Some argued that closer and more efficient surveillance can be accompanied by additional taxation, which would cover the additional costs of the regulatory system and may replace, at least in part, the contribution of governments to the capitalisation of financial institutions in a number of European states.
Thus, the FTT has come to be regarded as a sort of ‘pay-back’ from the financial sector in return for the state aid it enjoyed between 2009 and 2010, all the more so since the financial sector, unlike other industries, still benefits from a tax advantage, namely the exemption from the value added tax. Aside from yielding additional tax receipts, the FTT is intended as a tool to be used in the policy of deterring the speculative transactions which do not add value to financial markets, but instead entail systemic risks.
Paradoxically enough, a tax on financial transactions is no new topic. It used to be in force in the US in the last century, before it was abolished in the mid-60s. In the UK, a similar system is still in use whereby a stamp duty of 0.5% of the transaction value is levied on certain financial transactions.
How does such a tax work? Any transaction involving financial instruments, carried out between financial institutions is subject to this tax, to be paid by the buyer; this means the trading cost will go up directly by this very amount.
In the European Union, things are more complicated due to the commitments undertaken by each Member State, i.e. refraining from taking steps that will cause competition distortions or adversely affect the operating of each domestic market. This raises legitimate questions about the way such a step would affect the competitiveness of the European banking sector as compared to the American and Asian ones, about the level of the harmonised tax (or whether it should be up to the Member States to decide their own respective tax levels) or about the tax implementation requirements.
Even though there are many questions still to be answered, there already are some states where the tax is in force: France (effective from 1 August 2012) and Hungary (effective from 1 January 2013), but this does not mean there are no controversies about the tax impact analysis, the administration cost etc.
While every Member State is making an individual effort, the European Commission is seeking to impose a harmonised view of the matter and in 2011 even came up with a proposed directive on a common system of FTT (2011/0261).
The goal of this approach is to secure a coherent common system in Europe, ensure the financial sector contributes its duty to the public finances and assure a more efficient financial sector trading concerned about the overall public welfare.
In the summer of 2012, heated debates were present at discussions about the proposed tax. Therefore, the Economic and Financial Affairs Council (ECOFIN) reached an understanding that a unanimous voice between the 28 Member States would not be a possible outcome under the time frame. However, 11 members have expressed a very strong willingness to adopt a common FTT, and in the autumn of 2012, wrote directly to the Commission. They requested an enhanced cooperation on the 2011 tax proposition to be transmitted for authorisation.
After a careful assessment by the Commission on the criteria for enhanced cooperation, the request was determined not to have ‘a negative impact on the Single Market or on obligations, rights and competences of non-participating Member States.’ In October 2012, a proposal by the Commission on enhanced cooperation was placed. Two months later, in December 2012, the European Parliament backed the proposal. Lastly, the European finance Ministers agreed at the ECOFIN in January 2013.
The EU FTT as it is known today, reflects the objectives of the original proposal dating back to the end of 2011. However, limited changes were applied in February 2013. The implementation will target a smaller geographic scale than previously expected. The idea is to ensure legal clarity and enforce anti-avoidance and anti-abuse provisions to make sure the objectives of the system is met.
The European Commission assures that the FTT will have low taxation rates. Similarly, the Commission has also declared its intention to set safety nets against the relocation of the financial sector. In fact, shares and bonds will be taxed at a rate of 0.1% and derivatives at 0.01%. Also, the Commission has set clear tax avoidance rules. The residence principle will apply to ensure that the tax will be liable for any transaction if a party is established in any of the participating member state. This point is independent of where the transaction actually takes place. For instance, if there is a transaction issued by a non-EU company which is traded on the New York Stock Exchange, the FTT is still applying if one of the parties is resident in an EU member state that applies the FTT.
Further protection set by the Commission is the issuance principle which declares that financial instruments issued in the member states will be ‘taxed when traded, even if those trading them are not established within the FTT-zone’. This means that shares of an EU issuer are still subject to FTT, even if traded between two non-EU counterparties.
There are clear exemptions to the transaction tax. As stated in the original proposal, the Commission declared that the FTT will not apply to:
- Daily financial activities of both individuals and businesses. This means the tax will not concern transactions such as loans, payments, insurance, and deposits, among others. The goal is to protect the real economy.
- Traditional investment banking activities. This relates specifically to transactions that have the objective of raising capital (like Initial Public Offerings).
- Financial activities related to restricting operations.
Transactions with central banks, European Central Bank, European Stability Facility, European Stability Mechanism,
and transactions with the European Union. The goal is to protect refinancing activities, monetary policy and public debt management for an exemption of this tax.
The estimated revenue delivered from this FTT is approximated at EUR 30-35bn a year. This sum of money could be used as government spending for the benefit of the public. Also, an FTT will curb speculations which destabilize the financial markets. Lastly, many supporters argue that it would hit the wealthy individuals and financial firms more than anyone else. Since ordinary Europeans have to pay a value-added tax on a large basket of goods, many are in favour of such legislation.
The fact that there is no uniform consensus on applying an FTT is problematic in its essence. The adoption of a FTT requires a consensual stand from the 28 Member States. The picture shows the current stand of each Member State, which makes it obvious to notice that such a directive will not be adopted in the entire Union.
However, at the end of September 2012, France and Germany approached the EU in order to initiate the enhanced cooperation procedure for the implementation of the FTT. The procedure allows a minimum of nine Member States (accounting for at least 70% of the EU population) to decide integration in a certain area, without the support of the other Member States. France and Germany have the support of another nine Member States, which makes it very likely for this procedure to result in the enactment of a FTT in the states concerned The FTT has raised resistance from several influential bodies.
