On 14 February 2013 the European Commission published its detailed proposal for a radical and wide ranging European financial transaction tax (FTT). The scope of the FTT is broad and will also impact on transactions by non-FTT Zone financial institutions.
- Which EU Member States are covered and which are not?
The proposed FTT would be adopted by 11 Member States (Austria, Belgium, Estonia, France, Germany, Greece, Italy, Portugal, Slovakia, Slovenia and Spain – the FTT Zone states). The European Commission had originally introduced a Directive (in 2011) for an EU wide tax, but 16 EU Member States decided that they did not wish to participate (Bulgaria, Cyprus, Czech Republic, Denmark, Finland, Hungary, Ireland, Latvia, Lithuania, Luxembourg, Malta, the Netherlands, Poland, Romania, Sweden and the UK).
Due to the wide drafting of the Directive, the FTT would apply to certain transactions undertaken by institutions outside the FTT Zone (in the 16 countries mentioned above or in countries outside the EU altogether).
- What will be taxed?
The FTT is a tax on 'financial transactions' of ‘financial institutions'.
- What instruments are covered and which are not?
The FTT applies to transactions in ‘financial instruments’ as defined in the Markets in Financial Instruments Directive (No. 2004/39/EC, ‘MiFID’). This includes shares, bonds, units in CIS, options, futures, swaps and other derivatives, treasury bills and commercial paper, but does not capture transactions in non-MiFID instruments such as loans, mortgages and insurance contracts.
- What transactions are covered and which are not?
'Financial transaction' includes the purchase and sale of a financial instrument, the conclusion of derivative contracts, repos, stock lending transactions and an exchange of financial instruments. Each material modification of a 'financial transaction' will be treated and charged as a separate 'financial transaction'.
FTT does not apply to primary market transactions such as the issue (rather than transfer) of shares and bonds because of the EU prohibition on capital duty (Directive No. 2008/7/EC).
The draft Directive does not provide for intra-group or financial intermediaries exemptions. Transfers between members of a group of the right to dispose of a financial instrument as owner are also captured.
- Who will be affected by the FTT?
FTT arises when there is at least one financial institution that is a party to a transaction and at least one party, or the issuer of the instruments, is established in a FTT Zone state. A financial institution is regarded as being established in a FTT Zone state and therefore liable to FTT if it is:
- authorised/incorporated in a FTT state. This will include eg a German bank,
- exercising passport rights (on a branch or services basis). This will include a UK bank in relation to its transactions allocable to its German branch and also a UK bank if operating in Germany without an actual German establishment under ‘passporting’ rules,
- dealing with a party that is established in a FTT Zone state. This will include a New Zealand pension fund trading with a party established in Spain (and that Spanish party does not have to be a ‘financial institution’). In this case the New Zealand pension fund will have to pay Spanish FTT. Whether or not the Spanish party will be liable to Spanish FTT will depend on whether that is a ‘financial institution’, or
- transacting in instruments issued in a FTT Zone state. An example to this would be a Hong Kong insurance company buying (OTC) German corporate bonds from a Japanese bank. In this case both the Hong Kong insurance company and the Japanese bank will have to pay German FTT.
FTT is not a single ‘per transaction’ tax. If two financial institutions are caught by the FTT on the same transaction, they both pay FTT. All parties participating in a transaction chargeable to FTT (eg each intermediary, broker, clearing member, clearing system etc with the exception of agents of disclosed principals) will be liable to pay FTT. The parties will have joint and several liability for all unpaid FTT.
- Which companies are regarded as financial institutions for FTT purposes
‘Financial institutions’ is broadly defined and includes banks and credit institutions, MiFID investment firms, private equity structures, insurance companies, pension funds, UCITs and AIF funds and securitisation and insurance SPVs. It will also capture treasury companies and non-financial sector companies if the value of their financial transactions represents over 50% of their average net annual turnover.
