On 14 February 2013, the European Commission released its proposal for a Directive on the introduction of a Financial Transaction Tax (FTT) under the enhanced co-operation procedure. The proposal follows on from the original proposal put forward in June 2011 for an EU level tax in the form of an FTT to provide direct funding for the EU. Whilst this received strong support from Germany and France, it ultimately became clear that unanimous agreement from all 27 Member States would not be possible. Accordingly, following requests from a number of Member States and in light of completion of the procedural formalities to move forward under the enhanced co-operation procedure, the Commission has proceeded to release this new proposal. For more detail on the background to the release of the new FTT proposal, see "EU Financial Transaction Tax".
Whilst the new proposal is structurally very similar to the original proposal, it does contain some significant differences. Notwithstanding its apparent more limited jurisdictional scope to those financial institutions established in Member States that wish to participate in the enhanced co-operation procedure, the main difference is the introduction of a supplementary "issuance" principle, whereby the FTT would in effect extend not only to transactions carried out within participating Member States, but also to transactions in respect of securities issued within participating Member States, no matter where they are carried out. This potentially controversial new element is explicitly designed to be an "anti avoidance" provision and deter the relocation of activities to jurisdictions which do not apply the FTT, although this element is aligned with a number of existing stamp duties (including the UK’s) which apply tax based on the location of the securities rather than the parties trading them.
The following Frequently Asked Questions (FAQs) seek to address the main elements in the Commission's latest proposal and their practical implications.
- Which Member States are expected to participate in the FTT?
- To which transactions will the FTT apply?
- Are there any exclusions?
- What is a "financial institution" for the purposes of the draft Directive?
- What about its territorial scope?
- Does a financial institution need to be a principal to the transaction for FTT to apply?
- What rate of tax will apply?
- What is the tax base for the FTT?
- How much is the FTT expected to raise?
- Who pays the tax?
- When will the FTT be payable?
- What about other FTTs, such as those introduced by France and Italy?
- What will it be used for?
- When will it be introduced?
- Will the FTT really be introduced?
- Where can I find more information?
1. Which Member States are expected to participate in the FTT?
Austria, Belgium, Estonia, France, Germany, Greece, Italy, Portugal, Slovakia, Slovenia and Spain all made formal requests to take part in the ECP and are expected to be the jurisdictions covered by the FTT. However, it is possible that other Member States might join in the FTT yet. For example, the Netherlands has indicated that it may be willing to take part if the final form of the FTT meets certain conditions it has put forward (such as revenues being retained by participating Member States and pension funds being excluded, which is not the position under the Commission’s latest proposal).
2. To which transactions will the FTT apply?
The proposed FTT will apply very broadly to all financial transactions where at least one of the parties is established in a participating Member State (or the transaction relates to a security whose issuer is located in a participating Member State) and a financial institution is also party to the transaction (in whatever capacity). See further below for the meaning of “established” under the revised FTT proposal. A financial transaction is widely defined to encompass the purchase and sale of any financial instrument (shares, bonds, notes, units etc), repos and stock lending involving financial instruments and entering into derivatives. It will also cover the purchase and transfer of structured products, such as tradable securities or other financial instruments offered by way of a securitisation. Whilst an exchange will be treated as two taxable transactions; in the case of a repo or a stock loan, only the outgoing transaction will be considered caught by the FTT.
Also caught are transfers of financial instruments between entities in a group or any equivalent transaction that transfers the risk associated with the financial instrument.
Derivative contracts will be caught by the FTT even where the underlying matter of the contract would not be (for example, physical commodities). Also, spot transactions in currencies are not caught, whilst currency derivative contracts are.
Any material modification to a financial instrument, such as a change in the parties to a contract or a material change to its terms, will be treated as giving rise to a new financial instrument for FTT purposes.
It should also be noted that the FTT will apply separately to each element of a layered financial transaction. So where parties enter into a derivative contract that requires the provision of collateral, the FTT might apply separately to the initial creation of the derivative, to the transfer of securities as collateral and at the end on closing out the derivative (unless merely left to run its course) and on returning the collateral securities. The revised FTT proposal still does not provide complete clarity as to the treatment of the posting and return of collateral, or of creation or removal of security and/or transfers by way of security or removal of security.
