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By Ben Fryer and Annabelle Trotter
The European Commission’s proposal for an EU wide tax on financial transactions ("EU FTT") has generated much public and political discussion since it was first published on September 28, 2011.
A harmonized EU FTT has remained, somewhat precariously, on the agenda of a number of EU member states’ governments—10 of which have expressed their willingness to move forward under the procedure of enhanced cooperation (Financial Transaction Tax under Enhanced Cooperation, February 14, 2018).
Since 2011, the U.K., under a Conservative-led government, has remained skeptical about the nature of the proposed tax and has opted out of the enhanced cooperation procedure. However, there are voices in the U.K., led by the opposition Labour Party, which argue that introducing a U.K. financial transactions tax ("U.K. FTT"), effectively by extending the scope of U.K. stamp duty, is good fiscal policy.
Under the harmonized EU FTT proposed by the 10 member states, including Germany and France, a 0.1 percent tax would apply on both the purchase and sale of securities such as shares and bonds and a 0.01 percent tax would apply to derivative transactions.
The proposed scope of the EU FTT is broad and would cover instruments which are negotiable on the capital markets, money-market instruments, units or shares in collective investment undertakings—which include undertakings for collective investment in transferable securities and alternative investment funds—and derivatives contracts. The EU FTT is not limited to trading activity in organized markets but would also cover other types of trades including over-the-counter trades.
The EU FTT has come under substantial criticism since it was first proposed in 2011.
The European Commission’s original proposal suggested adopting a very wide approach, under which all transactions would be caught by the EU FTT where either financial instruments are issued in the EU FTT-zone, regardless of where they are traded or where the parties to the transaction are established so long as a financial institution is party to the transaction (the so-called “issuance principle"), or where any financial institution transacts in relevant financial instruments with an entity which has a legal or physical presence in the EU FTT-zone or that has authority to operate there (the so-called “residence principle").
The extra-territorial application of the EU FTT and its potential “cascading” effect (i.e. the EU FTT would ostensibly be imposed on the various legs of a broader transaction, thereby multiplying the impact of the tax many times over) have unnerved both non-participating member states and frequent market participants such as asset managers, insurance companies and pension funds.
The U.K. has been one of the leading critics of the EU FTT and on April 18, 2013, the U.K. launched legal proceedings in the Court of Justice of the European Union ("CJEU"), challenging the European Council’s decision to authorize use of the enhanced cooperation procedure for the introduction of an EU FTT on the grounds that it would have extra-territorial effects and would impose costs on non-participating member states.
The CJEU declined to rule on the substantive questions raised by the U.K. (judgment of the Court (Second Chamber) of April 30, 2014—United Kingdom of Great Britain and Northern Ireland v Council of the European Union (Case C-209/13), June 24, 2014) which perhaps leaves the door open for opposing member states to bring a subsequent challenge if an EU FTT Directive is finally adopted by the participating member states.
Clearly, the FTT will impose a significant burden on the City of London as the largest financial center in Europe, as the home to large branches of banks headquartered in participating member states and as the center of European over-the-counter derivatives trading. As the U.K. has opted out of the enhanced cooperation procedure, one worry is that the U.K. will have no say in the design of the EU FTT despite U.K.-based and U.K.-focused institutions and investors theoretically having to pay a large share of the tax.
It would appear that Brexit-related pressures on EU member states have also contributed to the stagnation of negotiations under enhanced cooperation. Most notably, press reports coming out of the informal meeting of finance ministers in Estonia on September 16, 2017 suggested that member states expressed concerns over the potential impact of the EU FTT on their efforts to attract London-based banks and other financial institutions post-Brexit (Brexit Kicks EU Financial Transaction Tax Into the Long Grass, September 16, 2017).
In the U.K., linked to the extra-territorial effect of the EU FTT, concerns remain in relation to the enforcement of the tax, particularly for financial institutions based or headquartered in the U.K. and outside of the EU FTT-zone.
It is not clear how enforcement of the EU FTT would work in relation to the U.K. in the case of a “hard” Brexit. There is also some nervousness about the risk of double taxation where the EU FTT could operate alongside unharmonized tax regimes (e.g. U.K. stamp duty and Stamp Duty Reserve Tax (“SDRT”) or, as discussed below, a U.K. FTT).
As noted above, the Conservative Party has been one of the most strident critics of a harmonized EU FTT. However, the opposition Labour government announced in 2017 that, if in power, they would expand the existing U.K. stamp duty into a broader financial transactions tax. The Labour Party reiterated their intention to introduce the FTT at their recent party conference in Liverpool, which suggests their interest in a U.K. FTT has not subsided.
The Labour Party’s proposal is based on a paper published in 2017 by Professor Avinash Persaud (Improving Resilience, Increasing Revenue: The case for modernising the UK’s stamp duty on shares, May 2017). The proposal has several commonalities with the proposed EU FTT, but would in practice stand alone. Professor Persaud’s envisaged U.K. FTT would extend the current scope of U.K. stamp duty to apply to all debt and equity security trades where there is either a U.K. issuer, or a foreign issuer but one of the parties to the trade is a U.K. person. In addition, the proposal would see the U.K. FTT apply to derivatives where one of the parties is a U.K. person.
Aside from the radical broadening of the current territorial scope of U.K. stamp duty, there are certain obvious gaps within the U.K. FTT as proposed. For example, the proposed U.K. FTT has no intermediary exemption. Securities and derivatives transactions are commonly settled and cleared through multiple layers of intermediaries. Therefore, if a U.K. FTT was introduced in the manner proposed, there would be multiple points of charge producing a high effective rate of tax. This effective rate would inevitably be borne by the end-investors (again likely hitting institutional investors the hardest).
Another cause for concern is the potential distortive effect of the U.K. FTT as proposed. If the U.K. FTT were only to apply to derivatives and debt/equity securities where a party to the trade is a U.K. person, it would not be surprising if some end-investors and market makers either depleted their activities in the U.K., or relocated away from the U.K. altogether.
Whatever the outcome of the Brexit negotiations between the U.K. government and the remaining EU member states, it appears at this stage that the likelihood of the introduction of an EU FTT is somewhat remote as there still seems to be much disagreement between those member states contemplating the scope of the EU FTT.
In addition, there are political factors, such as Brexit, impacting the level of support for the measure. The Labour Party’s proposal for a U.K. FTT is also likely to arouse considerable opposition, both technically and commercially.
However, it appears that the ideology underpinning the financial transactions tax may continue to receive support from some quarters in one form or another, and in a political climate where it is not completely implausible to imagine the introduction of such a tax, all potentially affected parties would be well advised to monitor developments very closely.
Ben Fryer is a Partner and Annabelle Trotter is an Associate at Mayer Brown International LLP.
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