KEY POINTS Feature  Theprominence in the Financial Transactions (FTT) regime of territoriality may be viewed as an inherent vulnerability which is out of step with some other forms of taxation.  A notable feature of the FTT regime is the lack of exemptions in areas where they might commonly be found in a UK taxation context.  The next step appears uncertain – with the UK stating publicly it does not support the FTT and adoption under the enhanced co-operation procedure remaining a possibility. Authors Adam Blakemore and Oliver Iliffe Proposals for a European Union Financial Transactions Tax

Theproposals made by the EU This article considers the mechanics of the proposed financial transaction tax (the Commission on 28 September 2011 FTT) and some of the challenges faced in creating a workable solution. regarding an EU directive on a common system of financial transaction taxation in the 27 member states of the EU have been “Financial institution” includes banks, involving the transfer of risk other than debated widely since they were presented. credit institutions, insurance undertakings, credit risk. The Explanatory Memorandum The presentation of the proposed Directive pension funds, UCITS collective investment to the Directive makes it clear that the scope (the Directive), together with proposals to funds and their managers, securitisation of FTT extends to regulated markets, multi- amend Directive 2008/7/EC concerning special purpose vehicles (SPVs) and other lateral trading facilities and also over-the- indirect on the raising of capital, special purpose vehicles such as group counter trading in financial instruments.

PROPOSALS FOR A EUROPEAN UNION FINANCIAL TRANSACTIONS TAX UNION FINANCIAL TRANSACTIONS A EUROPEAN FOR PROPOSALS represent the latest stage in a series of treasury companies. There are a limited Importantly, a number of instruments announcements by EU authorities directed number of institutions and entities which are and transactions are excluded from the towards ensuring that the European financial excluded from being “financial institutions”, scope of FTT. Loans, deposits, spot forex sector should “contribute more fairly” towards such as central counterparties for clearing transactions, physical commodities and the costs of addressing and rectifying the houses and securities depositories. emissions credits are excluded from FTT. current European financial crisis. “Financial transaction” encompasses the The EU Commission has also announced With the depth and nature of the sale and purchase of a “financial instrument” that “all transactions in which private European financial crisis continuing to before netting or settlement (including repos individuals or SMEs were involved would evolve and the costs of stabilising and and securities lending) and the “conclusion fall outside the scope of the tax”, although recapitalising the European financial sector or modification” of derivatives agreements. this exclusion does not prevent the economic showing no signs of abating, the Directive The entry into a derivative, any change in costs of FTT being passed on to end- has come at a profoundly sensitive political its terms, any extension or close out of a consumers. and economic time. This article considers derivative, whether cash or physically settled, Primary market transactions including both the mechanics of the proposed financial would appear to fall within these concepts the issuance, allotment and subscription of transaction tax (the FTT) and some of and therefore fall within the scope of FTT. financial instruments are also excluded from the challenges which the EU Commission, “Financial instruments” are themselves the scope of FTT, “so as not to undermine member state governments and financial defined as being the instruments falling the raising of capital by governments and institutions will face in attempting to within Section C of Annex I of Directive companies”. Controversially, however, the create a workable tax which achieves the 2004/39/EC (the Markets in Financial issue and redemption of shares and units aims of its proponents. The analysis in this Instruments Directive). This definition in collective investment undertakings and memorandum is based on the Directive, encompasses a wide range of instruments alternative investment funds remain within and supporting documents, published on 28 covering shares, securities (including the scope of FTT. September 2011. listed bonds), units or shares in collective investment undertakings, options, futures LIABILITY FOR FTT WHAT IS THE SCOPE OF FTT? and other derivatives. Derivatives are FTT is payable by each financial institution Tax base included irrespective of whether they are (whether acting as agent or principal) The FTT is a tax applied to financial physically or cash-settled and regardless of which is a party to a financial transaction. transactions where at least one of the whether the underlying is itself a financial Where a financial institution transacts with parties is a financial institution and either instrument. Both repos and securities a non-financial institution counterparty that party or another party to the financial lending agreements are expressly defined as established in a member state, the non- transaction is established in a member state “financial instruments”, as are “structured financial institution will be jointly and of the European Union. The terms “financial products”, the latter being securities or severally liable for the tax. FTT payable in institution” and “financial transaction” are other financial instruments offered by way respect of a financial transaction entered very broadly defined in the Directive. of securitisation or equivalent transactions into by a bank branch in the EU will be paid

