There is widespread opinion that a financial transaction tax (FTT) won’t stabilise the markets and it would undermine economic growth. According to Barclays the FTT could cut EU GDP by 0.3%. Moreover, according to the City of London Corporation if the FTT is introduced there would be an increase on the cost of funds for corporations and such impact “is greater for non-participating Member States than participating Member States…”. Furthermore, the governments’ costs of funds it will also increase. The FTT’s costs on UK government debt have been estimated at £3.95 billion. As noted by Dr Kay Swinburne MEP, European Conservatives and Reformists group economics spokesman, “… a FTT will lead to job losses, slow growth, and businesses leaving the EU altogether.” The FTT would increase borrowing costs and would distort competition in the Single Market. And, on top of that, it is illegal too.
It is important to recall that taxation is one of the very few areas where unanimity is still required, under the Lisbon Treaty. The UK government has vetoed the FTT nevertheless it is going through enhanced cooperation. Last February, the European Commission put forward a draft proposal for a Council Directive implementing enhanced cooperation in the area of financial transaction tax, which would apply to 11 EU Member States. It is important to note that the proposal is based, as the original one, on Article 113 TFEU whereby the Council, acting unanimously, shall adopt “provisions for the harmonisation of legislation concerning turnover taxes, excise duties and other forms of indirect taxation” but only if such “harmonisation is necessary to ensure the establishment and the functioning of the internal market and to avoid distortion of competition.” According to the European Commission “A common system of taxing the financial sector, even if not applied by all Member States, is preferable to the fragmentation that would result from 27 different national systems.” However, one could say that by using enhanced cooperation to adopt the FTT, it can no longer be justified to avoid fragmentation in the internal market for financial services. Despite the Commission has asserted the opposite, enhanced cooperation on the FTT is likely to lead to a significant distortion of competition in the internal market, and it would not only negatively affect the functioning of the internal market, but also the rights and competences of non-participating Member States.
The conditions for enhanced cooperation are clearly defined under Articles 326 to 334 TFEU. Particularly, article 326 TFEU provides that enhanced cooperation “shall not undermine the internal market or economic, social and territorial cohesion [and] shall not constitute a barrier to or discrimination in trade between Member States, nor shall it distort competition between them.” Moreover, Article 327 TFEU provides that “any enhanced cooperation shall respect the competences, rights and obligations of those member States which do not participate in it”. Obviously, according the European Commission the proposal meets all the legal requirements. But, clearly the above-mentioned requirements have not been met given that the proposal not only does not respect non-participating Member States’ competences but it would also harm non-participating Member States.
Despite the veto and despite the non-participation in the enhanced cooperation, the UK will still be affected by such tax. The UK does not participate but this would not prevent the tax being collected from financial institutions in the UK. Hence, Government is absolutely right in challenging the decision authorising enhanced cooperation for the FTT.
The Commission has defined, in the original proposal, the FTT´s territorial application on the basis of the “residence principle.” Hence, "The tax would not be based on where transactions take place but on the parties involved". A financial transaction would be taxable in the EU, if one of the parties to the transaction is established in the territory of a Member State. Taxation will take place in the Member State where the establishment of a financial institution is located, if this institution is party to the transaction, acting either for its own account or for the account of another person, or is acting in the name of party to the transaction. A transaction would not be subject to FTT if the establishments of the financial institutions, parties to the transaction, are located in a third country, however the third-country financial institution will be deemed to be established in the EU if one of the parties to transaction is established in the EU and, in this case, the transaction would become taxable in the Member State concerned. In a note further explaining the residence principle and the territoriality of the proposal, the Commission said “The only possibility for EU resident entities to avoid the proposed tax is to relocate themselves to third countries completely or through the formation of subsidiaries and in both cases give up their European customer base, a strategy which it is unlikely to be adopted.” By making such assertion, the Commission is conceiving that there is the risk of the proposal having as effect the relocation of investors outside the EU.