In addition, given that there is no general relief or exemption for financial intermediaries, the “cascade” effect means that the FTT can apply at multiple stages of the chain of settlement leading to single transactions being subject to an effective rate of FTT significantly higher than the minimum rates provided for under the proposal (see below). The only situation in which an intermediary may be protected from a charge is where they are acting for another financial institution on a disclosed agency basis, which is uncommon.
A number of other common transactions can also give rise to multiple FTT charges. For example, a common strategy for businesses is to hedge foreign currency exposure by entering into rolling one month FX forwards - each such derivative would give rise to a separate FTT charge, and to the extent that collateral is posted or returned by either party, this could also be taxed. Banks funding themselves through overnight repos of their inventory may also be faced with significant FTT liabilities.
The FTT will not however catch most retail financial transactions such as mortgage lending, consumer credit, insurance etc and will not extend to normal commercial lending.
The proposal now notably includes a widely drawn general anti-abuse rule, which targets any artificial arrangements put in place "for the essential purpose of avoiding taxation". Any such arrangement will be ignored and taxed instead by reference to its "economic substance". More particularly, the Commission is concerned at the possibility of trade in depositary receipts replacing trades in the underlying security becoming the norm so as to avoid the FTT. Accordingly, it has included a specific provision which will treat a depositary receipt or similar security "issued with the essential purpose of avoiding tax" as a security issued in the Member State where the underlying security is issued. Where trade in underlying securities has been generally replaced with trade in depositary receipts in relation to such securities, then it will be for the person potentially liable to FTT to demonstrate that the depositary receipt or similar security was not issued with the essential purpose of avoiding tax on transactions in the underlying security.
3. Are there any exclusions?
A few, but limited. Exclusions proposed include:
- the issue of shares or bonds by companies and Governments on "primary markets" so as to enable capital raising, including associated underwriting activities, and also the allocation and transfer of such financial instruments in the framework of their issue.
- the issue of shares/units by UCITS or alternative investment funds, although the redemption of such shares/units is taxable
- transactions with the central banks of Member States
- transactions with the European Union, the European Central Bank (ECB), European Investment Bank (EIB)and certain specified EU institutions, and
- transactions with certain other recognised international organisations and bodies.
Where such an exemption applies, the whole transaction is not subject to FTT - for example if a commercial bank enters into a transaction with the ECB or EIB, neither party is subject to FTT.
4. What is a "financial institution" for the purposes of the draft Directive?
The Directive defines financial institution very widely so as to encompass banks, investment firms, regulated markets, organised trade venues and platforms, credit institutions, insurers and reinsurers, UCITS and their managers, alternative investment funds and their managers, pension funds and their managers and securitisation vehicles and other finance SPVs.
It will also be drafted to include any other undertaking carrying on financial trading, investment holding, participation in or issuance of financial instruments (or services related thereto) where the average annual value of its financial transactions constitutes more than 50 per cent of its overall average net annual turnover. Accordingly, a holding company or a group treasury company may be treated as a "financial institution".
Central counterparties, central securities depositaries and international central securities depositaries and public bodies of Member States (when exercising the function of managing the public debt) will not be subject to FTT. However counterparties transacting with these entities will still be subject to FTT on the these transactions.
5. What about its territorial scope?
The Directive states that the FTT will only apply where a party to the financial transaction is “established” in a participating Member State and where a financial institution “established” in a participating Member State is also involved in the transaction. However, a literal reading of this requirement is misleading, as the proposal contains several provisions which will deem a financial institution to be established in a participating Member State where it would not ordinarily be regarded as such.
As with the previous EU wide proposal, where a financial institution is authorised by the authorities of a participating Member State to act as such, then it will be treated as established in that Member State in respect of transactions covered by that authorisation. Similarly a financial institution with a registered seat within a participating Member State will be treated as established in that Member State for all purposes, regardless of where the financial activity in question is carried on. So, for example, the London (or indeed US) branch of a French or German bank will be subject to FTT on all its securities and derivative transactions.
