Margarida Vasconcelos: The Government is absolutely right in challenging the decision authorising enhanced cooperation for the FTT

Following the UK and other Member States veto of the Commission’s draft directive introducing a financial transaction tax (FTT) in the EU, the Economic and Financial Affairs Council has decided to proceed through enhanced cooperation. The UK is home to Europe’s biggest financial centre, such tax was, therefore, considered an attack on the City of London. However, the damaging proposal for a EU-wide financial transaction has not been completely ditched. Despite the veto and despite the non-participation in the enhanced cooperation, the UK will still be affected by such tax. Hence, the recent Government’s decision to challenge the FTT before the ECJ is welcome.

There is widespread opinion that the FTT won’t stabilise the markets and it would undermine economic growth. It is important to recall that according to the Commission’s initial impact assessment a “0.1%, a transaction tax on securities could, without the application of mitigating effects, reduce future GDP growth in the long run by 1.76% of GDP and of 0.17% at a rate of 0.01". The Commission has revised its impact assessment, but it is now crystal clear, 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.” 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. They noted, that “the cost of funds would be higher for participating Member States as all transactions would be FTT-liable regardless of the residence of the counterparties to a transaction (due to the issuance principle).”

Nevertheless, a group of 11 EU Member States, Belgium, Germany, Estonia, Greece, Spain, France, Italy, Austria, Portugal, Slovenia and Slovakia have decided to go ahead with enhanced cooperation to by-pass the veto of other Member States in order to put in place a financial transaction tax. The European Parliament gave its consent last December and the Council gave the green light for enhanced cooperation in January 2013. It is important to recall that authorisation to establish enhanced cooperation must be agreed by the Council, acting by a qualified majority on the Commission’s proposal and after the European Parliament’s consent. Hence, the UK was not able to veto it, but the Government abstained, as there was no guarantee that the proposal would respect the competences of non-participating Member States.

Last February, the European Commission put forward a legislative proposal defining the substance of the enhanced cooperation. The draft proposal for a Council Directive implementing enhanced cooperation in the area of financial transaction tax will apply to the abovementioned 11 EU Member States, other member states may decide later to participate. This present proposal is very similar to the Commission’s original proposal, as the scope and objectives are the same. 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.” As the original proposal, the present draft directive is intended to “ensure a fairer contribution to public finances from the financial sector” and “reduce the fragmentation of the Single Market.” The European Commission has stressed, “that enhanced cooperation on FTT would contribute to a stronger Single Market, with less barriers and competitive distortions”.

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”.

Greg Clark, Financial Secretary to the Treasury, said to the European Scrutiny Committee that the European Commission has presented an impact assessment but “it gives only very limited detail on how the proposal would impact on non-participating Member States;” He particularly noted, that there is no details “on either the contribution to the tax take that the Commission expects from individual non-participating Member States, nor an assessment of the economic impacts on non-participatings” and there is “no assessment of the impacts the FTT would have on the existing tax base of non-participatings;” 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.

The Commission proposal will harmonise the participating Member States’ taxes on financial transactions. It will apply to “financial institutions operating financial transactions”. Under the Commission proposal the scope of the tax would be broad, because it would cover transactions relating to all types of financial instruments. As under its original proposal, the Commission has proposed “minimum tax rates”. The exchange of shares and bonds would be taxed at 0.1 per cent whilst derivative contracts taxed at a rate of 0.01%. The participating Member States would not be, therefore, allowed to maintain or introduce taxes on financial transactions other than the FTT or VAT.

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 European Parliament has kept the "residence principle" proposed by the Commission, but it added an issuance principle, which would extend the scope of the proposal to transactions involving financial instruments issued in the EU.

The European Commission has taken on board the European Parliament’s suggestion, as it introduced the “issuance principle” to the present proposal. The Commission proposed that 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.” Hence, as the Algirdas Semeta said "the tax will be due if any party to the transaction is established in a participating Member State, regardless of where the transaction takes place”. 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.

As above-mentioned, 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, as “it will be less advantageous to relocate activities and establishments outside the FTT jurisdictions, since trading in the financial instruments subject to taxation under the latter principle and issued in the FTT jurisdictions will be taxable anyway.” 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.

The Commission also noted that by complementing the residence principle with the issuance principle would also supplement the tax revenues. According to the European Commission this “could assist participating Member States in fighting evasion and relocation and catch another significant portion (about 10%) of financial transactions in shares issued by EU11 entities and of transactions in debt securities issued by EU11 entities (not captured by using the residence principle)., which would yield as revenues EUR 0.39 bn. from taxing shares and 0.83 bn. from taxing bonds and bills”.

According to the House of Lords EU Economic and Financial Affairs Sub-Committee the UK would be required to collect the FTT. The Committee, despite the European Commission denial, believes the UK would be under legal obligation to collect the tax. The Committee also noted that the Commission’s proposal "does not respect the competences, rights and obligations of those Member States which do not participate in it”.