- What is the rate of FTT?
Each FTT Zone state will be free to decide at which rate they wish to introduce the FTT. But the draft Directive provides for minimum rates, which are 0.01% for financial transactions related to derivative contracts and 0.1% for other financial transactions.
- How much will be collected and who will benefit?
FTT is a national tax (albeit under a harmonised regime across the FTT Zone states). The Directive has rules to determine which country’s FTT applies: this will determine the rate of FTT, which is applicable and which Member State is to receive the tax.
There are estimates that the total FTT might be in the order of 30 billion Euros per annum. The Commission proposes that part of the FTT revenue collected by Member States should be a resource for the EU budget and that the contributions to the EU budget paid by only the 11 participating Member States should be reduced accordingly.
- Can the FTT paid be offset against any other tax?
Once the European FTT is implemented, any similar national (eg French, Italian) FTT previously announced will have to be abolished by the 11 participating Member States.
No tax credits (against other tax) are, however, envisaged for FTT paid.
- How will the FTT impact financial institutions in non-FTT countries – for example those in the UK or the US?
Financial institutions outside the FTT Zone will be chargeable to FTT for example on an OTC transaction between a US and a UK bank involving French shares. There is a potential exemption where there is no link between the economic substance of the transaction and a FTT Zone state, but it is very unclear how this will operate in practice.
The sale of UK shares may be taxed twice: on the sale of UK shares by a UK bank to a German bank both German FTT and UK stamp duty or SDRT will be payable.
None of the proceeds of FTT will be payable to non-FTT EU states such as the UK.
- Can you avoid FTT? What are the restructuring opportunities?
The draft Directive contains a general anti abuse provision as well as a specific one targeted at the use of depositary receipts issued with the essential purpose of avoiding the FTT. The latter will apply where there is an attempt to avoid the FTT by the parties trading in the depositary receipts issued outside the FTT Zone instead of trading in the underlying FTT Zone issued securities. But in practice it may be difficult for an eg Hong Kong and Singapore party trading in the secondary market in Singapore issued depositary receipts (of eg Italian securities) to ascertain whether those depositary receipts were issued with the essential purpose of avoiding the FTT.
Parties will need to take account of FTT when structuring transactions: either to seek to avoid FTT altogether or to be subject to the FTT of countries with lower rates. Non-FTT Zone financial institutions may wish to avoid using FTT Zone branches and subsidiaries for trades in non-FTT Zone products and FTT Zone financial institutions may wish to arrange transactions in non-FTT Zone products through their non-FTT Zone branches and subsidiaries.
- What steps need to be taken in preparation for FTT?
An important practical consequence will be the impact on transactional documentation. Wording will need to be developed to allocate the cost and risk of FTT. For example, representations may be needed from transaction counterparties that they are not 'established' in a FTT Zone State in relation to the relevant transaction. Parties may also request indemnities to deal with the issue that each party to a transaction will be jointly and severally liable for any unpaid FTT. Particular attention may need to be paid to indemnity provisions contained in bond terms and mandate letters etc.
Corporates will need to review their relationships with FTT Zone banks and review the terms and conditions of their banking transactions to identify where the liability for the FTT sits (bearing in mind joint and several liability). Corporates involved in significant risk management activity (such as utility companies, airlines and shipping companies etc) will need to consider the direct impact of the FTT on their treasury or financing vehicles.
Financial institutions (and companies treated as such for the FTT) will need to have in place appropriate FTT management systems that are capable of separating financial transactions by the location and status of the counterparty, and by the place of issuance of the financial instrument. FTT reporting will have to be made to tax authorities of different Member States, who may not necessarily set the same rates or procedures for their operation of the FTT.
- What next?
The Commission is proposing that national legislation should be in place in the 11 Member States to implement the Directive by 1 January 2014. But press releases suggest that France and Germany may be working towards a December 2014 deadline and therefore this timing seems to be more realistic.