A number of EU member states remain strongly opposed to the introduction of the proposed financial transaction tax (FTT) next year. Indeed, the UK has raised a legal challenge in the EU. But while there is increasing dissent – even among FTT-zoned member states – it seems entirely possible that the FTT will survive, whether or not in its current form. It also seems likely that it will have at least some impact on almost all groups operating within the EU.
The FTT only applies where at least one party to certain transactions is a ‘financial institution’ and at least one party is established in the FTT zone, so it is not surprising that there is a common misconception that the tax will only apply to the financial services sector. As we discuss below, however, it is clear that all corporate treasurers – and not just those operating in the financial services sector – need to start thinking about the potential impact of the FTT. In the form in which it is currently proposed, the tax could have a significant impact not only on external financial transactions with financial services counterparties, but also on intra-group arrangements.
According to the European Commission proposals, the intention is for the FTT to become effective from 1 January 2014. Given the amount of work that remains to be done to bring it onto the statute books of 11 countries, this may be doubtful. Nonetheless, there is the political impetus such that some form of FTT is likely to be implemented eventually.
The Financial Transaction Tax Directive leaves the participating countries to decide the detail around registration and reporting obligations. But it does envisage close to same-time reporting of transactions subject to the FTT (by the 10th day of the following month) and immediate payment, at least in the case of electronic transactions (a three-day delay is permitted in other cases). Clearly, this has the potential to be burdensome and complex, and it remains to be seen how the states make it workable in their domestic legislation.
As noted above, the FTT applies where one party to certain financial transactions meets the definition of a ‘financial institution’. Unexpectedly, and perhaps unintentionally, the definition of ‘financial institution’ for these purposes goes far beyond regulated entities. Specifically, it includes:
Financial transactions include, among others, the purchase and sale of a financial instrument and the conclusion of derivative contracts. But ‘financial instrument’ is not defined in the directive – instead one is referred to another council directive. As both of these directives may have been enacted slightly differently in each member state, there is a possibility that one might arrive at a slightly different answer depending on which country is in point.
While the calculation to determine whether an entity is a ‘financial institution’ is complex, it appears that many group treasury companies are likely to fall within the definition. For example, assume the following scenario:
This is one of the areas where the calculation becomes difficult. The FTT Directive again refers us to another directive where ‘turnover’ is defined as comprising “the amounts derived from the sale of products and the provision of services falling within the company’s ordinary activities…” It is unclear, particularly in a treasury company context, whether the interest income earned on the intra-group loan would form part of turnover. Certainly, the return on the money market instruments cannot be said to derive from the sale of products or the provision of services and so presumably this income must be excluded. Therefore, in the best case, the company’s turnover would be £1.75m and in the worst case may be nil.
To determine the value of a company’s financial transactions, the FTT Directive instructs us to take 10% of the taxable amount in the case of transactions involving derivative contracts and the total taxable amount in all other cases.
The taxable amount for derivative contracts is defined as the nominal amount at the time of the financial transaction, ie upon conclusion of the contract. As the forward contracts (both external and internal) in our scenario are rolled on a monthly basis, UK Treasury Co will enter into 24 financial transactions during the period. Therefore, the relevant value is £480m (£200m x 10% x 24). The taxable amount for other transactions is “everything which constitutes consideration paid or owed, in return for the transfer”. In our case, this is the £100m paid to the UK financial institution for the money market instrument.
Therefore, the annual value of the financial transactions entered into by UK Treasury Co is £580m. Clearly, the average annual value of £580m far exceeds 50% of the company’s turnover (whether this is taken to be £1.75m or nil) and so UK Treasury Co will be regarded as a ‘financial institution’.
It is worth noting that, for the purposes of calculating the value of the financial transactions entered into by an entity, it is irrelevant whether or not the counterparty or issuer is established in the FTT zone.
As a final point in relation to the scope of the tax, looking at the intra-group debt of £500m, as there was no transfer of this instrument during the period, there can be no financial transactions to take into account. In the event that UK Treasury Co did transfer this loan, the extent to which this would give rise to a financial transaction for FTT purposes is again unclear. The loan note would need to be a ‘transferable security’, which is defined (again elsewhere) as a security that is “negotiable on the capital market”. While implementation of the relevant directive – the Market in Financial Instruments Directive – has varied across member states, the broad approach adopted by many suggests that transfers of certain intra-group loan notes could fall within the scope of the FTT.
UK Treasury Co, assuming that it is a ‘financial institution’ for FTT purposes, will only be liable to tax where it ‘transacts with’ an entity in the FTT zone. The definition of ‘transacting with’ for these purposes includes the following:
Looking again at the scenario described above, UK Treasury Co would be liable to FTT as follows. The taxable amount in respect of the forward contract with the French subsidiary is £2.4bn (£200m x 12) and the taxable amount in respect of the money market investment (the instruments are issued by an entity registered in Germany) is £100m. Note that there is no intra-group exemption.
The relevant tax rates are set out in the FTT Directive as 0.01% in respect of transactions involving derivative contracts and 0.1% in respect of all other transactions. Assuming that France and Germany in our scenario adopt the minimum rates of tax under the directive (though individual states could set higher rates), the total FTT liability for UK Treasury Co would be £340k (£2.4bn x 0.01% + £100m x 0.1%).
It is clear that active treasury companies may be entering into huge numbers of similar transactions and, where most of the counterparties or issuers are located in the FTT zone, the liability may become very substantial.
It is also worth noting that in the case of the transfer of the money market instrument, as the transferor is also a financial institution, it would also be liable to FTT of £100k. In this case, the German state would be entitled to collect the full amount of the tax from both counterparties. While the current proposals do not deal with the specifics of tax collection, from a practical perspective, the overseas authorities would likely require the cooperation of the UK authorities.
As is evident from the relatively simple example illustrated above, there are a number of areas of uncertainty with regard to the scope and calculation of the FTT. What is clear, however, is that, even taking the best possible answer where there is any confusion, a number of entities with no ties to the financial sector are likely to meet the definition of a ‘financial institution’. Even if they are not located within the FTT zone, there will be many instances of intra-group and third-party transactions that will trigger a charge (or indeed multiple charges) to the FTT.
The ACT has serious concerns over the impact that FTT will have on non-financial corporates. The European Association of Corporate Treasurers (EACT) has prepared a position paper for discussion with the European Commission and others, which is available on the ACT website www.treasurers.org/node/9078. The ACT strongly supports the EACT’s position.
Graham Robinson is a tax partner and Trudy Armstrong is a senior tax manager at PwC.