Global Tax Alert | 17 September 2013

European Council's lawyers opine FTT counterparty rule is contrary to EU law

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Executive summary

In an opinion dated 6 September 2013, the Legal Service for the Council of the EU (CLS) expressed the view that the “counterparty” rule in the proposed Council Directive (Directive) for a harmonized Financial Transactions Tax (FTT) is contrary to EU law.


The counterparty rule is set out in Article 4(1)(f) of the draft Directive.

The rule provides that a financial institution actually established outside each of the EU11 jurisdictions (the Participating Member State or PMS) is deemed to be established in a PMS if it enters into a financial transaction (for example, the acquisition of equities or bonds, or entry into a derivative trade) with another person (whether or not a financial institution) who is established in that PMS.

Thus, a UK bank, or a US bank, would be deemed to be established in Germany, simply by virtue of being party to a financial transaction with a bank or corporate client that is authorized or has its registered seat in Germany. In such a case, that respective bank would be liable to the EU FTT in Germany on the transaction (at the FTT rate applied by Germany).

In summary, the CLS expressed the view that the deemed establishment rule is contrary to EU law because it:

  • Exceeds Member States' jurisdiction for taxation under the norms of customary public international law as they are understood by the EU.
  • Is not compatible with Article 327 of the Treaty for the Functioning of the European Union as it infringes on the taxing competencies of the non-PMS (Article 327 sets out the conditions for the “enhanced cooperation” procedure governing the operation of the EU FTT proposal).
  • Is discriminatory and likely to lead to distortion of competition to the detriment of non-PMS.

What does this opinion mean for the EU FTT proposal?

It appears unlikely that the CLS opinion will spell the end of the entire EU FTT project but that, nonetheless, it is likely to act as a catalyst to further change the proposal content.

Although the timing of the CLS opinion appears to have come as something of a surprise, the conclusions are not at all surprising. Many commentators have already expressed the view that the counterparty rule is the most controversial and legally questionable aspect of the Directive, not least as it has no precedent or analog in international tax law. The CLS opinion is also consistent with the UK's protective submission to the European Court of Justice (ECJ) on the legality of the enhanced cooperation procedure particularly with respect to its comments on the operation of public international law.

Some commentators have already expressed the view that the CLS opinion signals the end of the EU FTT project. At this stage, it appears that the more likely outcome is that the EU FTT proposal will survive, albeit that its scope and content will change – a process which seemed to be already under way.

In this regard, there remains powerful political support among key European stakeholders for some form of EU FTT. The public reaction to the CLS opinion includes comments from the German Government that it “advocates a swift introduction of the FTT for good reasons. We want to make the financial sector contribute adequately to the costs of the financial crisis. Nothing has changed on that. The legal concerns must be cleared up and dispelled as quickly as possible.” The EU Commission has also continued to defend its position robustly.

Nonetheless, while the CLS opinion is not binding as a matter of EU law on the Council or the PMS, it would be difficult in practice for the PMS to ignore the opinion given by the CLS, especially as the CLS is the Council's own in-house legal unit, and is tasked with the responsibility of representing the Council before the ECJ in defense against the UK's legal challenge. Accordingly, it is likely that the “counterparty” rule will not feature in the FTT Directive if and when it is finalized.

It has been noted that a group of PMS, principally France, Italy and Spain, have already indicated that they would like to completely remove the establishment (not just the “counterparty”) rule from the Directive and move instead entirely to an “issuance” basis of taxation. In other words, they would like the FTT to apply (just as the domestic French FTT and Italian FTT operate) only to transactions involving securities issued by entities domiciled in the PMS. The CLS opinion will therefore lend further weight to this stance, and arguably weaken the contrary view that has been expressed by some of the other PMS who have advocated the retention of the establishment rule. This is because the inclusion of any establishment basis of taxation without the inclusion of a “counterparty” rule would inevitably lead non-financial institutions located in the PMS to transact wherever possible with financial institutions located outside the PMS, and give rise to a migration of business outside the PMS.

If the establishment rule (or only the counterparty rule) is removed from the Directive, there is a key question as to how, if at all, the FTT could effectively apply to, in particular, transactions in derivatives and depositary receipts. For example, in relation to derivatives, the current proposal applies the issuance rule only to exchange-traded derivatives (and not over-the-counter (OTC) derivatives). It may be that the PMS seek to extend the issuance rule to apply also to OTC derivatives, and to recast the issuance rule along the lines proposed by the European Parliament, by allowing the place of issuance of the derivative to “look through” to the location of the issuance of the underlying security. However, even this extension would apply only potentially to tax equity derivatives and bond derivatives. It would not appear effective to catch either interest rate derivatives or FX derivatives traded OTC or on exchanges located outside the PMS.

Another possible alternative would be for the PMS to supplant the “counterparty” rule with a form of reverse charge – something which has been floated in working group papers that have been circulated in Member States' discussions. Essentially, this would involve applying the tax charge only to parties actually established in a PMS, and would result in those parties looking to pass on the cost of the FTT in circumstances where a counterparty was established outside the PMS. The difficulty with this approach, however, is that it would mean that to be effective non-financial institutions would need to be primarily liable to FTT – and it is unlikely that this would carry any support amongst industrial concerns in the PMS.

The intervention of the CLS in such a robust way at this stage in proceedings would indicate that revised proposals can expect a similarly thorough legal analysis in future. This suggests a further delay in the policy-making process. It has already been reported in Germany this week that a Commission source has ruled out 2014 as a potential start date, with 1 January 2015 now being the earliest date. This seems more realistic.

Next steps

The CLS opinion has not yet been formally debated by the EU Member States in the EU FTT working group meetings. The CLS summarized their views at the last working group meeting on 9 September 2013. Although the UK and Luxembourg expressed their agreement, and the Commission expressed disagreement, with the CLS opinion, the Lithuanian Presidency deferred discussions of the issues on the basis that the Member States had not had sufficient time to consider the opinion.

The next meeting is scheduled for October (although at the date of writing no date has yet been set). It is expected that negotiations on the shape of the EU FTT will continue in earnest following the outcome of the German elections on 22 September 2013, and that inevitably these negotiations will need to take account of the CLS opinion.

For additional information with respect to this Alert, please contact the following:

Ernst & Young LLP (United Kingdom), London
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  • Mark Persoff
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Ernst & Young Société d'Avocats, Paris
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Ernst & Young Belastingadviseurs LLP, Amsterdam
  • Willem-Jan van Veen
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EYG no. CM3805