This is subject to the exception that if the person liable for the FTT “proves that there is no link between the economic substance of the transaction and the territory of any participating Member State" then a financial institution will not be deemed established in a participating Member State. So, for example, if the US branch of a German corporate entered into a financial transaction with a US bank, then it may be able to argue that that transaction should not be caught by the FTT so long as the underlying subject matter of the transaction does not relate to Germany (or any other participating Member State), although this would be a matter for the relevant financial institution to prove. Unfortunately there is currently considerable uncertainty as to precise scope of what would constitute a “link between the economic substance of the transaction and the territory of any participating Member State” and how the process for proving that no such link exists is intended to operate.
A further complication is that the revised proposal will deem any financial institution which benefits from an "EU financial services passport" (or is otherwise entitled to operate in a participating Member State from abroad) to be established in the Member State in which the relevant transaction is authorised / otherwise entitled to take place. So, for example, where a UK bank makes use of its passport to enter into a financial transaction with a French counterparty, it may be deemed to be established in France for the purposes of applying FTT to the relevant transaction. In addition, since the definition of financial institution includes regulated markets and other organised trade venues or platforms, any transaction conducted on an exchange in the participating Member State will be taxable, regardless of where the buyer, seller or any other financial institution is established.
Perhaps the most controversial element of the entire proposal is that a financial institution will be deemed to be established in a participating Member State simply by being party to a financial transaction with a counterparty in a participating Member State (whether that counterparty is a financial institution or not). Accordingly, the FTT will in essence apply whenever there is a party to the transaction in a participating Member State and any financial institution is involved in the transaction (no matter where they are based).
For example, if a German corporate enters into a financial transaction with a US bank, then that transaction will be subject to the FTT with the US bank liable to pay German FTT (see Question 10, Who pays the tax? below).
In addition, the revised proposal for a Directive also provides as a supplementary measure that a financial institution will be deemed to be established in a participating Member State where it is a party to a transaction involving a structured product or financial instruments which have been issued within the territory of a participating Member State, with some limited exceptions, for example in relation to OTC derivatives. This is known as the "issuance principle" and has been introduced to the new FTT proposal specifically to remove some of the attractions for financial institutions based in participating Member States to relocate their activities.
As an example of how the issuance principle may operate, if a US bank sells securities issued by a German company to another US bank, then, no matter where the trade takes place, German FTT would be payable by both US banks.
The FTT proposal contains no provisions to deal with any potential double taxation issues should transactions be subject to both the FTT under these deeming provisions and also any local transactional taxes, such as UK stamp duty or stamp duty reserve tax.
Equally, where a US bank with a German branch enters into a financial transaction with a counterparty outside the participating Member States, the transaction should only be subject to the FTT where the transaction is connected with the German branch of the US bank, again subject to proof by the US bank that the transaction does not have a link to a participating Member State.
6. Does a financial institution need to be a principal to the transaction for FTT to apply?
No, it is merely necessary that a financial institution should be a party to the transaction, whether it is acting on its own account or for the account or in the name of another person.
So, for example, a financial transaction between two non EU funds would appear to be brought within the scope of the FTT if either fund has a manager based in a participating Member State which acts as its agent in relation to the transaction.
7. What rate of tax will apply?
The Commission has proposed a minimum rate of 0.1 per cent to apply to financial transactions other than derivatives and 0.01 per cent to derivatives.
However, these headline rates are again misleading. Where multiple financial institutions are party to a financial transaction, each will be liable to a separate FTT charge in the Member State in which they are (or are deemed to be) established. In addition, the “cascade” effect means that the FTT can apply at multiple stages of the chain of settlement leading to single transactions being subject to an effective rate of FTT significantly higher than the minimum rates proposed.
These are minimum rates since it is anticipated that the Directive will provide for a common structure for an FTT in each Member State but allow individual Member States to set rates and other administrative elements of the tax - ie so participating Member States are free to set their FTT rate as higher (but not lower) than the minimum.