104 February 2012 Butterworths Journal of International Banking and Financial Law PROPOSALS FOR A EUROPEAN UNION FINANCIAL TRANSACTIONS TAX Feature

to the member state in which the bank’s The Directive is proposed under Art 113 member states; and (ii) a financial institution head office is authorised or incorporated. of the EU Treaty, and would therefore require “established” in a member state is party to In circumstances where multiple parties unanimous approval by each of the member the transaction acting either for its own are participating in a transaction, multiple states. In the event of any member state not account or as an agent. A number of deeming FTT liabilities may arise. For example, adopting the Directive, it might be possible for provisions widen the scope of the second where a financial institution acts as agent the proposals to progress under an enhanced limb of the test. A financial institution is for a non-financial institution, both could be co-operation procedure under which one deemed to be “established” in a member state liable to FTT. Furthermore, transactions are or more member states may be authorised if the institution has (amongst other factors) individually subject to FTT. Where a single to exercise EU non-exclusive competencies its usual residence, permanent address, financial deal includes multiple, smaller, through various EU institutions with a view registered seat, or a branch in that member component transactions, each component to protecting EU interests and propelling EU state in respect of transactions carried out by transaction may be charged with FTT, even integration. However, it is uncertain whether that branch. where the transactions are entered into the provisions of Art 20 of the Treaty of the A financial institution will also be between group members. European Union and Arts 326 and 327 of the deemed to be “established” in a member state Treaty on the Functioning of the European if it is a party, whether acting as principal Rates and collection Union are capable of being satisfied in the or as agent, to a financial transaction with FTT will be charged at two rates. While particular circumstances of the FTT being another financial institution established member states will be able to set their own introduced among only some, and not all, of in that member state, or is a party to a rate, a minimum rate is proposed to be set the member states. financial transaction with a counterparty at a level which achieves the “harmonisation established in that member state which is not objective” of the Directive while minimising Withdrawal of other similar taxes a financial institution. The practical impact the risk of delocalisation and attempting The introduction of the FTT would be of this condition is to widen significantly the to avoid a negative impact on financial matched by the withdrawal of other taxes residence and location tests of “establishment”, markets. Accordingly, a minimum rate of on financial transactions across the EU. and thereby the scope of FTT. For example, 0.1% is the rate of FTT generally charged Although VAT and insurance premium a US bank (being a financial institution) on the purchase price or other consideration tax would not be affected, existing taxes entering into a financial transaction with an for a financial transaction. In the event such as stamp duties and stamp taxation EU incorporated company (a non-financial that consideration is lower than market on securities would almost certainly need institution) would be subject to FTT as price or is the consideration for intra-group to be repealed. This would be welcomed by regards that financial transaction. This would transactions, the taxable amount is to individual investors and certain funds which be the case even if the financial transaction is be the market price determined at arm’s currently pay UK stamp duties or stamp entered into by the US bank from New York. length at the date of the FTT charge. A taxation on the purchase of UK shares at a The US bank would be liable for any FTT lower minimum rate is to be imposed for rate of 0.5% of the purchase consideration. due, with the EU corporate counterparty derivatives at 0.01% of the notional amount Purchasers of UK shares and any securities being jointly and severally liable. at the time the derivative is purchased, sold, which are subject to UK stamp taxes which One important exception to the transferred, concluded or modified. are established outside the EU and which “establishment” rule is that a financial The time at which FTT is required to transact with non-EU persons outside the institution will not be treated as being be paid to a tax authority of a member state scope of FTT would be able to avoid both established in a member state where the will depend on the nature of the financial FTT and UK stamp taxation. However, person liable to pay FTT is able to show transaction. Where a transaction is carried these residual benefits have to be set against that there is “no link” between the economic out electronically, such as through a clearing the prospect of some member states losing substance of the transaction and the territory system or on an exchange, FTT is payable “at significant stamp taxation revenue. of any member state. The term “economic the moment when the financial transaction substance” is not defined. It will be interesting occurs”. FTT is payable on non-electronic WHAT ARE THE KEY ISSUES WITH to see how and to what extent this provision is transactions within three working days from FTT? amplified or addressed in later versions of the the time the tax becomes chargeable. Territoriality Directive and supporting guidance. One of the key issues relating to the Implementation Directive is whether a financial institution Delocalisation The proposal is for the FTT to be enabled will be treated as being within the scope of As noted by the EU Commission itself “[t] by legislation in each of the member states FTT. As currently drafted in the Directive, here are strong economic reasons for a high by the end of 2013, with the tax taking this happens when: (i) at least one party degree of harmonisation and co-ordination effect from 1 January 2014. to the transaction is “established” in the in order to avoid substitution and loopholes”.

