It has hardly been plain sailing for the financial transactions tax (FTT), perhaps the European Union’s most significant ongoing tax file, in recent weeks despite the determination of EU heavyweights Germany and France, and of course European Commission, to push it through. Indeed, signs of more obvious cracks in the coalition of 11 member states proceeding with the FTT were beginning to show after the last meeting of the EU Economic and Financial Affairs Council (Ecofin), which ended with a statement signed by only 10 of them. Slovenia chose not to put its name to the statement.
The statement makes clear the intention of participating countries to work towards the progressive implementation of an FTT, focusing initially on the taxation of shares and some derivatives. If a deal was reached, these measures would enter into force by January 1, 2016, at the latest. However, while the post-meeting communique makes reference to the rates first mooted by the Commission in it is proposal adopted in 2011, it does not indicate whether they remain on the table after it emerged last year that some participating member states were worried that the tax might too high, and its scope too wide. For example, it is now unclear what types of derivatives will be included, or whether any will be included at all. Some participating member states also appear to have expressed reservations about including corporate bonds in the FTT’s ambit, given ongoing concerns about businesses’ access to finance with banks still reluctant to lend to small firms. Furthermore, late last year it was reported that a “compromise” paper drawn up by the then Lithuanian presidency of the EU proposed to exclude all collateral management and repo market transactions from the FTT.
Under the original proposals, the FTT was supposed to be imposed on all transactions in financial instruments with the exchange of shares and bonds taxed at a rate of 0.1 percent and derivative contracts at a rate of 0.01 percent from 2014. Transactions of individuals, such as credit card payments or private loans, savings or insurance contracts are not included in the scope of the tax, and transactions directly linked to the financing of the productive economy, such as the primary issuance of shares and bonds, loans to businesses and spot foreign exchange transactions would also not be taxed. The principle objective of the tax is to ensure that the finance industry pays its fair share towards the cost of cleaning up the financial crisis, and it is estimated that it will raise around EUR35bn per year in revenue, although it is unclear how FTT receipts will be apportioned to the respective member states, or whether they will make up part of the EU’s own budget.
The 11 member states which originally signed up to the initiative on the basis of “enhanced cooperation” are Belgium, Germany, Estonia, Greece, Spain, France, Italy, Austria, Portugal, Slovenia and Slovakia. At least nine member states must be willing to be involved in an enhanced cooperation procedure for the process to be allowed to go ahead.
However, it is not the rates themselves that are generating the most controversy, but the way in which the proposed legislation tries to mitigate the risk that financial institutions will relocate out of the FTT zone in an attempt to avoid the tax. The Commission tries to get around this problem by including the principles of issuance and residence in the proposed FTT law. This means that the major factor in determining where and how much tax is due is essentially the location where the financial instrument was issued, rather than where the instrument was traded, which potentially gives the FTT wide extra-territorial reach. A recent House of Lords report cited as an example a transaction between a UK and a US financial institution of German shares, which would give rise to FTT upon both parties, payable to the German tax authorities. However, given the clear problem of trying to collect the tax from the US institution, the German tax authorities could impose joint and several liability for both instances of the FTT upon the UK financial institution and recover the whole amount using the EU mutual assistance regime.
Predictably then, the UK remains very hostile to the FTT, not only because of its possible impact on the City of London, but also because of a lack of transparency in the discussions between the participating member states. "We have a situation where eleven member states are working up their proposals, largely in secret and we get a piece of paper handed to us all saying 'oh this, by the way is what we've agreed,’” remarked UK finance minister George Osborne at the Ecofin meeting. “There is absolutely nothing on crucial issues, or which derivatives are going to be included. There's absolutely nothing here on the potential extraterritorial impact. I'd like to hear what the issuance rules are. Is this tax going to apply to shares and derivatives issued in all member states?"
In April 2013, the UK Government submitted an action in the European Court of Justice (ECJ) to annul the Council Decision 2013/52/EU authorizing the EU11 to proceed with the FTT on the basis of enhanced cooperation, arguing that the tax will have extraterritorial effects which will fail to respect the competencies, rights and obligations of the non-participating states." However, delivering their judgment on April 30, 2014, the ECJ justices dismissed the action because the contested decision “does no more than authorize the establishment of enhanced cooperation, but does not contain any substantive element on the FTT itself.”
“The elements of a future FTT challenged by the United Kingdom are in no way constituent elements of the contested decision", a court statement explained.
"Likewise, the contested decision contains no provision on the issue of expenditure linked to the implementation of enhanced cooperation. That issue can therefore not be examined before the introduction of the FTT," the statement added.
Nevertheless, a number of legal analyses of the FTT suggest that the tax remains deeply flawed and easily open to challenge.