The extra-territorial elements of the Commission’s proposal would impinge on the sovereignty of the non-participating Member States. Obviously, London as well as Amsterdam and Luxemburg, being important financial centres, are concerned that certain activities would be subject to the FTT. In fact, as the Commission has stressed “transactions involving financial institutions deemed to be established in the FTT jurisdiction would be taxable, independent of whether they were carried out in Frankfurt, London, New York or Zurich.” By using both residence and issuance principles it would have as effect making additional transactions taxable. Thus, one could say that enhanced cooperation on FTT does not respect the rights of non-participating Member States. Non participating member state would be affected by the enhanced cooperation on the FTT.

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. In fact, the European Commission has conceded that a common system of FTT at the level of EU11+ is not as “effective as the same policy implemented at the level of EU27” as “it will not be possible to avoid all incidents of double taxation within the entire EU27”.

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". The Telegraph also reported that international trade bodies have urged the G20 finance ministers to oppose the EU financial transaction tax. They noted, the FTT would have “unprecedented extraterritorial impacts, contrary to G20 principles”. 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.

If the above-mentioned criteria are not complied with the use of enhanced cooperation could be challenged at the ECJ. The UK couldn’t block the use of enhanced cooperation, but it could challenge it before the ECJ. The FTT proposal does not respect the UK’s jurisdiction over its own tax system, and violates Article 327. The Government had no option but to challenge it.

Thus, 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. A Treasury spokesman said,
"While we will not participate in a Europe-only tax, we have also said we will not stand in the way of other countries, but only if the rights of countries not taking part are respected.” However, "The proposal currently on the table from the European Commission does not meet these requirements, which is why we have lodged the legal challenge." The Financial Secretary to the Treasury, Greg Clark explained to the European Scrutiny Committee that the Government has decided to take this step because “there is a risk that, in the event that it needs to challenge the Directive that would implement the FTT, currently under negotiation, the case could be rejected by the Court as being too late.”

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. The Government believes that the current proposal “would infringe the rights and competences of non-participating Member States and would depart from accepted international tax norms;” 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. According to the Government such provision is “likely to breach Article 327 TFEU (concerning respect for the competences of Member States not engaged in enhanced cooperation) and to be in conflict with international tax law and customary international law.” The Government is also challenging the draft directive on the ground that the UK tax authorities could be obliged to collect the FTT, which is a breach of 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.”

It is important to recall that there has been already a legal challenge of a Council decision authorising enhanced cooperation. Spain and Italy (Cases C-274/11 and C-295/11) brought legal proceedings before the ECJ seeking the annulment of the authorizing decision of enhanced cooperation in the area of the EU unitary patent. Both Spain and Italy argued that enhanced cooperation was inadmissible and that the authorising decision has breached Treaty requirements for its use. They particularly argued that the authorization for enhanced cooperation violated the principle of non-discrimination, destabilized the single market and, did not respect the rights of the non-participating states. The ECJ has recently rejected both applications. These cases have not addressed any ‘extra-territorial’ effects of an enhanced cooperation measure, but it is important to mention that the ECJ as regards the alleged infringement of Article 327 TFEU, held “While it is, admittedly, essential for enhanced cooperation not to lead to the adoption of measures that might prevent the non-participating Member States from exercising their competences and rights or shouldering their obligations, it is, in contrast, permissible for those taking part in this cooperation to prescribe rules with which those non-participating States would not agree if they did take part in it.” Then, the Court stressed, “…the prescription of such rules does not render ineffective the opportunity for non-participating Member States of joining in the enhanced cooperation.”

The formal application submitted by the UK (Case C-209/13) was launch on 18 April on the basis of article 263 TFEU concerning judicial review whereby the ECJ has jurisdiction in actions brought by a Member State, the European Parliament, the Council or the Commission to review the legality of legislative acts, “on grounds of lack of competence, infringement of an essential procedural requirement, infringement of the Treaties or of any rule of law relating to their application, or misuse of powers.” It is important to note that the “proceedings provided for in this Article shall be instituted within two months of the publication of the measure, or of its notification to the plaintiff”.