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Modern financial transactions are extremely be achieved if the result of FTT introduction collateral falling within the scope of FTT, mobile; the EU Commission itself cites the is a wider, systemic dislocation in European and being charged separately on each transfer Swedish financial transactions tax enacted financial trading and banking markets. at the higher rate of 0.1% applicable to in various forms between 1984 and 1991 securities. Consequently, and coupled with as an example of the danger of unilateral Revenue raising? the exemption of lending transactions from introduction1. The provenance of the FTT is readily the scope of FTT, the imposition of FTT The territoriality of FTT may be apparent as being a tax arising from the on posting and transferring collateral would construed as propelling market participants financial crisis which is aimed at both appear to encourage fewer collateralised towards delocalisation and restructuring their disincentivising transactions which are lending transactions (for example, repos activities on an entity by entity basis. For a perceived to pose a risk to market stability and stock loans) and an increase in non-EU financial institution, FTT could and also eliciting a degree of reparation from uncollateralised lending. Such a development be mitigated through derivative contracts the European financial sector. The revenue is unlikely to add materially to fiscal stability being effected outside the EU with non-EU estimates for the FTT are significant, being or creditor protection. counterparties. While the EU Commission predicted as being in the region of €57bn Even at the lower FTT rate applicable to has acknowledged this risk within Europe per year shared between the member states. derivative transactions, the EU Commission (hence the Commission’s insistence that However, at a time when growth in many anticipates that between 70 and 90% of the introduction should be across the 27 member countries in the Eurozone is exceptionally EU derivatives market would be rendered states, including the UK), it is noteworthy low, economists have noted that the uneconomical. Nevertheless, there is

