On 14 February 2013, the European Commission (the “Commission”) published its detailed “proposal for a council directive implementing enhanced cooperation in the area of financial transaction tax” (the “FTT Directive”). This proposal is based upon, and broadly replicates, the Commission’s 2011 FTT proposal, which will now be withdrawn; however, certain changes have been made. The two main differences between the present FTT Directive and the 2011 proposal are that the territorial scope of the FTT has been both (a) narrowed, as participation in the FTT is now limited to eleven participating Member States, and (b) widened, as the tax will also now apply to transactions involving shares, securities and other financial instruments issued by companies in those participating States (the so-called “issuance principle” to complement the existing “establishment principle”).
If enacted, the FTT could therefore apply to many transactions carried out by financial institutions regardless of the place in which they are resident and so will be relevant to institutions in the UK, the US and elsewhere, where either the counterparty or the subject securities are of a participating Member State.
The following key questions are addressed in this alert:
1. Which jurisdictions are involved?
Eleven Member States are currently involved: Austria, Belgium, Estonia, France, Germany, Greece, Italy, Portugal, Slovakia, Slovenia and Spain (the “FTT States”). It nevertheless remains open to other Member States to join the FTT States in implementing the FTT Directive at a later stage.
2. When does it come into force?
1 January 2014. The terms of the FTT Directive will be negotiated over the coming months (a European Parliament committee reading is scheduled for 28 May 2013), and, if agreed by the minimum number of FTT States (9), it is anticipated to be enacted by the summer. Under the present timetable, each of the FTT States would have to introduce domestic regulations necessary to comply with the FTT Directive by 30 September 2013. The FTT States’ provisions implementing the FTT Directive would then come into force on 1 January 2014.
3. Which financial transactions are caught by the FTT?
The scope of the FTT is wide. It covers on-exchange and over-the-counter financial transactions, in a range of financial instruments, carried out by financial institutions acting as party to the transaction (either as principal for their own account or as agent for another person) or acting in the name of a party to the transaction. The relevant definitions in the FTT Directive generally refer to those already adopted for EU regulatory purposes.
Relevant “financial transactions” include purchases and sales of financial instruments, intra-group transfers of the right to dispose of (or risk associated with) financial instruments, exchanges of financial instruments (these are considered to give rise to two chargeable transactions for FTT purposes), repurchases, reverse repurchases, securities lending and borrowing, and the conclusion of derivatives contracts. “Material modifications” of any of the relevant types of financial transaction are deemed to constitute a new financial transaction. In the case of repos or stock loans, the FTT would only apply once, rather than to each leg of the transfer and retransfer of the underlying securities.
“Financial instruments” include equities and debt securities, money-market instruments, units in collective investment undertakings, and derivatives contracts. Structured products, including financial instruments offered by way of securitisation, can also form the object of a taxable financial transaction.
The definition of “financial institution” is broad and includes investment firms, credit institutions, insurance and reinsurance undertakings, collective investment undertakings and their managers, pension funds and their managers, holding companies, and special purpose vehicles.
4. Which financial transactions are not caught by the FTT?
Exemptions include: loans (including transactions in loans), the issuance of shares and securities and other primary market transactions other than the conclusion or material modification of derivative contracts (though redemptions of units in collective investment undertakings are caught), and the conclusion of insurance contracts, mortgage lending, consumer credit, payment services, currency transactions on the spot market, and certain restructuring operations. In addition, certain transactions with the central banks of the Member States and the European Central Bank (and certain other supra-national bodies) are outside the scope of the FTT Directive.
Note that there are no general exclusions for intermediaries, pension funds or for intra-group transactions (in fact, intra-group transactions are subject to a wider FTT coverage).
5. What is the territorial scope of the FTT?
This is the main adjustment to the 2011 FTT proposal. Broadly, the FTT will catch not only financial institutions located in the FTT States, but also financial institutions outside the FTT States which enter into either financial transactions with parties in the FTT States or financial transactions over securities issued by entities in the FTT States (wherever the counterparty is based).
The present FTT Directive applies to all financial transactions where at least one party is established in an FTT State and a financial institution, which is established in an FTT State, is party to the transaction, either acting on its own account or for the account of another person, or is acting in the name of a party to the transaction.
“Establishment” in an FTT State is very broadly — and somewhat artificially — defined. A party can be established in an FTT State for the purposes of the FTT Directive if it has its place of usual residence, its registered seat, its permanent address, or a branch in the FTT State. A financial institution is also treated as being established where it is authorised or passported (in respect of transactions covered by the relevant authorisation). More significantly, a financial institution located outside the FTT States will be deemed to be established in an FTT State, and therefore subject to the FTT, where it is party to a financial transaction with another party that is established in an FTT State.
The principles outlined above, which broadly replicate those in the 2011 proposal, have now been supplemented by the “issuance principle”. This new principle is similar to the UK’s stamp duty reserve tax and has the effect of extending the territorial scope of the FTT to a situation where neither party to the transaction is deemed to be established in an FTT State under the rules outlined above, but the parties are trading in financial instruments issued within an FTT State. This essentially concerns shares, bonds and similar securities; money-market instruments; structured products; units and shares in collective investment undertakings; and derivatives traded on organised trade platforms. The effect is that the parties involved will be deemed to be established in the relevant FTT State.
