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EU transaction tax

10 May 2013

If the proposals for a financial transaction tax (FTT) are implemented as proposed by the Commission, the FTT is likely to cause distortion in the financial sector, both within the EU and outside, and will almost certainly change the way we do business.

The FTT will apply to securities and derivatives transactions by financial institutions that are established in a participating Member State – that is, Belgium, Germany, Greece, France, Austria, Portugal, Slovenia, Estonia, Spain, Italy and Slovakia (the FTT zone).

However, the FTT will also apply to financial institutions established outside the zone. This will be the case if they operate within the FTT zone, transact with a counterparty in the zone or (following changes to the Commission's proposals) transact in securities issued by entities incorporated or registered in the FTT zone. This means that a transaction between a UK and a U.S. entity relating to, for example, German bonds could give rise to an FTT charge.

The FTT will be charged at a minimum rate of 0.1% on buying and selling securities and 0.01% on concluding derivatives. In practice, a transaction could attract a much larger effective rate because the tax applies to both parties (if they are both financial institutions) and there is no wide market-maker exemption. A subsequent charge could apply to a material modification of the transaction (even an existing transaction), which is of particular concern for derivative transactions.

There are only limited exemptions from the FTT, eg primary market transactions.

Some financial transactions carried out in the FTT zone, eg high-volume/ low-margin derivative trades, may become uneconomic. Possible market reaction could include relocation of activities of entities of participating Member States to subsidiaries based outside the FTT zone (although a new general anti-abuse rule would need to be considered).

Contracts will also need to be updated to take account of the FTT. For example, where a financial institution fails to pay the tax on time, any party to a relevant transaction will be jointly and severally liable for the FTT. Indemnity wording will be needed to deal with this risk.

Financial institutions will need to adapt their systems in order to comply with the FTT regime. This is likely to involve considerable cost and time. A challenge is the proposal to start charging the FTT from 1 January 2014, though this timescale may not be achievable. An added complication is that the participating Member States are still negotiating the scope of the FTT, so the scope of the tax that it eventually agreed upon is not clear currently.

The Commission expects the FTT to raise around EUR 34 billion a year. In late April 2013, the UK Chancellor of the Exchequer announced that the UK has challenged the legality of the extra-territorial aspects of the FTT proposals under EU law. It is understood that the UK Government hopes in the meantime to continue negotiations with other Member States as to the scope of the FTT.