PROPOSALS FOR A EUROPEAN UNION FINANCIAL TRANSACTIONS TAX UNION FINANCIAL TRANSACTIONS A EUROPEAN FOR PROPOSALS that there is nothing in the EU Commission’s macroeconomic effect of the FTT, resulting little suggestion in the EU Commission’s proposals about the risk of financial activities in a “small, but non-trivial” reduction in publications relating to FTT that derivatives migrating outside the EU. economic output of between 0.53% and have a valid purpose to hedge and mitigate For EU financial institutions, treasury 1.76% in the member states, does nothing to risk. The FTT would therefore penalise risk subsidiaries and SPVs could be established in help fragile economic recovery. reduction instruments that aim to hedge non-EU territories to prevent the contracting Moreover, estimates of revenue raised market risk such as FX risk, interest rate financial institution being subject to FTT. by the FTT appear to be predicated on an risk or credit risk. By disincentivising such Additional analysis will be needed before absence of widespread relocation of financial hedging instruments, there is a danger that such planning could be implemented, such transactions to non-EU jurisdictions. The the imposition of the FTT engenders, and as considering carefully the double negative impact of the FTT, through an does not reduce, systemic market risks. network of the jurisdiction in which the increase in the cost of capital as financial As noted above, the possible incentives treasury subsidiary or SPV could be located, institutions attempt to pass FTT costs to for financial institutions to undertake but the territoriality of the current drafting clients, is unlikely to be welcome at a time financial transactions outside the EU, in of the Directive does little to discourage such when the European financial system is focused consequence of the territorial scope of FTT, avoidance. While the Directive provides on liquidity provision, sustainable economic also appear likely to encourage financing for the member states to adopt measures to growth and bank recapitalisation. away from regulated, highly capitalised “prevent , avoidance and abuse”, European institutions and markets towards the prominence in the FTT regime of Reducing “overly risky less regulated, more thinly capitalised offshore territoriality (as well as the identification of transactions and activities” financial centres to which derivative broker/ “instruments” and “transactions”) may be One of the anticipated benefits of the FTT dealers and other market participants may viewed as an inherent vulnerability which is is that the tax will “set incentives to reduce have migrated. out of step with some other forms of taxation overly risky transactions and activities” and Combating such migration will be (such as services and supply-based taxes). “curb speculation, noise trading and technical difficult. It is unrealistic to anticipate that Given a global integrated financial system, , and...decrease markets’ volatility”. offshore financial centres would, in the it can be strongly argued that unless all key While it is possible that automated high- short term, willingly impose a financial financial jurisdictions (including tax havens frequency trading undertaken by EU entities transactions tax. Furthermore, it is difficult and low tax jurisdictions) are encompassed and from EU permanent establishments may to discern a regulatory and policy approach in an FTT, the risk of delocalisation may be driven out of the EU by the introduction within the FTT which is contiguous with be insurmountable. Although the EU of FTT, any reduction in systemic market other EU regulatory initiatives. For example, Commission accepts that introduction of and financial risk may be outweighed by whereas regulatory initiatives such as the FTT would come with the risk of “relocation other negative, behavioural consequences Solvency II Directive includes measures to or disappearance” of some transactions (such resulting from the tax. determine whether non-EU insurer solvency as high-frequency derivative transactions), the For example, the definition of “financial regimes demonstrate sufficient equivalence policy objectives behind FTT are unlikely to transaction” would result in transfers of to European regulatory requirements, the

106 February 2012 Butterworths Journal of International Banking and Financial Law PROPOSALS FOR A EUROPEAN UNION FINANCIAL TRANSACTIONS TAX Biog box Adam Blakemore is a tax partner at Cadwalader, Wickersham & Taft LLP, London. Feature Email: [email protected] Oliver Iliffe is a tax associate at Cadwalader, Wickersham & Taft LLP, London. Email: [email protected]