In April of 2013, the Czech Prime Minister at the time, Pter Necas said that the FTT will harm the European economy. ‘It is important for us to prevent the introduction of this tax from harming the single market of financial services in the EU. In some cases it may even harm those EU Members States that will not join.’ Necas has mentioned he does not exclude taking radial steps, like going to ECJ, to ensure the FTT will not be legislated. There is a clear pattern in the arguments provided by criticizers of the tax proposal.
The UK, Sweden, and other member states have expressed a concern that their economies will be hurt even if they do not participate in the regional agreement. On May 22, 2014, Bundesbank President Jens Weidmann said ‘The problem with requiring the financial sector to participate in the costs is that the tax doesn’t necessarily impact those that are supposed to pay it. It’s a fact that the transferral of the tax burden from the financial sector to its clients and therefore to the real economy and private investors is possible.’ Officials from the European Central Bank have also voiced some scepticism.
It appears that there is consensus between think tanks that higher transaction taxes ultimately lower investment, which would ultimately reduce government revenues and substantially counterweight the direct gain from such a tax.
On April 18, 2013, the UK filed a case to the European Court of Justice (‘ECJ’) on the decision by ECOFIN which authorised the enhanced cooperation. The UK based their legal action on the grounds that it infringed the fundamental freedoms as outlined in the Treaty of the Functioning of the EU. In addition, they claim that it would also entail costs on member states that are not participating in the proposition, such as the UK and Romania.
On April 30, 2014, the ECJ rejected the case filed by the UK. In particular, ECJ argued that the claims of the UK were aimed at elements of the potential FTT, and not the authorisation of an enhanced cooperation. In other words, it stated the UK was attacking the idea of FTT rather than the agreement of the enhanced cooperation, which dates to 2013. Therefore, the ECJ did not accept the arguments delivered by the UK.
On May 6, 2014, ECOFIN addressed the revised application for a Directive which was submitted on February 14, 2013. The proposal, issued by the European Commission, introduced a common FTT in the eleven Member States. This essentially grounded on the original plan, but with a more limited scope to reflect a narrow application of the Member States.
Even though a clear proposal is still being discussed at high levels within the participating parties, there is a clear desire to implement the refined proposal by the beginning of 2016. The statement issued by ten out of the eleven members on the status of the application is nowhere near a full clarification of the scope and operation of the tax. However, the statement did list some clear guidelines and expectations of high the FTT will implement. There are four main areas concerning the introduction of the tax:
- The tax would be introduced in a progressive procedure. Also known as a phase approach, this means the implementation will be in a step-by-step method. It seems the first step will concern a tax on equities and some derivatives.
- During the first phase, participating member states will be allowed to tax other financial activities under their own determination.
- Due to the necessity of further technical work on the application, a compromise is set for the end of 2014.
- The implementation of the first phase of the FTT should be January 1, 2016 at the latest.
A number of questions still remain. There is no clarity as to whether exemptions will be introduced. In fact, the exact specifications of derivatives subject for a levied tax is still being discussed by senior officials behind closed doors. It will be interesting to see if the first phase covers just equity derivatives or entail a wider scope, like interest rate and currency derivatives. The degree of the implementation is important because such instruments might significantly impact the non-financial services sector. This is because in some instances, industries use derivatives in their treasury activities.
Another concern is whether independent jurisdictions will implement and retain taxes outside the first phase. This could potentially increase tax revenue, but might hurt industries and decrease the competitiveness as compared to other member states.
Lastly, a few member states have expressed a concern with the lack of transparency in the discussions by the countries participating in the enhanced cooperation agreement. Countries which have expressed their concern with the meeting in early May included Sweden, Denmark, the Netherlands, and Malta. They have also requested a more substantial opportunity for engagement in the discussions.
The exact Romanian stand on the issue is not fully clear. However, in early 2012, the Romanian Minister of European Affairs Leonard Orban announced that Romania will support an introduction of unilateral tax cooperation if all the member states reach an agreement. Nonetheless, Orban highlighted the implication of adapting such a common system only in Europe because it could lead to the delocalization of financial institutions of EU member states.
What does the future bring? Financial services institutions may need to restructure some of their strategies. The FTT will certainly have a direct impact on investors and financial products. Some of the strategies currently played by financial services may no longer be viable.
Institutions will witness an increase in operational costs. Firms will be challenged legally when determining what laws apply to their operations. Similarly, companies will work on complying and adapting to a new regional legislation.
Companies established outside of the EU will be affected as well. Thomas Donohue, the chief executive of the US Chamber of Commerce, strongly opposes the tax proposal: ‘I have news for you: we will not allow the FTT to happen.’ This shows that non-member states are very much concerned about the implications of a regional transaction tax. Donohue realizes that such a tax would make institutions located outside the EU still liable to some tax under certain transactions.
Since it appears the FTT will be introduced in phases, companies will need to act quickly and pay attention to the progress of the tax implementation. Certain laws associated ith the transaction tax may be enforced with no caution. Some institutions will find it in particularly challenging to follow.
Since the clarity of the matting in early May is limited, there is no definitive action institutions should be performing. Currently, it seems clear that the first phase will probably include a tax on certain equities and derivatives within the participating countries. Therefore, some institutions may wish to review and asses their individual implications and responses to FTT in Italy or France. In such a way, institutions can start planning for remedial work if need be. In any case, it is unrealistic that the first phase of FTT would be introduced earlier than January 1, 2016.
Independent of what the future holds for this tax, one thing is certain: European and even global trends show enhanced regulating of the financial sector. This indicates that the foundations are being laid for a future where claims such as ‘too big to fail’ will no longer be a reason strong enough to convince governments to bail out private financial institutions.