EU FTT

1. Residence v Issuer Basis

We understand that the working group has a preference, initially at least, for the FTT to be applied on the issuer basis for equities issued in the 11 participating member states. However, the working group does leave it open to individual member states to apply the residence principle (i.e. to apply where one party is the resident in a participating member state).

In April 2013, the UK government launched a legal challenge to the FTT, specifically the residence principle (which was dismissed in April 2014 on procedural grounds). The working group’s preference for the issuer principle on equities issued in their own jurisdictions may insulate the directive itself from further legal challenge. However, should an individual member state decide to apply the residence principal, this may leave that member state more exposed to legal challenge.

2. Gross v Net Transactions

We understand that the working group has a preference for transactions to be taxed on a gross basis (similar to UK stamp duty reserve tax). Effectively, this means that each buy and sell transaction of an in-scope equity would be subject to the tax, unless it is exempt for another reason. This is in marked contrast to the unilateral French and Italian FTTs which impose the tax on a net end of day basis – i.e. only end of day positions are subject to tax. Taxing transactions would certainly increase the importance and emphasis placed on other exemptions, e.g. for market makers.

3. Market Maker Exemption

The working group now appears to be in favour of introducing a market maker exemption. In contrast the February 2013 draft directive made no provision for a market marker exemption. However, we understand that the working group’s preference is for the definition of market maker, for FTT purposes, to follow an existing regulatory definition, e.g. short selling regulations. This mirrors the approach taken by the Italian FTT and contrasts with the French FTT, under which the market maker exemption is broader.

4. Transaction Chain

One of the key concerns with the February 2013 draft directive was the so called “cascade effect”. A single buy order from a purchaser typically involves a security flowing through several intermediaries and under the February 2013 draft directive all intermediaries in the transaction chain would be subject to the tax. The working group appears to be in favour of addressing this point by exempting “agency” trades. However, intermediaries may well, even when acting in an “agency” capacity, have a payment/reporting obligation depending on the final outcome.

5. Derivatives

We understand the working group is in favour of taxing a broad range of derivatives (not just equity derivatives) but exempting derivatives which reference sovereign bonds. Taking a broad range of derivatives. This would mean that the FTT has a far wider scope than existing similar taxes such as:

• UK SDRT – which does not apply to derivatives;
• French FTT – which does not apply to derivatives; and
• Italian FTT – which applies to equity derivatives only.

Essentially, this means that the FTT would cover derivatives such as interest rate swaps, currency swaps, inflation swaps and other derivatives to which the Italian FTT does not apply. This may be of particular interest to pension funds, noting that the February 2013 directive did not exempt pension funds, which are not exempted from the tax and there has been no indication to date that the working group is in favour of a pension fund exemption.

6. Computing Taxable Amount on derivatives

The working group is considering taxing derivatives based on the following approaches:

• Options – the option premium
• Other derivatives with a maturity – a “term adjusted” notional amount or market value
• Other derivatives without a maturity – the notional amount or market value.

In Summary

It appears that the participating members states are becoming increasingly closely aligned on the scope of the tax. The working group's preference seems to be a more nuanced proposal which could form the basis of a revised FTT directive.

If the FTT were to be enacted on the basis as outlined above, it would certainly be broader than existing similar taxes. The combination of applying the tax on a gross basis with a narrow market maker exemption means that the number of in-scope transactions would be likely to exceed that of the unilateral French and Italian FTTs. Furthermore, the relatively broad tax on derivatives would extend the reach of the FTT further, and impact the broader financial sector more deeply and directly, than existing transaction taxes have done to date.

The largest remaining barrier appears to be how to divide FTT revenues raised between the member states, in particular between states with larger and smaller economies. No concrete progress can be made until there is agreement on this crucial aspect of sharing revenues and there is no indication of an impending break through. If the participating member states were however able to resolve this matter, then a FTT implementation date of January 2017, although ambitious, may not be unrealistic.

We will continue to keep you updated on all material developments.