Maud Poncelet Landwell & Associés, Neuilly-sur-Seine Cedex -- France
Maud Poncelet is Lawyer, Tax Director at Landwell & Associés, France
In a context where there are debates on the new EU draft directive which was released on February 14, 2013 based on the enhanced cooperation procedure, it might be worth to consider to what extent the French model can be viewed as an alternative to the model proposed by the Commission.
France introduced its financial transaction tax (French FTT) in August 2012, pursuant to Article 5 of the first Amended Finance Bill of March 14, 2012 as amended by the second French Amended Finance Bill of August 16, 2012 (the French FTT Law).
Originally proposed by the previous government, the provisions of the French FTT law have been amended and enacted by the new government; hence demonstrating a strong political will to push ahead with implementing the tax.
Those developments and amendments made France the first country in Europe to levy FTT further to the original proposal released by the EU Commission in September 2011. Initially envisioned at 0.1 percent, the French FTT has been hiked to 0.2 percent.
Two other taxes applicable to financial transactions were also introduced in August, including a tax on high frequency trading and a tax on naked sovereign credit default swaps.
It is worth noting from the start that France also has a very old stamp duty coming from the French Revolution age which may apply upon the acquisition of equity shares at a 0.1 percent rate. More specifically, the French stamp duty is levied on transactions in French listed shares which are evidenced by a written deed, either executed in France or abroad. The stamp duty may also apply to transactions in non-French shares when a written deed is executed in France. Several exemptions reduce the scope of the stamp duty, in particular the tax is not due when the French FTT is levied and the French tax authorities have confirmed that transactions on exchange should be out of scope (BOI-ENR-DMTOM-40-10-10-20120912, no. 70).
In a context where there are debates on the new EU draft directive which was released on February 14, 2013 based on the enhanced cooperation procedure, it might be worth to consider whether the French model can be viewed as an alternative to the model proposed by the Commission.
As a short backdrop, what are the basics of the French FTT?
There are five principal criteria which have to be assessed to determine whether a transaction falls within the scope of the tax (French tax code, Article 235 terZD I). The transaction must meet the following cumulative conditions. It must:
• qualify as an acquisition for consideration;
• result in a transfer of ownership of securities;
• involve equity securities or assimilated instruments…;
• …which are admitted to trading on a regulated or recognised market; and
• issued by a French-listed company having a market capitalisation in excess of EUR 1 billion on the 1st of December preceding the year during which the transfer occurs.
Under the French model, all transactions which give rise to a transfer of securities are not automatically subject to the tax. The transfer of ownership of the shares must be subsequent to a transaction qualifying as an acquisition which is strictly defined by the FTT law as a “purchase”, an “exchange” or an “attribution as consideration for a capital contribution” of equity securities. Since the French tax rules do not specifically define such concepts for the application of the French FTT, reference must be made to other areas of French law, and in particular to French civil law (for an application of this reasoning by the administrative courts, see for example, French Supreme Administrative Court, 5 July 1996, SCI du Faubourg Montmartre, n° 115275: R.J.F., 08-09/96, no. 985). Only those transactions which would qualify under French civil law as a purchase, an exchange or an attribution as a consideration for a capital contribution, or transactions that are governed by a non-French legislation but bear similar traits should fall within the scope of the French tax.
Based on such principles, a transfer of securities between accounts held by the same beneficiary but with different financial institutions will not fall within the scope. Similarly, the transfer of shares in the context of gifts or successions (Q&A published by the French tax authorities, question no.6) is not subject to tax. Additionally, the French FTT should not apply to stock borrowing and lending transactions, even if paradoxically, the tax authorities do not seem to think that such transactions - which should not qualify as “acquisitions” but as loans - should fall outside the scope of the tax (BOI-TCA-FIN-10-20-20121127, §210), and to a certain extent, to transactions of shares transferred as collaterals.
Similarly, the tax should not be levied on the transfer of French stocks upon creation and the ongoing issuance of shares of exchange-traded-funds (ETFs) --to the extent such issuance does not involve any payment in cash, or any compensation between cash and the stocks portfolio. A transfer of stocks upon issuance is a contribution and not a “purchase” of stocks. However, the French tax authorities take a different view and have indicated that such transactions constitute an “acquisition”. The concept of “acquisition” for French FTT purposes need therefore to be clarified.
The liable party will therefore have to understand the purpose of each transfer of eligible securities with the view to apply the proper FTT treatment, especially when the transaction is flagged in the settlement systems as a “Free of Payment” (FOP) transaction.
This criterion is related to the transfer of ownership is also crucial in the French scheme: the tax is due only where there is a transfer of ownership of the stocks which, from a French legal standpoint, is crystallised on the date of settlement of the transaction, i.e., on the date on which the securities are credited to the purchaser's securities account. In this respect, the French model differs from the original proposal released by the European Union Commission in September 2011 (and the latest Commission draft released in February 2013) under which the taxable event is the purchase and sale of a financial instrument before netting and settlement (Article 2, (1) 1 a). This implies that, under the French rules, intra-day trading, even where it is performed across different exchanges, but subject to certain conditions, is not subject to the French FTT. Only the net buying position in respect of a given security at the end of the day will be subject to the FTT. This solution allows to a certain extent the parties to conciliate the transactions settled in their systems and the transactions which are reported on the forms sent to Euroclear France -- the central securities depositary acting as a tax collector.
