Tax alert: New EU Financial Transaction Tax proposal
What it means for non-financial sector businesses
On 14 February the European Commission presented its draft Directive for an EU Financial Transaction Tax (FTT) for 11 participating Member States (Germany, France, Italy, Spain, Portugal, Greece, Austria, Belgium, Estonia, Slovakia and Slovenia). The FTT is proposed to take effect from 1 January 2014.
Although the FTT is primarily aimed at certain transactions concluded between financial institutions, corporates and non-financial businesses could adversely be impacted because of their dealings within the FTT zone.
Under the FTT proposal, certain financial transactions may become subject to a tax of 0.01% (1 basis point) on the notional amount mentioned in the derivative contract for derivatives and 0.1% (10 basis points) on the market price of other financial instruments.
The targeted financial transactions include trades in a broad range of financial instruments such as equities, bonds, fund units and derivatives. Taxable trades are not limited to trades on public stock exchanges and include inter-band and over-the-counter trades.
The following transactions are not subject to FTT:
- Primary market transactions (issuance of securities, e.g. bonds and shares), whereby redemption and sale/purchase transactions of securities do not qualify as such primary market transactions.
- Spot currency transactions.
- Qualifying restructurings within the meaning of the Capital Duty Directive (2008/7/EC) (e.g. a merger).
- Day-to-day financial activities of ordinary citizens and businesses (e.g. insurance contracts, mortgage and business lending, credit card transactions, payment services, deposits, spot currency transactions, etc.).
- Transactions with the central banks of Member States and European institutions such as the European Central Bank.
The European Commission expects that EU FTT will raise about €31bn annually, assuming the participation of 11 Member States.
Potential impact for non-financials
The new Commission proposal, closely based on its initial proposal of September 2011, remains a very broad measure, taxing transactions in equities, bonds, fund units and derivatives. The tax will have an impact beyond countries that enact FTT and beyond the financial sector.
The Directive would affect non-financial sector businesses in two key ways as a result of:
- The broad definition of ‘financial institutions’ – likely to include treasury companies, pension funds, and other non-financial sector companies with a significant turnover in financial transactions – they will be directly subject to the tax for transactions with FTT zone parties or in transactions in financial instruments issued in the FTT zone.
- Financial institutions passing on the estimated €35bn annual costs of the tax through higher borrowing and hedging costs, lower returns on pension and investment fund assets and higher energy and commodity costs to consumers, or as a result of joint and several liability provisions of the Directive.
In light of the Directive, corporates will need to:
- Review their banking relationships with FTT zone banks.
- Consider the direct impact of the tax on their treasury or financing vehicles and on pension funds.
- Review terms and conditions of transactions with banks to see where liability for FTT sits, bearing in mind joint and several liability.
- Consider their hedging strategy for interest rate, currency and commodity risks, all taxable if executed with FTT zone counterparties.
Definition of ‘financial institution’
A non-regulated person will be treated as a financial institution (FI) if the average annual value of its financial transactions is more than 50% of its overall average annual turnover (net of sales rebates and turnover taxes).
For this purpose the value of financial transactions includes the full sale or purchase price for each sale or purchase of equities, bonds or fund units and 10% of the notional principal of any derivative transactions.
Companies affected are likely to include:
- Corporate treasury, holding and potentially operating companies of groups carrying on hedging activities.
- Utility companies, transport undertakings such as airlines and shipping companies, food manufacturers and distributors, and other businesses involved in signficant risk management activity, whether this covers FX, interest rate, counterparty credit or commodity price risks.
- Corporate pension funds involved in dealing and managing exposure on their investment portfolios, including through repo and stock lending transactions
It is not clear that such a broad definition of financial institution is in line with the stated purpose of the FTT. As currently drafted, the scope of the Directive appears to go well beyond the provision of financial services by ‘shadow banking’ entities which earlier Commission papers identified as a target of the extended definition.