8. What is the tax base for the FTT?
In the case of financial transactions except derivatives, the tax base will be the actual consideration for the transaction (or the market value (ie the arm’s length price) of the transaction where that is higher or in an intra group transaction).
For derivative contracts, the tax base will be the "notional amount" of the derivative contract. However, as this may be a largely arbitrary figure in many cases, and payments under the derivative may represent many multiples of that base figure, the general anti-abuse rule may apply to prevent avoidance by manipulating the notional amount of a derivative contract to minimise FTT liabilities.
It is also worth noting here that the FTT will apply to some derivatives where the economic equivalent would not be subject to FTT. For example, neither a fixed rate loan nor a floating rate loan will be caught by the FTT; however a financial institution that chooses to use an interest rate swap to hedge a floating rate loan against a fixed rate, or vice versa, will have to pay FTT on the derivative contract providing that hedge.
In addition, the FTT will operate more severely on short term treasury operations compared to long term positions. A financial institution that chooses to take a long term position on a hedge will obviously pay less FTT than one that monitors its position weekly or monthly and adjusts, for example, or rolls over positions on a weekly or monthly basis. Similarly, FTT will place a particularly onerous burden on high frequency trading and on funds such as money market funds that enter into significant numbers of transactions on an ongoing basis.
9. How much is the FTT expected to raise?
The Commission has estimated that the tax might raise €30bn to €35bn a year. However, this is highly dependent on other factors such as the likely relocation of some financial institutions or financial activities outside the participating Member States. It also doesn't take into effect the expected long run negative impact on GDP of at least 0.28 per cent (by the Commission's own estimate), which would clearly impact employment and corporate tax take. Overall, therefore, it is difficult to gauge how much (if any) extra tax revenues the FTT might raise. Certainly, although based on a very different model, the experience with the recently introduced French unilateral FTT is that revenues have been significantly below the estimates initially provided.
10. Who pays the tax?
The FTT will primarily be payable by any financial institution party to a financial transaction. However, all counterparties will be jointly and severally liable for the payment of unpaid FTT, including counterparties who are not themselves financial institutions. This joint and several liability principle, which was a much criticised aspect of the original 2011 FTT proposal, may be the only effective means of collecting tax in relation to transactions involving financial institutions outside the participating Member States. There is also the possibility under the draft Directive for the participating Member States to extend joint and several liability more widely beyond the counterparties to a transaction.
The FTT will be payable by "each financial institution which ... is a party to the transaction" whether as agent or principal. However, where a financial institution acts as disclosed agent for another financial institution, it is only the latter that is liable to pay the FTT (subject to the rules on joint and several liability). Nevertheless, due to the “cascade” effect, the FTT may be charged multiple times on a single financial transaction.
So, where a financial transaction involves a German bank and a French bank, the expectation is that the German bank will pay German FTT and the French bank French FTT.
However, the rules to determine where a financial institution is established work on a priority basis based on the following priorities (highest priorities first) (1) where it is authorised, in respect of transactions covered by that authorisation (2) where it is “passported” or otherwise entitled to operate, in respect of transactions covered by such passport or entitlement (3) where its registered seat is based, (4) where its permanent address or usual residence is located (5) where its branch is, (6) the location of the counterparty it is transacting with, and (7) the location of the issuer of the financial instruments which are the subject of the transaction.. This potentially appears to lead to an unexpected, and unfair, allocation of FTT across participating Member States. For example, a transaction between a German bank and the French branch of an Italian bank trade Spanish shares, then the French branch of the Italian bank would appear liable to pay Italian FTT rather than French or Spanish FTT. The Commission has recognised that these priority rules may work unfairly and that other options exist, however, and suggests that the participating Member States should decide on the relevant ranking of conditions.
Equally, the rules deeming an institution to be established in a Member State are relevant to this aspect of the rules also. So, under a transaction between a German bank and a US bank, the US bank would be deemed to be established in Germany for the purposes of the FTT on that transaction. Accordingly, both the US and German banks would be required to pay FTT in Germany.
In addition, as a result of the inclusion of the supplementary “issuance” principle, two US banks undertaking a transaction in relation to Spanish shares may each be treated as established in Spain for that transaction and hence liable to Spanish FTT.
