdens, further, some of the arguments in the proposal document appear flawed.

Most obviously, the Commission notes the need to ensure a consistent approach to FTT across the EU to prevent migration of activity, while apparently ignoring the scope for migration outside the EU to other G20 countries.

The elephant in the room – Swedish financial transaction tax in various forms from 1984–91 – is only referred to briefly in the Annex.

This assumes that the only lesson to be learned is that national level transaction tax results in migration of activity rather than revenue collection.

There is no explanation of why the displacement cannot cross EU borders.

Similarly, the Commission argues that FTT will not adversely affect individuals, conveniently ignoring:

At the moment, the sense is that most of the financial sector across Europe possibly joined by some smaller Member States is hoping that the UK will use its veto to block or win substantial modifications to the proposals.

  • the likelihood of the cost of the FTT being passed on through pricing;
  • the impact of the FTT in the form proposed on pension funds (direct and through pension fund investments), insurance, and savings invested by a broad range of individuals; and
  • the economic effect of the 0.5% drag on GDP which is the Commission’s own estimate of the long-term effect of the tax.


Key factors

There are several headline factors worth drawing out:

  • The minimum rate of tax, at 0.1% for financial instruments other than derivatives and 0.01% for derivatives, sounds low: however, the actual economic cost would be much higher because transactions between financial institutions are chargeable on each institution (ie, each transaction will attract a double hit) while in some cases what the parties think of as a single transaction will attract multiple charges – this is considered further below.
  • The use of the taxes raised has been left to ‘complementary proposals’: a headline figure of €57bn per annum is given as the total expected to be raised but there is no estimate of the effect of this by Member States, and only some very general commentary about this forming ‘wholly or partly’ EU budget resource to replace a proportion of national budget contributions. No basis for the 0.5% estimated drag on GDP is given and this figure is lower than figures reported shortly before publication of the proposals. Also, no attempt has been made to quantify the distribution of the burden between Member States.
  • Member States would have to withdraw other taxes on the same type of transaction – from a UK perspective it is expected that this would cover stamp duty/SDRT on securities transactions. The yield from stamp duty/SDRT on these in 2009/10 was calculated by HMRC at £2bn. Because the rate of FTT is much lower for some transactions (eg, certain equities) this will reduce the burden of tax for flex transactions but (i) there is no equivalent of the current stamp duty/SDRT regime for securities in clearance systems, or the exemptions for brokers, dealers and financial intermediaries; (ii) currently most forms of debt security and derivatives are exempt from stamp duty/SDRT; (iii) units in unit trusts and OEICs are charged only on issue not surrender; (iv) the territorial scope of stamp duty/SDRT is radically different, eg, the important SDRT exclusion for shares not listed in a UK share register.
  • It appears that if the tax were introduced the cost of it would be tax deductible for taxpaying entities (or that, if passed on to corporate customers and some individuals, would be indirectly tax deductible for them). Obviously, this would not apply to, eg, exempt pension funds and UCITS. However, to the extent that the tax was actually collected, it would therefore have a direct negative effect on the Member States’ corporate tax base.
  • The FTT would create substantial additional costs for entities with high frequency trading strategies but many of these are among the most mobile market players. Further, studies on the market benefits and risks attaching to high-frequency trading have to date been inconclusive.
  • The extent/interpretation of the exemption from FTT for agency arrangements is not clear – this is crucial for certain sectors, especially brokers.
  • The preamble suggests that collection of the tax by reference to the place of establishment of the financial institution rather than the place the trade occurs is deliberate and will avoid concentration of the revenues – but it also means a number of difficulties with the ambit of the tax, particularly for entities with PEs.
  • While collection mechanics have been left to local states to implement, the Directive stipulates simultaneous payment for electronic transactions and payment within three days for other transactions. This will impose a significant burden in terms of collection mechanisms – and will in some cases accelerate payment of FTT beyond the settlement date for the transaction itself.


Stings in the tail

There are a number of areas where the detail of the drafting seems to contain stings in the tail which give additional cause for concern.

These include the following areas.

Multiple charges on transactions, particularly derivatives

The starting point appears to be that where more than one financial institution is involved in a transaction, there may be multiple charges to tax.