‘Residence’ basis now supplemented by ‘issuance’ basis
The first draft of the FTT Directive considered residence to be the main nexus for granting taxing rights to a participating Member State. In other words, the tax would apply to a financial institution residing in the FTT zone, extended to include any other financial institution entering into a transaction with a person (whether or not a financial institution) resident in the FTT zone (the so-called ‘deemed establishment’ rule). It is understood, however, that the ‘residence’ basis was considered by the participating Member States to be insufficient to prevent the relocation of trading activity outside of the FTT zone.
The ‘issuance’ basis is, therefore, included as a supplementary basis of taxation. This means that the trading of financial instruments issued in the FTT zone will be subject to FTT, irrespective of where the parties to the transaction are located. For example, the sale by a US bank to a US treasury company of bonds issued by a German company would be subject to EU FTT.
The scope of the ‘issuance’ measure also extends beyond equities, bonds and fund units issued in the participating Member States to include depositary receipts and exchange traded derivatives issued in the FTT zone. This seems to ignore the fact that an ‘issuance’ basis can only apply to property which can be ‘issued’ and it is not currently clear, therefore, how this will work in the context of derivatives. In any event, the inclusion and scope of an ‘issuance’ basis is bound to be controversial, particularly in the UK, US and other markets not taking part in the EU FTT.
Transactions within a group are not excluded from FTT as long as at least one party to the transaction is a ‘financial institution’ and either the ‘residence’ basis or ‘issuance’ basis applies. The tax base is extended to include any intra-group transfers of risk associated with financial instruments covered by the Directive, even if such risk transfers are not themselves financial transactions within scope. This would mean, for example, that a parent company’s guarantee of its subsidiaries’ derivative positions could be subject to FTT if any of the companies involved are in the FTT zone or the positions involve FTT-issued instruments.
The new proposal contains a general anti-abuse rule (GAAR) modelled on the Commission’s Recommendation of 6 December 2012 on aggressive tax planning.
The GAAR would allow participating Member Statesto treat artificial arrangements aimed at avoiding the tax by reference to their economic substance.
Avoidance is defined through an objective test of whether the ‘object, spirit and purpose’ of the tax provisions is defeated. Given the wide-ranging objectives of the FTT as described in the Commission’s proposal – which include ensuring that ‘financial institutions make a fair and substantial contribution to covering the costs of the recent crisis’, and to ‘create appropriate disincentives for transactions which do not enhance welfare or the efficiency of financial markets’ – this anti-abuse measure coupled with the taxation of counterparties outside the participating Member States will be particularly controversial.
A mini-GAAR of this type does not sit well with a transactions tax intended to be operated in real time and applied (potentially) to both counterparties to any transaction.
Cost of the tax
The FTT minimum rate is 0.1% for transfers etc. of bonds and shares and 0.01% on the notional value of derivatives. These rates apply to each party to a transaction which is a ‘financial institution’ and to each link in a chain of transactions (the cascade effect), except where one FI acts as agent (in the name of or for the account of) another FI.
The directive provides for each party to a transaction (including non-financial institutions) to be jointly and severally liable for unpaid FTT.
As well as the tax charge itself, companies will need to adapt their reporting and compliance ystems to their new FTT obligations. The tax is payable on the same day as the liability arises (three days for paper transactions). This will involve (i) separating financial transactions by location and status of counterparty, and by place of issuance of the financial instrument, and (ii) having systems to report to, and account to, the tax authorities of the participating Member States, who may not necessarily set the same rates or procedures for their operation of the tax.
Following the European Commission’s adoption of its revised proposal on 14 February, the draft Directive will now be subject to further discussion and negotiation between all EU Member States (including those that are not part of the group of participating Member States) and the European Parliament will be invited to give its (non-binding) opinion on the proposal.
The non-participating Member States can be expected to press for changes to protect their interests and that of the Single Market as a whole but, to be adopted, the proposal (with or without further amendments) will need the unanimous approval only of the 11 participating Member States. A Sub-Committee of the U.K. House of Lords, however, has already suggested that the UK may take legal action if the draft Directive is approved in its current form.
Once the Directive is adopted, the participating Member States will then have to adopt domestic law and administrative provisions to apply the FTT. The draft envisages they do this by 30 September 2013.
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