It is important to stress that enhanced cooperation involves the adoption of two different acts, the authorizing decision and the substantive legislative act. The Council adopted the authorization decision last January, but the legislative act, the draft Proposal for a Council directive implementing enhanced cooperation in the area of financial transaction tax, proposed by the European Commission, is still being negotiated. The Government is challenging the authorising decision before the European Court of Justice. The Court will review whether the legal requirements for implementing the enhanced cooperation mechanism have been met, not the legality of the Commission’s proposal to implement that cooperation. The Court would address procedural issues. The Court is likely to consider that the UK’s challenge to the authorizing decision on the grounds that the substantive legal act, which is still being negotiated, breaches the treaty, by having an impact on the competences, rights and obligations of a non participating member state and it would distort competition in the internal market premature and consequently inadmissible, as the negotiations had not been concluded yet. It remains to be seen whether the ECJ would rule in the UK favour. But, the Court is unlikely to annul the Council’s decision authorising enhanced cooperation. The UK might have to launch another legal challenge against the Council Directive implementing enhanced cooperation in the area of financial transaction tax when adopted. At the moment, only Luxembourg has supported the UK in its decision to launch a legal challenge. Hence, the Luxembourg might decide to intervene in the proceedings before the ECJ.

Unsurprisingly, 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."

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. The Minister told the ESC that the Government would reconsider the legal challenge if the Council negotiations “result in a final design which addresses its concerns”. 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.

In the meantime, according to the Euobserver, civil servants in the EU Council drafted a memo which stresses that the FTT “would hit repurchase agreements on sovereign bonds, forcing up the cost of financing government debt.” It notes, it could "create an inappropriate burden on short term bonds, repo operations etc, compared to long term bonds." The 11 EU participatory member states have raised concerns over the lack of clarity about the scope, definition and collection of the tax . In fact, according to the EUobserver an EU source said: “There’s still very little clarity on the proposal and so many unanswered questions. Member states do not know how the FTT will actually work nor do they have answers about the impacts." The Commission will reply to the questions raised on 22 May. Several member states are therefore particularly concerned over the possible impact the tax is likely to have on their borrowing costs. It is important to note that 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.

It is important to recall that the inter-governmental Treaty on Stability, Co-ordination and Governance in the Economic and Monetary Union, explicitly states that “the Contracting Parties stand ready to make active use, whenever appropriate and necessary, of measures specific to those Member States whose currency is the euro as provided for in Article 136 of the Treaty on the Functioning of the European Union and of enhanced cooperation as provided for in Article 20 of the Treaty on European Union and in Articles 326 to 334 of the Treaty on the Functioning of the European Union on matters that are essential for the smooth functioning of the euro area, without undermining the internal market.” There is therefore an explicit reference to the possibility of using the general rules on enhanced cooperation within the current EU Treaties, to adopt EU measures that will apply solely to the member states that participate in this treaty, which was vetoed by David Cameron. According to the written evidence given to the European Scrutiny Committee from Professor Michael Dougan and Dr Michael Gordon “If put seriously into practice, increased recourse to enhanced cooperation on matters essential to the smooth functioning of the single currency could imply the emergence of a bifurcated Union in all manner of fields related to economic policy – not only the regulation of specific sectors or markets, but also employment protection, consumer rights, taxation and social security.” Hence, it is not enough to have a provision stipulating, "without undermining the internal market", as it will have an impact on the internal market.

It is well known the eurozone member states can use their voting power at EU level, and they will also have the support of the non-eurozone contracting parties to this treaty, to force through measures in detriment of the UK’s national interest. They will vote together outvoting the UK. There is a EU’s ‘power grab’ over regulation of the British financial services industry. There has been a shift of financial regulation from the UK to the EU, and bit-by-bit EU regulation would be taken over from national regulation, and this would be irreversible. The situation will exacerbate with the creation of a banking union. The chances of the UK being able to influence EU’s policies and legislation would be even more limited not only because of the QMV but also because of “solidarity” among eurozone member states, which would vote as a block outvoting the UK in matters of national interest. Once a banking union is in place, the Commission, under the single market umbrella, will propose banking and financial regulations, for all EU member states. The eurozone member states, as well as other member states participating in the banking union, will vote as a block, imposing further regulations on the City of London. The UK would see itself in the position of having no choice but to accept legislation without having the chance of negotiate it.

It is important to recall that taxation is one of the very few areas where unanimity is required, under the Lisbon Treaty. Consequently, the UK government can, in fact, veto proposals in this area. The Government has vetoed the FTT nevertheless it is going through enhanced cooperation and it would have a damaging impact in the UK. The UK does not participate but this would not prevent the tax being collected from financial institutions in the UK. Although the tax authorities of participating Member States are not allowed to impose a tax directly on non participating Member States’ firms they are allowed, under the EU Mutual Assistance Directive, to required HMRC to collect the FTT for them. Hence, the proposal entails costs to HMRC and British companies.
This clearly shows how the UK would be subject to damaging proposals even if it does not join in, consequently the Government ability to protect national interest would be been increasingly restricted.

These issues can only be addressed by renegotiating all the EU Treaties and the whole relationship with the EU, and give people a say in a referendum. Hence, as soon as David Cameron renegotiates the whole UK relationship with the EU the better. In fact, as Bill Cash has been saying, “we need a referendum, and ahead of the European elections in 2014….”to save Britain and British business.