New EU recovery prospectuses 'to reduce time and costs involved in raising capital'
Out-Law Guide | 09 May 2013 | 5:18 pm | 5 min. read
The progress of the Financial Transaction Tax (FTT) is currently uncertain. Previous European Commission proposals for a Council Directive implementing the FTT have been formally withdrawn by the Commission. 10 EU countries have committed to introducing some form of FTT under the EU's 'enhanced cooperation' procedure and full political agreement on all aspects of the FTT had been expected in June 2016 in anticipation of implementation commencing in 2017.
But in March 2016 it was reported that the 10 countries are struggling to reach agreement on aspects of the FTT. The enhanced co-operation procedure requires the co-operation of at least 9 member states. So if any further member states withdraw from the process, the FTT as currently proposed may have to be abandoned.
What is the proposed FTT?
The FTT is a tax, proposed by the European Commission, to be applied to transactions in "financial instruments" involving "financial institutions" where at least one party to the transaction is established in a participating member state (the FTT Zone) or where the transaction involves financial instruments issued in the FTT Zone. Most of the definitions are set out in the proposal for a Council Directive which also contains a helpful Explanatory Memorandum explaining the background and the detail of the FTT. However, as stated above, the European Commission's proposal for the Directive has been formally withdrawn and therefore, the definitions and other operational aspects of the final version of the FTT may differ from those originally proposed under the Directive.
"Financial instruments" include bonds, derivatives, shares, securities and units or shares in collective investment undertakings. "Financial institutions" include banks, collective investment schemes and pension funds. The definition, however, also includes persons (ie non-financial entities) carrying out certain financial activities (such as deposit taking, lending or financial leasing) where the average annual value of their financial transactions constitutes more than 50% of their overall average net annual turnover. It is this wider limb of the definition that could bring non financial institutions such as treasury companies into the scope of the FTT.
The European Commission had plans for an EU-wide FTT in 2012 but had to abandon them after there was insufficient support for the proposals. However, under the 'enhanced cooperation' procedure a minimum of nine member states are allowed to go forward with their own plan for the FTT, and currently ten participating member states are proceeding under this process. They are: Austria, Belgium, France, Germany, Greece, Italy, Portugal, Slovakia, Slovenia and Spain.
The UK challenged the use of the enhanced cooperation procedure to introduce the tax, but the Court of Justice of the European Union dismissed its challenge in April 2014. However, the court said its judgment did not prevent the UK from issuing a subsequent challenge to the tax itself once the proposals are fully developed.
What types of transactions are caught?
The sorts of transactions that are caught include the sale and purchase of bonds or derivatives, intra-group transfers of such instruments, exchanges of financial instruments and the conclusion of derivative contracts. In addition, each material modification of a taxable financial transaction is also caught.
The Directive includes a very wide general anti-avoidance provision to ensure that artificial arrangements that are put in place to avoid the FTT will not succeed.
Are there any exclusions to FTT?
The FTT is not intended to apply to standard investment banking transactions or the everyday financial activities of individuals and businesses (such as insurance contracts, mortgage and business lending and credit card transactions).
Similarly excluded are the activities of governments and other public bodies in relation to managing public debt, as are actions relating to monetary policy performed by entities such as the European Central Bank.
The primary issuance of shares and units in collective investment funds is excluded from the FTT (although redeeming those shares and units remains subject to the FTT). Restructuring operations (including share-for-share exchanges) are also excluded.
How will the FTT work?
Transactions will be taxed at 0.1% for shares and bonds, units of collective investment funds, money market instruments, repurchase agreements and securities lending agreements, and 0.01% for derivatives. These are proposed minimum rates and participating member states would be free to apply higher rates if they wanted.
The tax would have to be paid by each financial institution involved in the transaction. It will become chargeable for each financial transaction at the moment it occurs.
When is it likely to come into effect?
The participating countries intend to work on a progressive implementation of the FTT, focusing initially on the taxation of shares and some derivatives. It was initially proposed that the first steps would be implemented at the latest on 1 January 2016; however, it is currently anticipated that implementation will not begin until 2017.
Why is the UK opposed to the tax?
It is true that, currently (and consistently), the UK is (and has been) opposed to the introduction of the FTT – this view is also shared by some other member states such as Denmark and Sweden. The UK has always been against an EU-wide FTT, on the basis that any such tax would have to be global to stop traders simply routing their deals to New York and other financial centres outside the EU.
The UK's main objection to the current proposals is the ambit of the tax - there are several elements of the tax which make its reach much wider than just the FTT Zone.
The "residence principle" is a core element of the tax ie. "who" is party to the transaction is what counts, not where it takes place. This means that if a financial institution involved in the transaction is established in the FTT Zone, or is acting on behalf of a party established in this zone, then the transaction will be taxed, regardless of where it takes place in the world.
In addition the "deemed establishment" provision means that a financial institution outside the FTT Zone is still regarded as established in the FTT Zone if its counterparty on the transaction (financial or non-financial) is established within the FTT Zone. For example, if a UK bank were to trade bonds with a German bank this would be subject to the FTT. Also, if a UK bank were to provide hedging arrangements to a French trading group, transactions between the two entities would be subject to the FTT even though the UK bank is not in the FTT Zone, nor is the counterparty a financial institution.
As an anti-avoidance measure the FTT also applies to a transaction wherever and whenever it takes place if it involves financial instruments issued in one of the participating member states. This is the case even if the party and counterparty trading them are not resident in the FTT Zone. For example a UK bank selling shares in a German company to another UK bank would be caught.
Assuming the FTT goes ahead under the cooperation procedure, what is the practical impact in the UK likely to be?
If the FTT was to go ahead as proposed, it would have a detrimental effect on the big financial institutions based in London when they trade in financial instruments or with parties established in one of the participating states. The EU could even see a large proportion of its banking and investment business move elsewhere.
The difficulty with a financial transaction tax which is not applied globally is that money is fungible – why suffer tax trading with a bank in the EU when you can buy the same instrument in New York without it? It’s not just a question of where banks are located or their profits generated (and therefore taxed) either. It also affects what instruments pension funds and other tax exempt vehicles will buy – why accept French bonds as collateral if holding French bonds (instead of say US ones) costs you more? It is therefore likely to change the risk profile of group treasurers as to what financial instruments to deal in.
It is entirely probable that it would lead to the major financial institutions taking into account the cost of the FTT when agreeing the price to acquire, for example, German government bonds.
New EU recovery prospectuses 'to reduce time and costs involved in raising capital'