After a number of months in which the proposal for an EU Financial Transaction Tax (FTT) has been on hold, the meeting of the FTT Council Working Party held on 12 December provided a clear opportunity for the process to move forward. Ahead of the meeting, there had been reports in some parts of the media that a revised proposal was being prepared. Taken together with the positive ‘non paper’ of the European Commission responding to the legal opinion of the Council’s Legal Service and the German coalition agreement, some had suggested a renewed sense of momentum.
Last week’s developments
The meeting of the Council Working Party (WP) on Tax Questions – Indirect Taxation (FTT) held on 12 December was the latest in the series of negotiations between EU Member States.
On the agenda was the ‘non paper’1 produced by the Legal Service of the European Commission. This legal assessment provides a strong rebuttal to the EU Council Legal Service’s opinion issued in September. The Council Legal Service’s opinion had concluded that elements of the Proposed Directive issued by the Commission in February were unlawful.
In addition, the Lithuanian EU Presidency circulated a list of 13 technical issues for discussion ahead of the WP meeting. These included the possibility of an exemption for repo and reverse repo transactions and an exclusion for collateral transfers. The Lithuanian Presidency’s decision to circulate this list appears to have been prompted, at least in part, by the lack of a proposed compromise text from the eleven participating Member States (EU-11).
Shortly before the WP meeting, certain German media outlets had speculated that a compromise proposal from the EU Presidency was imminent. It was reported this would provide exemptions for repo transactions, government bonds, certain transactions involving pension schemes and transactions important to the ‘real economy’.
However, initial indications from the WP meeting are that profound divisions remain between the EU-11 on how to proceed. For example, Germany continues to favour a broad-based tax, while France is in favour of a narrower-scope tax more closely modelled on the existing French FTT regime.
A challenge also remains in terms of recognising the interests of smaller Member States within the EU-11 who want to raise revenue from a FTT, and who would stand to gain the least from a narrower, issuance-based tax.
Yet another hurdle to overcome will be the need to reconcile the opposing legal positions taken by the Council and Commission Legal Services regarding the extra-territorial scope of the Proposed Directive.
How did we get here?
These latest developments follow several months of uncertainty since the release of the latest Proposed Directive by the Commission in February this year. The Proposed Directive was issued following the authorisation granted by the ECOFIN Council for the EU-11 to proceed with the introduction of an EU FTT under the Enhanced Cooperation Procedure (ECP).
The Proposed Directive is very broad in scope, with extra-territorial application. Notably, it includes two principles under which financial institutions outside of the EU-11 (including those in non-EU countries) could come within the scope of the tax: when transacting with an EU-11 counterparty (the “counterparty principle”), or when transacting in instruments issued in the EU-11 (“the issuance principle”).
The debate on the introduction of the EU FTT has continued to be highly polarised, with a significant volume of analysis and research produced on the potential impact of the Proposed Directive2.
What happens next?
It is evident that Germany will be a key player in terms of addressing the divisions between the Member States.
The introduction of an EU FTT is a stated condition of the German coalition agreement. Now that the Social Democratic Party (SPD) members voted in favour of the coalition agreement with the Christian Democrats (CDU / CSU), we expect renewed leadership from Germany in driving the ECP process forward.
Given the need to balance all of the competing interests, there will almost certainly need to be changes to the scope of the proposed Directive in order for progress to be made. As such, a compromise text for the EU-11 will need to be released, and Germany may try to get additional EU Member States to join the ECP. The factors identified by the Lithuanian Presidency were intended to drive that compromise text, but ultimately it will probably have to come from the EU-11 themselves in order to gain real traction.
One possible route for accelerating the introduction of a FTT may be a phased approach (i.e., introducing a narrower regime which is later expanded). It is therefore possible that this type of approach may become more attractive politically in light of the continuing lack of consensus among the EU-11.
As part of this debate, it will also be necessary for the EU-11 to factor in the threat of future legal challenges as soon as the Directive is adopted, which would probably be less likely if a simple issuance tax were to be adopted.