It should furthermore be noted that a financial institution need not be principal to a financial transaction for FTT potentially to apply. So a financial transaction between a Japanese corporate and a French corporate facilitated by a US financial institution acting as an intermediary agent would require that US financial institution to pay French FTT.
11. When will the FTT be payable?
FTT will be chargeable for each financial transaction at the moment it occurs. In the case of transactions carried out electronically, the FTT will be payable immediately and in other cases the tax will be payable within 3 working days from the moment the transaction occurs.
These are very short timeframes and will, in particular, require trading platforms to be updated to enable the charging and processing of FTT. Given that the FTT can, in principle, apply no matter where the transaction takes place if it involves instruments issued by an entity in a participating Member States, it is wholly unclear how these deadlines will be met when trades take place on trading platforms based outside those participating Member States.
12. What about other FTTs, such as those introduced by France and Italy?
The FTT is intended to replace any other existing taxes on financial transactions and contains a requirement that participating Member States shall not maintain or introduce other taxes on financial transactions. As a result the unilateral FTTs introduced or being introduced by a number of participating Member States would need to be repealed, leading to more complications for market participants.
13. What will it be used for?
It is unclear at this stage to what extent revenues raised by the FTT would be retained by the relevant participating Member State or would be split between the EU Commission and national tax authorities. The FTT remains a major element of the Commission's proposals to obtain its own source of funding and reduce its reliance on national contributions from Member States (which will be reduced accordingly in the case of participating Member States). However participating Member States may well prove unwilling to give up this source of income.
14. When will it be introduced?
The proposal requires participating Member States to adopt the necessary domestic legislation to enact the FTT by 30 September 2013 and proposes 01 January 2014 as the commencement date for the FTT. However, this is, to say the least, a very challenging timeframe. Given the need for unanimous agreement amongst participating Member States on the detail of the proposals and upcoming elections in certain Member States involved, the chances of the January 2014 deadline being met seem extremely slim.
15. Will the FTT really be introduced?
Now that the EU Council has given the go ahead for the use of ECP to introduce the FTT, the chances that it will be progressed to fruition are very significant. Ireland, which has just taken over the six month rotating presidency of the EU Council, will lead efforts to agree the substance of the tax, following the release of the proposed Directive by the Commission, during its term in office. However, despite the short time frame suggested by the proposal for the introduction of an FTT, there is still much work to be done on the detail and it is understood that there are significant areas of disagreement even amongst the 11 participating Member States. The currently published proposal can perhaps be viewed as the outer limit of what the final tax could be - the scope might potentially be narrowed during the negotiation process.
Another substantial hurdle the FTT still has to overcome is that, to be legally valid, an ECP proposal also has to meet various requirements set out in the Treaty on the Functioning of the European Union, such as not undermining the internal market or economic, social and territorial cohesion; not constituting a barrier to or discrimination in trade between Member States; not distorting competition between them; and respecting the competences, rights and obligations of Member States which do not participate. This is only the third time the ECP has been used, and the first time in the field of taxation, so there is considerable uncertainty as to how these tests apply in a tax context. Nonetheless, the EU Commission concluded in October 2012 that it considers all the requirements are met, though this appeared to be more a statement of political position than an economic analysis. Some Member States which remain opposed to the FTT and various financial institutions have raised concerns over whether the current proposal complies with EU Treaty requirements, and may still challenge whether the ECP has been validly used in the fullness of time. Ultimately, the extent of any damage to EU financial markets will depend upon the final form of the FTT as negotiated between participating Member States, and particularly any extraterritorial effect it may have on non-participating Member States. Given the Commission's decision to bolster the already very wide residence principle with the issuance principle and to retain the concept of deeming a financial institution to be established in a participating Member State simply by transacting with a counterparty located there, that must make a challenge to the validity of the use of the ECP mechanism more likely.
16. Where can I find more information?
Follow these links to see the Commission's proposal document, along with its press release and FAQs.
The Commission also has a webpage dedicated to the FTT which it updates with new developments.