On June 3, the Council of Europe issued a statement to the effect that the June 30 date for expected full agreement on a proposed EU financial transactions tax directive would not be met. One member state has dropped out of the group advocating for the tax; two more have expressed potential reservations with the plan, and member states continue to disagree about certain specifics of the proposal. This appears to be good news for traders. The plan for an EU FTT is stalled.

What is an FTT?

A financial transactions tax (FTT) is a tax on the gross proceeds of a financial transaction. For example, assume that Fredonia imposes an FTT of 0.2 percent on all securities transactions on the Fredonian stock exchange. If a taxpayer sells shares of Stock ABC for $100, a $0.20 tax will be imposed on the sale, regardless of the price at which the taxpayer purchased the shares. The $0.20 tax will be imposed regardless of the amount of gain recognized on the sale, and will be imposed even if the seller recognizes a loss on the sale.

Things become a bit more complicated when derivatives are involved. The base for an FTT may either be the notional amount underlying a derivative, or it may be cash payments. Since traders’ notional books tend to be much bigger than their cash books, an FTT imposed on notional amounts will often be imposed at a lower rate than an FTT imposed on cash transactions.

Jurisdiction for an FTT can rest on one of two bases. A country may tax all transactions in instruments issued by their residents (the issuance basis), or a country may tax all transactions entered into it by or with their residents (the residence basis). Critics of financial transactions taxes have said that FTTs based on the residence of parties to a transaction create an incentive for capital to leave the taxing jurisdiction.

Proponents of FTTs say that, since they are imposed at low rates on a broad base, they burden neither the “real” economy nor retail investors. To the extent that they burden anyone, the argument goes, they burden speculators who contribute nothing to the real economy; and they are a good source of state revenue. Opponents say that they reduce liquidity, which negatively impacts issuers’ ability to raise capital (to be put to work in the real economy). Traders hardest hit by an FTT include high frequency traders, scalpers, rebate traders, and index/ETF arbitrage desks.

Real-World FTTs

The UK, Ireland, and certain Asian jurisdictions, have long had stamp duty taxes, which are a type of FTT. The UK stamp duty applies only to cash equity transactions; it does not apply to derivatives, or to transactions in debt instruments, and it also does not apply to market making activities. Jurisdiction for UK stamp duty is purely issuance-based.

France and Italy instituted FTTs four and three years ago, respectively. Both the French FTT and the Italian FTT are broader than the UK FTT. The French FTT applies to the acquisition of equity securities (including certain convertible bonds) of French issuers with a market capitalization greater than 1b euros, as well as certain high-frequency trading activities and speculation in credit default swaps. The tax on trades in equity securities applies to all traders who purchase equity securities issued by French-resident issuers with a market cap of greater than 1b euros, subject to certain exemptions for, inter alia, market-making and ancillary activities; the taxes on high frequency trading and speculation in credit default swaps applies only to French-resident traders. The Italian FTT applies to the purchase of equity securities issued by an Italian resident with a market cap greater than 500m euros and on derivative contracts that reference same, as well as on certain high-frequency trading activities. Jurisdiction for the Italian FTT is based on the residence of the issuer of the relevant security or underlie.

A harmonized, EU-wide FTT was first proposed in 2010. This was opposed by certain member states, most notably the UK, which did not want an FTT to divert business from the City of London. Eleven member states supporting implementation of an FTT instituted a procedure called “enhanced cooperation,” which allows a minimum of nine member states to implement integration or cooperation only within the participating states. In 2013, the member states that agreed to enhanced cooperation issued a proposed directive mandating an FTT within their borders, with full agreement expected by June 30, 2016.

The proposed EU FTT is broader than existing FTTs in several ways, inter alia:

  • It applies to a broader universe of financial instruments, including debt, equity, and derivatives on debt and equity;
  • It applies to a broader universe of transactions, including transactions not ordinarily thought of as taxable transactions, such as repos, securities loans and, possibly, the posting and return of collateral;
    • Example: U.S. taxpayer purchases ADRs in German issuer from US bank. Because the issuer of the subject security is resident in a participating member state, the transaction is subject to tax;
    • Example: Japanese purchaser buys shares in Peruvian issuer from German bank on the Hong Kong stock exchange. Because one of the parties to the transaction is resident in a participating member state, the transaction is subject to tax; and,Jurisdiction for the taxation of a transaction is based both on the residence of the issuer of the relevant security or underlier and on the residence of parties to the transaction.
  • There are very limited carve-outs for market-making, raising the specter of a “cascading” tax on a single transaction with multiple intermediaries.

Per a statement issued by the Council of the European Union on June 3, it appears that the June 30 date for full agreement will slip. Estonia opted out of the process in late 2015, and Belgium and Slovenia have also voiced potential reservations. Without these three, there will not be enough participating members to constitute a quorum for enhanced cooperation. Nonparticipating members oppose potentially extraterritorial effects of the proposed directive in its current form, and participating members are currently debating whether the market making exception should be broadened, as well as the optimal scope of application of the rule to derivative transactions. Given the breadth of the scope of the proposed tax and its potential extraterritorial effect, this is likely good news for traders.