For example, if there is a purchase and sale between two financial institutions, with a third acting as agent for one of them, it appears that all of the institutions will be required to pay FTT under Article 9(1), tripling the charges.

Further, derivatives are financial instruments as defined (see Article 2(2) and Directive 2004/39/EC Section C((4)-(7)).

This makes it likely that on entry into a derivative the FTT will apply under the 'purchase and sale' head.

Any roll is likely to be either a 'modification' or (possibly) a 'conclusion', and close out will clearly be a 'conclusion' if the derivative is cash settled or results in delivery of an underlying.

It seems less clear whether a lapse is a 'conclusion' for this purpose, but it is arguable that it would be.

The preamble specifically contemplates at para 3.3.1 of the Commission Proposal (COM/2011/594) that where, eg, a forward runs to delivery of something which is itself a financial instrument, the instrument transfer will also be taxed (though it might as a matter of the Directive wording not be beyond doubt whether this is ‘purchase’ of the underlying security).

So in the life-cycle of a derivative contract including a straightforward hedge, there could be multiple charges to FTT.

It seems likely in practice that financial institutions will pass these on to corporate customers.

Also, for certain types of contract, the amount subject to charge itself is not clear.

See Examples 1 and 2.


Multiple charges on transactions

Example 1

UK plc has taken out a floating rate $ loan with a five-year maturity, which it hedges back to £ fixed rate via six monthly fixed/floating swaps with a bank provider.

The loan will not be subject to FTT (including the spot payment of forex on repayment).

But it appears that the bank will have to pay 0.01% on inception and 0.01% on close out of each individual swap.

It is not clear whether the amount is calculated by reference to the £ or $ leg but given the reference in Article 6 to the ‘highest amount’ presumably, this would be whichever delivers the higher tax charge by reference to the relevant exchange rates.

And this seems to apply regardless of the functional currency of either party.

(So, if the transaction was instead a $ functional entity entering into a $/€ swap, the same seems still to apply, translated to £).

Example 2

UK bank takes out an option to acquire some tradable securities.

This appears to trigger 0.01% FTT on the market value of the securities (not just the option price) (i) on grant; and (ii) on exercise or, probably, lapse, and 0.1% FTT on the transfer of the securities, calculated by reference (probably) to the exercise price, but possibly to the premium and exercise price.

If the counterparty is another EU financial institution, the same will apply. 

What sort of organisation is caught?

The definition of ‘financial institution’ appears to be extended by some very broadly drafted ‘sweep up’ clauses (see Article 2(7)(j) which could be treated as bringing into scope PE funds and even holding companies – it extends to undertakings carrying out as a significant part of their overall activity in terms of volume or value ‘acquisition of holdings in undertakings’).

It is not clear how this would be interpreted but could be read as applying to a broad range of investment holding companies (it is not clear what weight should be given to the reference to 'acquisition of' holdings in Article 2(7)(j)(iii) since typically a holding company’s main activity is retaining rather than acquiring shares).

Further, any entity which is for example a finance lessor (see Article 2(7)(j)(i) which cross refers to point 3 of Annex 1 to the CRD) appears to be included also, even if its activities are purely intra group.

What sort of connection with a Member State is required?

As noted above, to trigger FTT a transaction has to involve a financial institution ‘established in’ a Member State but the natural assumption as to what this means is altered by deeming provisions.

A financial institution is deemed to be established in a Member State in which (in order of priority):

1.  it has authorisation relevant to the transaction;

2.  it has its registered seat;

3.  it has its permanent address or usual residence;

4.  it has a branch to which the transaction is attributable;

5.  another party to the transaction which is not a financial institution has its registered seat, residence, permanent address or usual residence or a branch to which the transaction is attributable.

In other words, where a financial institution with no connection whatsoever with a Member State enters into a transaction with another entity which is established in that jurisdiction it will be necessary to rely on the ‘get out’ in Article 3(3) for cases where the person liable for payment of FTT ‘proves that there is no link between the economic substance of the transaction and the territory of any member state’.

This potentially gives rise to significant problems in relation to both branches and the priority order of the provisions.

See Examples 3–5.


Connections with Member States

Example 3

A US bank enters into a normal hedging transaction with the US PE of a UK trade co.