As regards the securities in scope, the French FTT applies to transactions consisting of acquisition of equity securities in French listed companies or similar securities. This also includes instruments giving access to capital or to voting rights in the said companies, and includes securities issued under foreign law. The scope of the French FTT does not cover the derivatives when not physically settled, or acquisitions of debt securities, except convertible and exchangeable bonds, which are included but benefit from a dedicated exemption. Beginning with transactions traded on or after December 1, 2012, the parliament's intention was to include the American Depositary Receipts (ADRs) and assimilated securities “representing” French in-scope equities in the scope of the tax. Many uncertainties remain in relation to the legality (notably in the absence of sufficient link between the French territory and the taxable event, i.e., the transfer of non-French securities occurring outside of France) and the enforceability of this specific provision outside of France, especially when the parties are located in the United States.
It should be noted that only securities “representing” French in-scope shares are subject to FTT and not financial contracts (therefore equity derivatives should not typically be taxable). It will have to be assessed on a case=by-case basis whether a specific instrument would qualify as a security within the meaning of the FTT law and subsequently attract FTT.
November 9, 2012 was the first tax-collection date for the period from the beginning of August 2012 to the end of October 2012. The tax payments and related returns received by Euroclear France from its members were subsequently transferred to the French tax authorities at the end of November 2012.
Initial indications from the first round of reporting suggest that there was an adherence by financial establishments to the French tax. As a general principle, the reporting obligations are not suffered by the final investor (to the extent it does not qualify as an investment service provider -- “ISP”), but by the broker who is involved in the purchase order, or where no broker is involved, the bank responsible for the custody of the acquirer's securities account (even if, pursuant to the law, the broker or the securities account holder is not located in France). A significant number of parties, essentially those located within the EU, have filed reports and have transmitted payments to Euroclear France. Parties located outside of the EU, and notably in Switzerland, have also complied with the regime.
However, due to the complexity of some rules and uncertainties which remain unresolved, notably in relation to the identification of the liable party where different brokers are involved or in relation to the computation of the net buying position, the French tax may have been levied twice or even more. Liable parties may therefore have to consider whether they can benefit from a regularisation of their tax position or can claim back from the French tax authorities the tax which has been unduly paid.
Some transactions (notably repurchase agreements) even if they are exempt from the French tax, have to be reported by the financial institutions. Such reporting results in significant operational and IT developments which may be detrimental to the attractiveness of such instruments. Some complexity may also arise in the reporting of corporate actions involving French equities. An exemption of such transactions from the reporting obligations would release the financial institutions from a burdensome obligation.
In introducing the tax, the former French government chose to front-run the wider EU initiative; however in the design of the regime, the government has followed a model which more closely resembles UK SDRT.
In a context where there are debates on the new EU draft directive which was released on February 2013, based on the enhanced cooperation procedure, the French/UK model may certainly be viewed in some aspects as an alternative. It shall be noted that pursuant to the new draft, the EU FTT shall only apply in the States of the “FTT zone” which is currently composed of eleven participating EU Member States (Austria, Belgium, Estonia, France, Germany, Greece, Italy, Portugal, Slovakia, Slovenia and Spain). Other states can also join.
Based on the EU draft directive, the participating member states cannot maintain or introduce taxes on financial transactions other than the EU FTT. In particular, this means that the French and Italian FTTs would need to be repealed, or modified to align with the EU FTT model. Existing national FTTs in Europe outside the FTT zone (such as UK SDRT) will continue to exist. This may lead to double taxation under the Commission's proposal.
The original model proposed by the EU Commission was based on a “residence principle” (i.e. the tax is levied by reference to the location of the parties to the transaction) whereas the French and the UK regimes are only based on the location of the securities' issuer. The Italian tax on equity securities, which applied from March 1, 2013, is based on the issuance principle as well.
With a view to reducing the risk of relocation, for the purposes of determining where an entity is “established” under the regime, the new draft directive adds the “issuance principle” to the definition of establishment. This means that a financial institution with no nexus with the FTT zone can now be liable to the tax when it is involved in a transaction over instruments issued within the FTT zone.
However given the highly mobile nature of both capital and the financial services sector, the impact of the EU Commission model would be particularly severe due to both the risk of relocation of financial services outside the FTT zone and importantly to the risk of capital flight to countries outside the FTT zone.
Clients located in the FTT zone would also be adversely affected by the introduction of the tax as compared with clients located outside of the FTT zone. Clients outside the zone may not suffer tax on a similar transaction, and this may be viewed as a distortion in the treatment between the member states. For example, a US bank would be subject to the FTT when transacting with an Italian client, but not when transacting with a Luxembourg client. The impact on the financing costs of non-financial groups located within the EU zone will also have to be seriously considered.