FTT may result in delocalisation of financial November 2011, the UK government It is also possible that the 17 Eurozone activities to less intensively regulated offshore publicly stated that it would only endorse member states, or the member states except jurisdictions where such equivalence may not an international version of FTT, and would for the UK, may move to introduce the FTT yet have been established. not support an EU-wide introduction alone. under the enhanced co-operation procedure. This position was firmly articulated by the However, such moves would be bound to raise Absence of exemptions UK Chancellor of the Exchequer at the questions about the possibility for the migration Another notable feature of the FTT regime ECOFIN meeting on 8 November 2011, of financial transactions towards the City of is the lack of exemptions in areas where where reference was made to concerns over London. For this reason, Denmark, Ireland, Italy they might commonly be found in a UK the mechanics of the FTT and its suitability and Luxembourg have all expressed reservations taxation context. Unlike with UK stamp in dealing with the objectives stated in the about a selective introduction of the FTT which taxation, there is no exemption for intra- EU Commission’s proposals. does not encompass all the member states. A group transactions. This is surprising as It appeared for a short time that the selective introduction of FTT may also be hard it is hard to envisage a situation where proposed Directive might remain in limbo to justify under the legislative requirements of group companies could realise an overall pending further discussions by the EU the enhanced co-operation procedure. “speculative” profit from round-tripping Commission and ECOFIN in 2012. However, It is also possible that the proposals for the EU financial instruments or entering into a joint letter from the French President and FTT might be overhauled radically. Possible intra-group derivative contracts that are fully German Chancellor to the European Council changes may focus on the origin of financial hedged by external ones. President on 7 December 2011 made clear instruments rather than the territory in There is no general exemption for reference to the creation of the FTT as one which such instruments are to be transferred. intermediaries. This could be interpreted of the measures needed to achieve the greater Such changes would recast the FTT along as a symptom of a tax which is targeted convergence of economic policies among the the lines of a more familiar imposition such at all levels of the market and not just the 17 Eurozone member states. While the as the UK’s stamp reserve tax, and may ultimate investor (in contrast to the regime FTT was not mentioned in the communiqué prove difficult to avoid where instruments are of UK SDRT and exemptions of the European Council following the transferred electronically. for intermediaries). However, the “cascading” EU summit on 9 December 2011, the UK And it is possible that the FTT might effect of the FTT through a series of government’s decision not to support the “new be replaced altogether with an alternative transactions would add materially to the fiscal compact” among the other 26 member method of imposing reparative liabilities on the impact of the FTT in a way which is not states leaves a European-wide introduction of European financial sector, such as some form of factored into the EU Commission’s Impact FTT (at least in its current form) in further European bank levy or financial activities tax. In Assessment of the tax. Unlike the proposed doubt. Recent statements by the UK Prime this context, the increase in the rate of the UK EU directive dealing with central clearing Minister on 8 January 2012 rejecting the FTT bank levy in the 29 November 2011 Autumn (EMIR), there is no exemption from FTT for proposals unless introduced on a world-wide Statement announced by the Chancellor of transactions of corporate entities done for the basis have reinforced the divisions between the Exchequer might be construed as a careful purposes of hedging. the member states on the topic. move by the UK government to show that the Furthermore, there are no exemptions The next step appears uncertain. Statements raising of specific bank levies is a credible, non- for repos or securities lending (and indeed by the French Prime Minister on 9 January FTT alternative to other methods of seeking other collateral arrangements) where the 2012 suggest that French legislation to impose contributions from the banking sector towards purpose of the transfer of the financial a unilateral financial transactions tax may the costs of the financial crisis. n instrument is an ancillary purpose of the main be presented as early as February 2012. Any transaction. The absence is more surprising attempt by a member state to unilaterally 1 The Swedish tax on equity securities, fixed where the accounting of a repo is as a secured introduce the proposals for an FTT is, income securities and financial derivatives, loan. A mortgage or charge of a financial however, likely to face a number of legal imposed between 1984 and 1991, led to instrument between members of the same hurdles. Legally, such a unilateral adoption disappointing tax revenues, a fall in Swedish group would also appear to be caught under would be questionable owing to the provision share prices and a very significant fall in the Directive, although it will be difficult in in Art 401 of the EU VAT Directive which market trading. During the first week of the such circumstances to identify any taxable prohibits member states from maintaining tax, the volume of bond trading in Sweden consideration for such a transaction. or introducing “turnover taxes”. Whether the fell by 85%. During the period of the tax, the FTT is a “turnover tax” is not free from all volume of futures trading fell by 98% and the CONCLUSION doubt, and member states are likely to be wary Swedish options trading market disappeared. Divisions have, perhaps unsurprisingly, of any unilateral introduction of any tax in a (“Transaction Taxes and the Behaviour of the emerged between the member states manner which might precipitate subsequent Swedish Stock Market”, S Umlauf, Journal of regarding the proposals for FTT. In early legal challenges. Financial Economics 33, pp 227–240).

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