The US bank is liable for the tax (as it is deemed established by virtue of Article 3(1)(e)) unless it can ‘prove’ by an unknown process that the transaction has no connection with the UK.

Where the US entity has a UK or other EU branch, this may present particular issues.

Example 4

A US bank with multiple European branches including UK enters into a prop trade with a Korean bank.

Again, FTT will apply to both Korean bank (it is dealing with an entity with EU establishments) and US bank unless no Member State connection can be proved.

However, in this case the banks may face the need to demonstrate this under different compliance regimes in the different Member States with none taking obvious priority because there is no single jurisdiction of establishment for the US bank.

Example 5

A UK bank group entity which is Dutch incorporated but UK tax resident enters into a share sale transaction with a UK corporate counterparty executed in the UK.

There is no group definition of financial institution (unlike UK bank levy and UK Bank Payroll Tax) so the fact that the entity is part of a bank group is not relevant.

The position of the entity must be assessed on a standalone basis.

If it is a financial institution, the transaction is caught – but the liability is to Dutch FTT not UK FTT because of the 'tie breaker' in Article 3(2).

If the transaction had instead been between US bank and a Dutch incorporated UK resident financial institution, the position becomes even worse.

The US bank appears to be deemed established in both the Netherlands and the UK by virtue of Article 3(1)(e) and it is uncertain whether on the actual wording the tie breaker in Article 3(2) operates, although it might be construed as doing so to provide a way out of an otherwise unworkable position.


A blunderbuss ...

No doubt further issues, including sector-specific concerns, will emerge as institutions start to do a high-level impact analysis.

In the meantime, it is hard to resist the conclusion that far from being a Robin Hood tax, or an appropriately designed and proportionate taxation measure for the financial sector, it is a blunderbuss with a number of features which unless this is vetoed would need to be modified or clarified before implementation. 

Financial transactions tax: the basics


  • The tax is proposed to take effect from 1 January 2014, with enabling legislation in Member States due by end 2013.
  • The charge would be on financial transactions where a financial institution ‘established in a Member State’ is a party to the transaction (Article 1(2)) – but deeming provisions take this wider than might be expected).
  • There are exclusions for certain state or state-established entities and also for Central Counter Parties, Central Securities Depositories, and Internal Central Securities Depositories but other trades where a financial institution acts as agent are caught.
  • The definition of financial institution includes all the categories which would be expected – eg, banks, prop traders and brokers, but also include insurers, UCITS, pension funds, alternative investment funds and fund managers, securitisation vehicles, and certain other entities that would not generally be regarded as financial institutions.
  • The tax is levied on:

• purchase and sale of financial instruments;

• any other transfers between group entities of the right to dispose of a financial instrument and equivalents resulting in transfer of the risks associated with these;

• the ‘conclusion or modification’ of derivatives agreements.

  • Financial instruments are defined in line with MiFID and include bonds and other securities, as well as equities, derivatives, repos and stock lending, and ‘structured products’ (defined in the draft directive itself as tradable securities and other instruments offered by way of securitisation or ‘equivalent transactions involving the transfer of risks other than credit risk’: the preamble suggests this includes notes, warrants and certificates and insurance securitisations).
  • Physical commodities, emission credit trading and spot forex transactions are not caught (though FTT would extend to commodity derivatives and other forms of forex transaction, including simple over the counter forwards and options taken out by corporates from banks for hedging purposes).
  • FTT would also not extend to issues of shares by corporates, the making of loans or entry into other retail credit transactions, including mortgages or insurance policies. However, it does extend to issue and surrender of shares and units in UCITS and alternative investment funds.
  • The minimum rate is 0.01% for derivatives, calculated on the notional amount and 0.1% for other transactions, calculated on the consideration or the market price in the case of related party transactions – in both cases before netting. Member States would be free to set a higher rate.
  • Each financial institution which is a party to any transaction caught is liable to FTT (Article 9(1)) – all other parties, including non-financial institutions are jointly and severally liable for the payment (presumably to the Member State to which the tax is due), with provision for other parties (possibly related entities?) also to be liable if Member States provide.
  • Tax must be paid ‘at the moment when the tax becomes chargeable’ for electronic transactions and within three working days for other transactions, with ancillary provisions for the filing of monthly returns.

Sarah Lane, Tax Partner, KPMG