Taxing times in Europe

Discussions between European Union member states on the European Commission’s proposed legislation for a financial transaction tax are gathering momentum.

If enacted, from 1 January 2014 the draft directive will impose the tax on financial transactions where at least one of the parties is established in an EU member state, and one is a financial institution. The rate and calculation depends on asset-type – bonds and shares are charged at 0.1 per cent of the higher of purchase price or market value, while derivatives contracts are charged at 0.01 per cent of the notional value.

The tax is unattractive on four grounds. First, its wide scope will discourage trade with EU entities, yet provides ample scope for avoidance. Second, by taxing each intermediary to a single trade, it creates a disproportionate burden. Third, if introduced without G20 backing, it risks the relocation, not reform, of its targeted ‘socially useless’ transactions. Fourth, it will reduce long-term gross domestic product and employment which, combined with the relocation of certain industry sectors, is likely to make it revenue-negative. Unless, that is, the ‘cascade effect’ operates unchecked to inflate the effective rate of the tax.

The scope of the tax is best demonstrated by the directive’s definitions. For instance, ‘established in an EU member state’. For individuals and entities other than financial institutions this simply covers place of incorporation and branch location. But for financial institutions, the definition catches any entity authorised in that member state, incorporated there, resident there, carrying out the transaction through a branch there, or party, as principal or agent, to a financial transaction with any entity established there.

The extraterritoriality is deliberate. The commission aims to reduce the risk of banks relocating outside the EU. But it follows that a US bank transacting with a French individual is ‘established’ in France for the purposes of the tax, and therefore liable to pay it. To aid collection, the French party is jointly and severally liable.

Beside banks, financial institutions includes pension and investment funds, and their managers, insurers, credit institutions, leasing companies and special purpose companies.

The definition of financial instrument is also surprising. Borrowed from the Markets in Financial Instruments directive, it includes shares, bonds and other securities, options, futures and derivatives, units in unit trusts and other investment funds, repurchase agreements, structured products, and securities lending.

The scope is wide but there are a few obvious omissions – loans, deposits, spot foreign exchange, emissions credits and commodities. It also excludes most consumer products, such as insurance contracts, mortgages and consumer credit.