Timing of next steps
Given the developments over the weeks preceding the latest WP meeting, a revised proposal in early 2014 was looking increasingly likely. However, this now seems ambitious, and a potential timeframe of May or June 2014 appears more realistic.
This is further evidence of the difficulties of passing law under the ECP, and may explain the recent statement by the German Finance Minister that FTT revenues will be included in Germany’s budget for 2016.
If, under renewed German leadership, a breakthrough can be found, perhaps in the form of a phased approach, implementation could still occur in a relatively short timeframe. A start date of 1 January 2015 can therefore still not be ruled out entirely at this stage.
In this regard, it is worth noting that the Commission is continuing to work on the practical details relating to the collection mechanism for the EU FTT.
Legal status of the proposal
In response to the Council Legal Service’s opinion, the non paper prepared by the Commission’s Legal Services concludes that the counterparty principle is not in breach of international or EU law.
The Commission opinion provides a very firm rebuttal to all three of the key arguments put forward in the opinion of the Council Legal Service3.
The discussion in the Commission Legal Services non paper mainly centres around the correct application of international customary law, and whether territories can be in breach of this if another jurisdiction has a more relevant taxing right over a transaction.
The contradiction between the two legal assessments, both from EU bodies, underlines the complexity surrounding the interaction between customary international law and EU primary law in the context of territorial scope of taxation, especially in the context of ECP. We understand that due to the strong push-back from the Commission, the EU-11 may simply choose to ignore the legal opinion from the Council Legal Service.
Furthermore, the Council and Commission legal assessments have only focused on the counterparty principle. However, a recent opinion of the German Bundestag suggests that the issuance principle may also breach international customary law in certain circumstances.
In this context, it is worth noting that the German banking federations have raised concerns with respect to the (issuance-based) French and Italian FTTs with the European Commission. It remains to be seen whether this will have any bearing on the political process for the agreement of an EU FTT.
Reaction of the non EU-11 Member States
The UK continues to be involved in the process as one of the 28 Member States, as there is no defined EU institutional framework for the ECP. The timing of its legal challenge against the ECP, launched in April 2013, remains uncertain.
The need for the UK’s continuing involvement was reinforced by a report published on 10 December by the UK’s House of Lords EU Committee which also warns against the “significant detrimental effect” of an EU FTT4.
Other EU countries may join the EU-11 if there is sufficient scaling back of the scope. For example, the Netherlands has expressed an interest in joining the ECP if an exemption for pension funds is included.
Beyond the EU FTT, there continue to be developments with the domestic FTTs.
Italian media outlets have reported this week that a proposal for a substantial amendment to the Italian FTT could be presented to the Italian Parliament. The reported amendments would dramatically widen the scope of Italian FTT by bringing bonds and all derivatives into scope, removing netting, and by repealing exemptions for intra-group transactions and pension funds. These changes could be seen as representing an attempt to align the existing regime with the EU FTT Proposed Directive, and may provide an indication of the direction of travel for the revised draft of the Directive in due course.
What should FS institutions be doing now?
Recent developments have suggested increased momentum behind the introduction of a FTT. However, the WP has made it clear that there are still significant differences of opinion among the EU-11. The role of Germany remains critical, and only with their renewed leadership can real progress be expected in early 2014.
Therefore, it will be important for financial institutions to closely monitor the developments over the coming weeks and months. In view of the possibility of a swift implementation in the event of a phased approach, it will also be important for financial institutions to remain agile.
In the meantime, financial institutions are advised to use the additional time up to the introduction of the FTT most effectively. In practice, this is likely to involve revisiting the systems that were implemented in respect of French and Italian FTTs to determine whether they remain fit for purpose and assessing whether any lessons can be learned from these for the implementation of EU FTT.
Separately, the degree of uncertainty around the legal position is causing a number of institutions to rethink whether the issuance-based regimes implemented by France and Italy comply with EU and international law. This position is also likely to evolve over the coming months.