The Commission wants to prevent investors from moving from the 11 participating member states to avoid the FTT, so it has decided to complement the residence principle with the issuance principle. Consequently, the draft directive implementing enhanced cooperation in the area of financial transaction tax would apply “to all financial transactions, on the condition that at least one party to the transaction is established in the territory of a participating Member State and that a financial institution established in the territory of a participating Member State is party to the transaction, acting either for its own account or for the account of another person, or is acting in the name of a party to the transaction.” Consequently, it would have an impact in the City of London, as the tax would apply to any transaction involving investors based in the participating member states, even if it was executed in London.
Under the Commission’s proposal a financial transaction would be subject to FTT, even if “none of the parties to the transaction would have been “established” in a participating Member State”, but they are trading in financial instruments, such as shares, bonds and equivalent securities, money-market instruments, derivatives, issued in that Member State. Hence, due to the issuance principle, financial institutions will have to pay FTT in the participating Member State in which the issuer is located. Article 4 of the draft proposal, specifies that a financial institution or a natural person would not be deemed to be established in the territory of a participating Member State, if those liable for payment of FTT are able to prove that there is no link between the economic substance of the transaction and the territory of any participating Member State. Consequently, they would be liable to pay FTT if they are deemed established within a participating Member State because there is a link between the transaction and the territory of any participating Member State. Hence, under the enhanced cooperation proposal the FTT would apply to financial products, even if they are traded outside the FTT area or outside the EU, but they are issued from the participating countries, in order to prevent relocation from the participating member states to other financial centres.
It is therefore clear that enhanced cooperation on FTT does not respect the rights of non-participating Member States. No participating member states would be affected by the enhanced cooperation on the FTT. The extra-territorial elements of the Commission’s proposal would impinge on the sovereignty of the non-participating Member States.
The Commission proposal has also raised concerns of double taxation, as traders outside the FTT jurisdiction would be liable to pay the tax. Thus, if an UK trader trades with a financial institution in one of the participating member states it would be liable by the UK's stamp duty and the FTT.
Moreover, according to The Financial Times, a coalition of US business groups has sent a letter to the European Commission complaining about "the unilateral imposition of a global financial transaction tax". According to the group, "These novel and unilateral theories of tax jurisdiction are both unprecedented and inconsistent with existing norms of international tax law and long-standing treaty commitments". In fact, it is possible to argue the proposed issuance principle does not comply with international tax law principles.
The extra-territorial elements of the Commission’s proposal would have as effect extending the taxing jurisdiction of the participating Member States over entities established outside their territories. It is particularly forbidden under international law requiring a financial institutions established outside the territory of any participating Member State to collect and pay, for the account of a given participating Member State, the FTT due.
The UK couldn’t block the use of enhanced cooperation, but it could challenge it before the ECJ. Thus, last April, the UK has lodged an application at the European Court of Justice for the annulment of the Council’s decision authorising enhanced cooperation for an FTT(Case C-209/13).
The Government believes the FTT represents a breach of the EU treaty, as the requirements for the enhanced cooperation procedure has not been properly fulfilled, particularly taking into account that such tax would also have an impact on non participating member states. It has focused the challenge on the extraterritorial elements of the tax. It is particularly concerned over the proposed "deemed establishment rule" whereby financial institutions in non-participating Member States would be considered to be established in the FTT are when trading with counterparties based in the FTT area. The Government is challenging the Council Decision 2013/52/EU (the Authorising Decision)
on the ground that it breaches Article 327 TFEU, since “it authorises the adoption of a financial transaction tax ("FTT") with extraterritorial effects which will fail to respect the competences, rights and obligations of the Non-Participating States.” The Government has stressed, “the proposal's wide extraterritorial effects mean that the Authorising Decision has authorised a FTT which would interfere with the ability of non-participating member states to decide that parties or transactions on their territory should not be subject to the FTT.” The Government is also arguing that there is no justification in customary international law for the adoption of a FTT with extraterritorial effects consequently the Council Decision is unlawful because it authorises its adoption. Article 332 TFEU that specifically states “Expenditure resulting from implementation of enhanced cooperation, other than administrative costs entailed for the institutions, shall be borne by the participating Member States, unless all members of the Council, acting unanimously after consulting the European Parliament, decide otherwise.” The Government noted that “implementation of the enhanced cooperation FTT will inevitably entail costs for non-participating states under Council Directive 2010/24/EU concerning mutual assistance for the recovery of claims relating to taxes, duties and other measures and Council Directive 2011/16/EU on administrative cooperation in the field of taxation." Hence, the Government is also challenging the Council Decision on the ground that is contrary to this provision, as the implementation of the FTT “will inevitably cause costs to be incurred by the Non-Participating States.”
