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European Financial Transaction Tax: The Proposal

Monday, October 3, 2011

Sarah Jane Leake | Bloomberg Law Proposal for a Council Directive on a common system of financial transaction tax and amending Directive 2008/7/EC – European Commission Proposal COM(2011) 594 final of 28 September 2011 The European Commission has been exploring the idea of taxing the financial sector at EU level for several years. In a Communication published last October, the Commission put forward two possible ways to tax the financial sector – a financial transaction tax (FTT) on all transactions on all financial instruments between financial institutions or a financial activities tax (FAT) on corporations to tax excess profits and compensation. In response to calls from the European Parliament1 and the European Council to further explore the feasibility of introducing a FTT at both European and international level, the Commission has now published a formal proposal for a Directive introducing a common framework for a tax on financial transactions in all 27 Member States. In the Commission's estimation, the FTT would raise approximately €57 billion each year. If effective from 1 January 2014 as planned, the FTT would therefore raise an additional €285 billion before the end of the decade. Revenues of the tax would be shared between the EU and its Member States.

Rational for Tax in the Sector

In view of the significant support that the financial sector has received from public funds since the start of the crisis, there is strong consensus across the globe that the financial sector should contribute more fairly to the cost of the crisis. Furthermore, financial services currently enjoy preferential treatment when compared with other sectors – for example, in the majority of cases financial services are exempt from VAT which, in effect, leads to under-taxation. A harmonised EU approach to taxation in the sector would also help prevent fragmentation in the market. This is particularly important given the increasing number of uncoordinated tax measures currently being introduced by individual Member States. In the Commission's view, the high degree of mobility of most of the transactions to be potentially taxed means that Member States can no longer act unilaterally in this regard; to do so would encourage tax arbitrage, and potential double or non taxation – in effect, weakening the internal market for financial services.

Tax Rate

To discourage relocation and therefore reduce the risk of market disruption, the FTT would be set at a low rate, at least initially. The Commission proposes a minimum tax rate of 0.1 percent for the trading of bonds and shares and 0.01 percent for financial transactions related to derivatives agreements. Member States would, however, be at liberty to impose higher rates.


The FTT is focused on financial transactions entered into by financial institutions acting on own account or for the account of others, or in the name of a party to the transaction. This would help to ensure that the FTT is comprehensively applied. Liability to FTT would arise upon the sale, purchase or transfer of financial instruments, including those offered by way of securitisation. To exclude them, as they are comparable to any other financial instrument, would "open avoidance opportunities" and consequently disrupt the orderly functioning of the market. Furthermore, it does not matter whether the transactions in question take place on organised markets or over-the-counter – both would give rise to a FTT charge. — Financial Institutions To avoid circumvention of the tax, the definition of "financial institution" is cast very wide and includes investment firms, organised markets, credit institutions, insurance and reinsurance companies, collective investment undertakings (including undertakings in collective investment in transferable securities (UCITS) and alternative investment funds (AIFs)) and their managers, pension funds and their managers, holding companies, financial leasing companies and special purpose entities. Central counterparties, central securities depositaries and international central securities depositaries are not classed as financial institutions for these purposes, in the sense that they exercise functions that do not constitute trading activity in itself. Further, financial transactions entered into with the European Central Bank and national central banks would be excluded from scope in order to avoid any negative impact on refinancing possibilities or monetary policies. — Financial Instruments The proposed FTT seeks to cover transactions relating to all types of financial instruments, on the basis that they are often used as close substitutes for each other. As drafted, the FTT will apply to instruments negotiable on the capital market, money-market instruments, units or shares in collective investment undertakings (including UCITS and AIFs), as well as derivatives agreements. As to derivatives transactions, spot currency transactions would not be taxable, in order to preserve the free movement of capital. Currency derivative agreements would, however, give rise to a charge because they are not, in reality, currency transactions. Further, although commodity derivatives contracts relating to commodities would fall within scope of the Directive, physical commodity transactions would not. — Transactions Currencies traded on primary markets would be excluded from the scope of the FTT. Securities would be similarly excluded, as this would otherwise undermine the raising of capital by governments and companies alike. Transactions entered into by retail banks with private households or businesses, save for where they relate to the purchase of bonds or shares, fall outside the scope of the proposed Directive. As such, the day-to-day financial activities carried on private households and SMEs, such as house mortgages, bank borrowing, insurance contracts, consumer credits, payment services etc. will fall outside scope. The subsequent trading of these products via structured bonds is, however, included. The day-to-day financial activities carried on by EU businesses and citizens will therefore be largely unaffected. — Geographical Coverage The FTT would work on the principle of residency – in order for a financial transaction to be taxable in the EU, one of the parties to the transaction must be established within a Member State. Logistically, taxation would take place in the Member State where the financial institution is established. This would help to reduce the risk of relocation, as a transaction would be taxed in every case where an EU financial institution is involved, regardless of whether the transaction is carried out outside the EU. Taxes would be payable immediately by institutions to Member States in electronic format on the basis of the transactions undertaken, before netting and settlement.

International Dimension

Given the increasingly international nature of Europe's financial markets, the Commission, together with the European Parliament and the European Council, consider there to be a pressing need to introduce a FTT at international level. This proposal substantially contributes to the ongoing international debate on taxation in the financial sector, paving the way for a more coordinated approach to be adopted internationally. The Commission will continue to explore ways in which a FTT may be introduced at global level. By proposing a FTT at EU level first, the Commission intends to be in a position to promote common rules for the introduction of such a tax at global level, notably during the next G20 summit, to be held in Cannes this November.

Next Steps

The proposal has now been passed to the European Parliament, which will shortly vote on the matter. It will then need to be discussed and agreed unanimously by Member States in the EU Council of Ministers. If adopted, the Directive will be reviewed in 2016, and every five years thereafter, to assess its impact on the proper functioning of the internal market, the financial markets, and the real economy. Disclaimer This document and any discussions set forth herein are for informational purposes only, and should not be construed as legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Review or use of the document and any discussions does not create an attorney-client relationship with the author or publisher. To the extent that this document may contain suggested provisions, they will require modification to suit a particular transaction, jurisdiction or situation. Please consult with an attorney with the appropriate level of experience if you have any questions. Any tax information contained in the document or discussions is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code. Any opinions expressed are those of the author. The Bureau of National Affairs, Inc. and its affiliated entities do not take responsibility for the content in this document or discussions and do not make any representation or warranty as to their completeness or accuracy. ©2014 The Bureau of National Affairs, Inc. All rights reserved. Bloomberg Law Reports ® is a registered trademark and service mark of The Bureau of National Affairs, Inc.

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