The breadth of the deemed establishment concept means that financial institutions established in those Member States which have chosen not to implement the FTT Directive (including the UK), and financial institutions established outside the EU, could find themselves liable to pay FTT if they enter into transactions with parties established in one of the FTT States or transactions relating to equities or securities issued by an entity in an FTT State. Also, transactions between a London branch of a French financial institution and a New York bank would be subject to the FTT as one of the financial institutions is established in France, which is an FTT State.
The territorial scope of the FTT is theoretically limited in cases where the person liable to pay the FTT proves that there is no link between the economic substance of the transaction and the territory of the relevant FTT State (but it is not clear when this argument will be applicable in practice).
6. When is the FTT charged?
It is chargeable on each financial transaction at the moment it occurs, with no repayment or relief for subsequent cancellation of the transaction (except in cases of errors).
7. Which party is liable to account for it?
Each financial institution which is party to a financial transaction or is acting in the name of a party to the transaction is separately liable to pay FTT on the same transaction, with the effect that the transaction would essentially be taxed twice if it takes place between two financial institutions.
Each party to the transaction (including persons other than financial institutions) will be jointly and severally liable for the payment of the FTT due from the financial institution(s), and the FTT Directive also provides that the FTT States may provide that other persons are held jointly and severally liable for the payment of the FTT. An FTT State may therefore not need to enforce a claim for FTT against a financial institution located outside the FTT State as it could recover the FTT from the resident counterparty.
With the intention of avoiding a “cascade of tax”, the Commission proposes that where a financial institution acts in the name of, or for the account of, another financial institution, only the latter financial institution should pay the FTT. However, there is no general “intermediary exemption”, and so transactions with brokers, financial intermediaries or market makers will be caught by the FTT unless (unusually) they are acting for another person as a disclosed agent. A fairly typical transfer of a security from the seller to a purchaser may involve several transfers (e.g. via brokers and clearing members), and several stages of the overall transaction could therefore be subject to the FTT (though note the exemption for clearing houses). As each party to each transaction has to account for FTT, structuring transactions via brokers and other intermediaries will be likely to have a significant impact on the overall amount of FTT due.
Parties liable for the payment of FTT would pay the tax directly to the relevant FTT State and would be obliged to submit a return to the tax authorities. If the relevant transaction is electronic, the FTT would be paid at the moment the FTT becomes chargeable, and, if the transaction is not electronic, the FTT would have to be paid within three working days.
8. What is the rate?
In respect of financial transactions related to derivatives contracts (purchase/sale, transfer, exchange, conclusion or material modification) the FTT States must apply a rate that is not lower than 0.01 per cent of the notional amount referred to in the relevant derivatives contract.
In respect of the sale and purchase of financial instruments (other than derivatives), intra-group transfers, repurchase agreements, reverse repurchase agreements, and securities lending and borrowing agreements, the FTT States must apply a rate that is not lower than 0.1 per cent of the consideration for the transfer. Where the consideration for the transfer is lower than the market price or where the transfer takes place between members of a group and does not fall within the notions of “purchase” and “sale”, the taxable amount for FTT purposes shall be the arm’s length market price at the time of the transaction.
As the percentage rates are minimum rates, FTT States will be free to impose higher rates.
As noted above, the effective rate of FTT for a commercial transaction involving intermediaries would be higher as the FTT would apply to each separate element of a chain of settlement as there is no intermediary exemption.
9. Are there anti-avoidance provisions?
Yes. There is a general anti-abuse rule which broadly disregards “artificial arrangements” which have the purpose of avoiding tax. There is also a targeted anti-abuse rule addressing perceived problems linked to depositary receipts and similar securities.
10. Will the rules be the same across each FTT State?
Broadly, yes. The proposal aims to set out a uniform definition for the essential features of the FTT by setting out a common structure for the tax and common provisions on chargeability. As noted above, the FTT States will have some discretion as to setting rates above the minimum thresholds. The intention is to confer implementing powers on the Commission to ensure uniformity in collection of the FTT, and the Commission will be empowered to adopt detailed rules in areas such as registration, accounting and reporting obligations.
11. What will happen to local taxes in the FTT States that overlap with the FTT?
FTT States shall not be allowed to maintain or introduce taxes on “financial transactions” as defined in the FTT Directive other than the proposed FTT itself or VAT. For instance, the French tax on financial transactions introduced in August 2012 would need to be repealed on introduction of the FTT. Taxes of a different nature, such as taxes on insurance premia or certain registration fees on financial transactions, can be maintained.
Member States that are not participating in the FTT will not be required to revoke their taxes on financial transactions. It is not hard to envisage instances of double taxation. For example, if a UK insurance company were to buy shares in an English company from a German bank, the UK insurance company would have to pay German FTT plus UK stamp duty in respect of the same acquisition.
12. Will the FTT be challenged?
It remains to be seen whether the FTT Directive will be the subject of legal challenge on the basis that it is incompatible with EU law. Potential grounds of challenge may be that the FTT introduces distortion of competition between Member States or that it constitutes a barrier to free movement of capital (a protected freedom), amongst others. A challenge could be mounted by either a Member State taking its case to the European Court of Justice or, once the FTT comes into force, any EU person subject to the FTT could challenge its legality in its domestic (and potentially through the European) courts.
This article was originally published by Bingham McCutchen LLP.