According to the European Commission the proposal is " legally sound” and "It is fully in line with international law and the principles of the single market. Transactions will only be taxed if there is an established economic link to the FTT-zone, in a way that is fully compatible with the principles of cross-border taxation." However, following an opinion from the EU Council Legal Service the UK’s arguments have been vindicated.
The EU Council Legal Service has recently deemed the FTT incompatible with EU law. According to the EU Legal Service’s legal opinion the Commission’s proposal for a FTT “infringes upon the taxing competences of non-participating member states” and “exceeds member states' jurisdiction for taxation under the norms of international customary law as they are understood by the Union”. It is particularly stressed that the “residence principle” would entail "the exercise of jurisdiction over entities located outside the geographical area concerned by the legislation adopted under enhanced cooperation." The EU Council Legal Service believes therefore that such proposal breaches international law and the EU treaties. In fact, they suggested that the proposal was "discriminatory and likely to lead to distortion of competition to the detriment of non-participating member states.”
Although the EU Council Legal Service’s opinion is not legally biding one could think that, at least, would create doubts over the legality of the proposal, particularly the “residence principle”. In fact, having so many parts of the proposal being considered unlawful the Commission should withdraw the proposal straight away. However, unsurprisingly, the European Commission strongly disagrees with the Council lawyers' opinion on the FTT. A spokeswoman for Algirdas Šemeta, according to Euractiv, said, “We stand firm that the proposed FTT is legally sound and fully in line with the EU Treaties and international tax law. It does not pose the risk of discrimination against any Member State – whether inside the FTT-zone or not,”. It is important to note that several member states are particularly concerned over the possible impact the tax is likely to have on their borrowing costs. The 11 member states have also different concerns over the proposal, whereas Italy believes state bonds should be excluded from the proposal, Holland wants to exclude pension funds. Despite the EU Council Legal Service’s opinion, Germany has reiterated its support for the proposal, according to the EuropeanVoice a spokeswoman for Germany's finance ministry said “This has not changed in the least,… The legal concerns must now be clarified and dispelled as quickly as possible.”
It remains to be seen whether the 11 member states will continue supporting the introduction of a FTT. The Commission will continue to push for it. According to the Euobserver, Algirdas Semeta said "The European Commission is absolutely confident in the legality of the tax we have proposed. We reject any claims that it goes against the treaties or that it compromises the single market," Moreover, he has already made it clear that the European Commision would not give up on the proposal, he pointed out, "I believe that we will present arguments to our member states for the next meeting of the council working group. So the work is in progress and I do not see any reasons to stop this work or to make some additional reflections," .
The Government is planning to continue to participate in the Council debates on the FTT in order to make sure the final text of any tax agreed by the participating Member States addresses the Government main concerns and reflects the UK’s views. However, it is important to note that although the non participating member states may participate in the discussions they have no say, as solely the member states participating in enhanced cooperation are allowed to vote. In fact, the proposal must be agreed unanimously by the participating member states. The European Parliament will be consulted, but the member states are not bound by the Parliament’s opinion.