In February 2014, Law Society chief executive Desmond Hudson wrote to EU finance ministers to raise the Society's concerns that current tax proposals do not sufficiently respect the rights and competencies of the countries that have chosen not to be involved. The European Commission is accused of failing to "provide the necessary clarity on a number of practical, yet important issues," leading to uncertainty as to "how the tax will be collected and enforced, and what the legal position would be for non-participating member states and third countries." Hudson's letter further states that the cumulative effect of the levy's "wide scope, the broad definition of establishment, the issuance principle as well as the FTT's joint and several liability is an extra-territorial reach that would make entities in non-participating member states subject to the FTT to an extent far beyond transactions with a genuine link to one of the territories of a participating member state." It could therefore be "fundamentally incompatible" with EU treaties he warned. Hudson also foresees a potential "cascade effect” where the structure of the FTT leads to the possibility of multiple charges on one transaction as there is no exemption from the FTT for intermediaries. In turn, this "increases the risk that the tax will ultimately be passed on to end users," while the intended "joint and several liability would have the effect that non-financial institutions may nevertheless be liable for the FTT."
The European Council’s own legal advisors expressed similar warnings in a legal opinion leaked to the Financial Times last September. According to the internal document, which offers non-binding advice, the tax "infringes upon the taxing competencies of non-participating member states," and is therefore incompatible with the EU treaty. The document warns that imposing "deemed residency" on financial institutions in non-participating states amounts to the exercise of jurisdiction over entities outside the zone, in contravention of customary international law, and that the proposals therefore go beyond what is allowable under enhanced cooperation. Further, in cases where a financial institution engaged in a transaction is not established within the zone, that institution's jurisdiction has a stronger claim to impose a tax on the transaction. The lawyers explain that a concern that the FTT would prompt institutions to migrate transactions outside the zone would not justify extraterritorial tax legislation, and that anti-fraud or anti-evasion measures would not be justified under the principle of proportionality. The opinion also suggests that the differential treatment of cross-border transactions within and outside the zone would be discriminatory, while a clause allowing a party to avoid being regarded as resident by showing that there was no economic link between a transaction and the state in which the party resides would risk disparity of application and litigation, as it would be "quite impossible" for member states to define when this would apply.
Immediately after the May 2014 Ecofin meeting, the Government of Luxembourg, also staunchly opposed to the FTT, challenged the European Commission to demonstrate that the tax’s introduction as drafted in 11 EU member states will not have an extraterritorial impact on non-participating countries. Echoing Osborne’s concerns, Finance Minister Pierre Gramegna said that the FTT proposals have been drawn up "without the necessary transparency" required under the EU Treaty, and with disregard to the effects of the levy on countries opting out of the initiative, which, he added, will have a negative impact on growth, the European financial markets, and – potentially – the cost of financing the European Investment Bank.
Meanwhile, Dutch Finance Minister Jeroen Dijsselblom expressed his concerns about the impact of an EU11 FTT on Dutch pension funds, prompting Dutch business organizations to state that the Netherlands should under no circumstances join the group of participating member states. They argued that the tax will hinder growth and economic recovery, reduce investment and employment, and prove harmful to small businesses and pensioners.
So, given the weight of the legal arguments stacking up against the FTT that adopting the tax on the basis of enhanced cooperation will very clearly have a detrimental effect on non-participating member states in contravention of EU treaties, it seems surprising that the ECJ rejected the UK’s action. Indeed, the court’s ruling has led to accusations from some quarters that the Commission leant heavily (privately of course) on the court to come up with the “right” decision. Nevertheless, this seems unlikely to be the end of the story, and the ECJ’s April 30 ruling is expected to be just the start of a long-running legal saga.
Chris Morgan, Head of Tax Policy at KPMG UK observed that: “The UK admitted in its arguments that the challenge may well have been premature and in fact it was rejected on these grounds.” However, he dismissed suggestions of pro-FTT bias in the court’s decision, noting that: “At this stage the UK could only challenge the issuing of that decision and, from a procedural point of view, that decision was issued correctly.”
“The Court did not in any way comment on the merits of the UK’s challenge to some of the proposal for the FTT,” he continued. “The enhanced cooperation process has been moving forward again in recent months, and it seems possible, depending on the outcome of that process that there may be a further UK challenge to an EU FTT. Whether this happens, and the prospects of success, will depend on the scope of the charge and its impact on states such as the UK that have chosen not to participate.”
Other vocal critics of the FTT, including Luxembourg, the Netherlands and Sweden, could also join the UK in challenging the tax’s legitimacy, although no other member state has yet launched an action, or formally declared that it will do so. The Irish Government has however already ruled out such a possibility, stating that the tax is unlikely to have a serious impact on its financial services industry.
In the meantime, Europe’s finance industry awaits further details of the tax’s rates and scope, which the Commission promised will be announced by the end of 2014, with the EU11 (or should that now be the EU10 in the light of Slovenia’s ambivalence?) now favouring a phased approach to its implementation, beginning in 2016. Perhaps all this will do is allow more time for the tax to be discredited, as yet more uncertainty about EU tax policy takes hold.