In its impact assessment1, the EU Commission referred to research by academics, Chisari, Estache and Nicoldeme, which concludes that a mild international mobility dramatically amplifies the negative effects of the FTT, which almost triples. Studies show that trading activity in French equities on the European exchanges fell by 16 percent in the three months after the tax entered into force.
Due to the multiple intermediaries that may be involved in a transaction over a financial instrument, the effective burden of the tax under the EU model may be ultimately higher than expected since the tax will be due at each step. This might also considerably alter the market processes, and may contravene other rules and regulations such as the best execution obligations. Financial supply chains may therefore be shortened. This mechanism may also benefit large, integrated institutions which are members of most of the exchange platforms and do not need to route their order via third party intermediaries.
Whereas in the French/UK model, most of these transactions are exempt by application to the market maker exemptions. Under these models, exemptions apply in order to mitigate double taxation at the level of UCITS funds, whereas under the draft EU directive, an exemption is only granted at the time of the issue of the units. No specific exemption has been included in the draft to avoid a migration of the asset management industry outside the FTT zone.
Another obvious point to note on the cumulative effect is that the French tax only applies at the level of the purchase, whereas the EU model applies the tax on both legs (i.e. sale and purchase). It cannot be ruled out that an EU FTT, which applies on the price, (and at each time an intermediary is involved) may also have to cope with the French Constitutional Supreme Court's recent tendency to review more extensively than in the past, new legislation which may contravene the principle under which a tax must be equally borne among the taxpayers, in proportion to their ability to contribute.
One of the other potential impacts of the EU model is its impact on the liquidity of banking assets. In the EU proposal, one of the concerns relates to the increased costs of repurchase agreements and, more generally, the increased costs of all the transactions aimed at providing liquidity on exchanges (i.e. liquidity provider activity, client facilitation) which may be discouraged. The French and UK models instead provide for a reduced scope and for exemptions in relation to repurchase agreements, stock lending and to market maker activities in order to mitigate this concern.
Under the EU model, pension funds and managers, special purpose entities, securitisation companies, financial leasing companies, other traders of financial instruments with significant financial transactions could be treated as financial institutions, all suffering the associated extensive compliance burden. Such entities, and notably the holding companies and the treasury companies of non-financial groups, may have to deal with increased funding costs and obligations for which they have currently no operational infrastructure. It should be noted in this respect that the new draft introduces a revenue-based test for determining whether non-financial entities fall within the regime (entities carrying out the prescribed activities will qualify as financial institutions only if they derive more than 50 percent of their overall average net annual turnover from financial transactions). The issue of corporate bonds within the FTT zone will likely be less attractive as such instruments will suffer the tax on the secondary market. The French/UK model instead refers to a narrower scope of financial institutions.
Some commentators have suggested that the application of the French FTT may contravene a wide range of legal principles, including the compatibility of the tax with the EC Directive 2008/7 concerning indirect taxes on the raising of capital and with the free movement of capital principle by the EC Treaty. The 0.2 percent French FTT payable on acquisitions of shares in French listed companies with market capitalisation of above EUR 1 billion may be regarded as a non-discriminatory restriction on the free movement of capital, making the purchase of the relevant French shares more expensive and hence, depressing the market price and inhibiting the raising of new equity by those companies, notably due to the fact that non-resident institutions have to understand the (complex) rules, and to send monthly returns to the French authorities.
More particularly, the situation of non-French parties in relation to the French tax has to be analysed, especially in light of any local legislation to which the French FTT may contravene, the rights that the French authorities have to enforce the tax locally and the specific provisions of the applicable tax treaties notably in the context of bilateral or multilateral agreements. In particular, we note that the France-US tax treaty includes a provision (Article 29-4) under which a transaction on French equities executed through a stock exchange in the US shall be exempt from “stamp or like tax”. A Representative of Congress proposed legislation in late 2012 aimed at preventing foreign jurisdictions taxing securities transactions occurring in the US between US persons. An EU FTT may have to cope with these legal constraints too, and with others such as Articles 326 and 327 of the Treaty on the Functioning of the European Union concerning whether the regime creates a distortion of competition and a barrier to trade within the EU.
There is an English adage which may be worth to mention here “Grasp all, lose all”. As reflected in this article, the EU Commission will have to reconcile various conflicting interests. The EU Commission will also have to secure the future of the tax by proposing sound legal foundations and a scope which preserves the tax basis. The developments to come this year will certainly be crucial.
Maud Poncelet is Advocate, Tax Director at Landwell & Associés in Neuilly-sur-Seine Cedex - France, member of PwC International network and may be contacted by email at firstname.lastname@example.org or by telephone at +33 (0) 1 5657 1835.
1 Impact assessment, Commission staff working paper, impact assessment, COM (2011) 594 final, p. 50.