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Special Report

Impact investing


Top 400 Asset Managers: Taxing financial deals

There is a compelling case for excluding investment funds from the scope of the financial transaction tax, write Camille Thommes and Susanne Weismüller

On 14 February 2013, the European Commission presented its proposal for a Directive implementing enhanced co-operation in the area of financial transaction tax. Belgium, Germany, Estonia, Greece, Spain, France, Italy, Austria, Portugal, Slovenia, and Slovakia were authorised to proceed with the introduction of a financial transaction tax (FTT) using the enhanced co-operation system, because it was established that the objectives of the proposal for a Directive on a common system of FTT, published by the Commission in September 2011 could not be attained within a reasonable period by the EU as a whole.

What will be affected?
Upon request from the participating member states, the scope of the Commission proposal mirrors the 2011 proposal, but some adaptations had to be made.

An FTT would be a tax levied on financial transactions at a predetermined rate. The term ‘financial transaction’ would apply to the exchange of financial instruments between financial institutions. According to the Commission, the latter should cover a wide range of institutions to avoid circumvention of the tax, effectively including investment firms, organised markets, credit institutions, insurance companies, UCITS and their managers, pension funds or IORPs and their managers, alternative investment funds and alternative investment fund managers, securitisation special purpose entities and special-purpose vehicles.

However, the day-to-day financial activities of ordinary citizens and businesses (eg, insurance contracts, mortgage and business lending, credit card transactions, payment services, deposits, spot currency transactions, and so on) should be excluded from the FTT to protect the real economy.

Moreover, the raising of capital (ie, primary issuance of shares and bonds/units of collective investment funds as opposed to redemptions of shares and units in investment funds) and some restructuring operations would not be taxed.

Exchanges of financial instruments would be considered as two transactions for tax purposes, while repurchase and reverse repurchase agreements and securities lending and borrowing would be regarded as only one transaction, as they are economically equivalent to a single credit operation.

The financial instruments in question would include not only bonds and equities (including shares or units in investment funds), but also derivatives. The Commission has proposed a minimum tax rate for the trading of bonds and shares of 0.1%, and 0.01% for derivative products. However, member states would be free to apply higher rates and the tax would be payable by each party to a transaction.

Who else would be affected?
The aforementioned eleven member states form part of the so-called FTT-zone. Any other EU jurisdiction may opt to join the enhanced co-operation at any time and the Commission will try to convince as many countries as possible to adopt similar rules.

When transposed into national law, the new provisions would apply to all financial institutions established within the FTT-zone. The ‘residence principle’ would go beyond pure residence, however, to prevent businesses from simply relocating outside this territory to non-participating member states and third countries. According to the Commission, the important factor is therefore the identity of the parties to the transaction, not where it takes place. Consequently, if a financial institution involved in the transaction was acting on behalf of a party established in the FTT-zone, then the transaction would be taxed, regardless of where it took place.

As a further tax avoidance prevention measure, the legislative proposal also operates on the basis of the ‘issuance principle’. This means that transactions would also be taxed, regardless of when and where they took place, if they involved financial instruments issued in one of the participating member states.

The Commission is confident that an established economic link is present in both of the above cases, meaning that any extra-territorial effects would be justified. On the other hand, a general rule has been included which would allow the persons liable to pay the FTT to prove that the link between the transaction and the territory of a participating member state is insufficient (economic substance clause), and that they therefore do not have to pay the tax.

The European Parliament recently presented a proposal to complete the residence and issuance principle with the transfer of legal title principle. This means that transactions on which no FTT has been levied would be deemed legally unenforceable and would thus not result in the transfer of the legal title of the underlying instrument. Also, it would be deemed not to fulfil the requirements for central clearing under the EMIR and CRD IV regulations.


Why exempt investment funds?
From the outset, the asset management and investment fund industry, both at European level through EFAMA, as well as at national level through ALFI, have requested that investment funds be excluded from the scope of financial sector taxation, in whatever form it may take.

Fund managers are of the opinion that if investment funds were included, the ultimate tax burden would fall on the end-investor and not on financial institutions. Even though the issuance of shares and units in investment funds would be exempt from FTT, any transaction at portfolio level would be taxed, as would redemptions.

In particular, money market funds launched from or investing within the FTT-zone with the aim of achieving a money market yield would no longer be viable, as these funds are characterised by high liquidity, which entails frequent transactions at portfolio level. It is also worth noting that money market funds are not the speculative financial instruments that FTT is supposed to curtail. Moreover, taxing redemptions of shares/units in funds would not respect the principle of tax neutrality between direct and indirect investments.
As a result, investors would have to pay more tax when they invested their money in a fund and not directly in the underlying assets.

Taxation of investors would have a negative impact on all long-term savings products, including pension funds. The tax would notably limit the access of small savers to high-quality, professionally-managed savings products.

Restricting the introduction of an FTT in the EU or in a limited number of countries would also fail to create a level playing field compared to third countries and lead to business relocations. In a globalised world it is easy to move operations from one jurisdiction to another, and the obvious cost pressure encourages fund promoters to choose the least cost-intensive option. Trading securities with FTT-zone-resident counterparties would be more expensive than trading the same securities with counterparties not in the FTT-zone.
This March, EFAMA conducted an impact analysis and concluded that if applied at the start of 2011, the annual total cost of the FTT would probably have been €13bn (of which €7.3bn would be attributed to the FTT-zone and €5.7bn to countries outside the FTT-zone). Investors would have paid €4bn on the redemptions of UCITS shares/units, whereas €9bn would have been levied on the sales and purchases of securities by UCITS fund managers.

However, the actual effect of the tax is likely to be even more severe because it would be applied to each transaction several times, owing to the chain of trading and clearing that lies behind most securities transactions. The purchase of securities on a stock exchange ordinarily involves sale and purchase by parties including brokers, clearing members and the central counterparty to the clearing system. Each sale would be subject to the FTT with only the central counterparty being exempt. This ‘cascading effect’ would, say some studies, cause the same operation to be taxed up to 10 times.

Above all, ALFI continues to believe that there is a very compelling case for excluding investment funds from the scope of the FTT as it will not only have extremely negative impact on long-term savings but in addition limit European savers to access to high-quality, professionally managed products.

Camille Thommes is director general and Susanne Weismüller is legal adviser at the Association of the Luxembourg Fund Industry


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