EUFTT: the tax that is dividing a union

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    EUFTT: the tax that is dividing a union

    The European Union Financial Transaction Tax (EUFTT) is one of the most talked about regulations in the last couple of years. Despite the controversy, it will likely be imposed on almost all financial transactions by early next yearóif not in late 2014. In this article, Ajay Mathur and Thomas Zimmermann provide an overview of the current state of the discussion around the EUFTT and highlight some key concepts of the proposed legislation. They also address the challenges financial institutions may face during implementation and important next steps firms should take to prepare for the EUFTT. Some attention will also be given to two principles of the EUFTT—the Principle of Establishment and the Principle of Issuance—and their extra-territorial application. Both are distinctively more intricate than the existing national FTT tax legislations.

    Introducing the EUFTT

    Legislation that could be in effect by early 2015, the EUFTT will levy a tax on financial transactions involving “securities trading, derivatives and financial-market bets” if, as a general rule, one of the members of the transaction resides in one of the participating member states.1 The main objectives that the European Union (EU) wants to achieve with the EUFTT include:

    • Harmonizing the legislation on indirect taxation
    • Preventing the fragmentation of the single market as a result of uncoordinated national approaches
    • Achieving fair and substantial contribution of the financial sector to public finances and covering the cost of the recent financial crisis

    The EUFTT would also discourage certain financial transactions, e.g., high-frequency trading, that do not contribute to the efficiency of financial markets or to the real economy.

    Status of the European Union Financial Transaction Tax

    In September 2011, the European Commission (EC) first introduced the concept of a harmonized EUFTT, which was supposed to go into effect on January 1, 2014.2 However, since its original inception as an EU-wide FTT, no unanimous agreement could be reached by all member states. Out of 27 countries, only 11 EU countries (EU-11)3 are currently supporting the EUFTT under the Enhanced Cooperation Procedure (ECP). This subgroup requested that the EC introduce a common system of FTT based on the original proposal.

    After the meeting of the EC FTT Council Working Party (WP) in December 2013, the previously stalled negotiations on the EUFTT proposal gained new momentum. Another strong impetus is that the newly elected German government has clearly stated in its coalition accord that it is in favor of EUFTT as part of strengthened cooperation within the EU.4

    Moving forward, there are some substantial issues involving the tax base, the type of transactions in scope (e.g., Germany supports the inclusion of Foreign Exchange transactions) caveats to be considered, legal concerns (extra-territorial aspects) and the ongoing effort to convince other member states to join the ECP group. At this point, itís difficult to know how it will unfold and itís possible that some of the EUFTT objectives will need to change to accommodate the needs of all parties involved.

    Because of these issues, it’s very unlikely that the EC will revise the EUFTT proposal before mid-2014. And, the next step could include a phased approach to rolling out the EUFTT tax regime, as was recently publicly expressed by the Commissioner Algirdas Semeta.5 Germany is now teaming up with France to possibly advance a gradual introduction and to take a first step with the EUFTT before the European elections in May 2014.6

    Figure 1 shows the major milestones of the evolution of the EUFTT and also the past milestones for the national FTTs.

    Figure 1

    Scope and Key Concepts of the EUFTT

    When drafting the proposal, the EC made sure that the EUFTT would cover all markets (regulated and over-the-counter), most of the financial instruments, and almost all market participants. The proposal aims to capture an extensive number of financial instruments and transactions, including:

    • All securities (equity and debt)
    • All derivatives (also derivatives contracts based on currency transactions)7
    • Repos, stock lending
    • All types of fund units
    • Money market instruments
    • Structured products
    • Swaps
    • Possibly collateral

    A number of transactions are excluded, mainly loans, spot FX transactions,8 spot commodities, new issues and transactions with the European Central Bank, Central Counterparties (CCP) and Central Securities Depositories (CSD). Private households, small- and medium-sized enterprises, public borrowing and ìconservativeî pension funds shall be ring-fenced.

    The tax rate will be 0.1% of the market price for securities trading (shares and bonds) and 0.01% of the notional for derivatives agreements (calculation of notional varies based on the product). For example, a €10 million IR swap would lead to €1,000 of taxes for each counterparty involved.

    Both financial institutions involved in the transaction are accountable for paying the FTT. The directive will apply to a wide range of entities, including:

    • Investment firms
    • Organized markets
    • Credit institutions
    • Insurance and reinsurance undertakings
    • Collective investment undertakings
    • Special purpose vehicles (SPVs)
    • Pension and retail funds

    The tax might also apply to corporate treasury entities if they bypass a certain threshold.

    To determine whether a financial institution is subject to taxation, the current working version of the directive is structured around two key principles—the “Principle of Establishment” and the “Principle of Issuance.”

    • The Principle of Establishment states that a financial institution is subject to taxation if it is established or deemed to be established in one of the eleven participating member states
    • The Principle of Issuance states that transactions in an in-scope financial instrument with the underlying issued in the EUFTT jurisdiction will be taxable

    The Extra-Territorial Application of the EUFTT refers to the fact that financial institutions outside of the EU could be imposed with the tax by entering into a transaction with a financial institution that is established in the participating member state. This becomes effective by the “counterparty principle” whereby if at least one of the involved parties is established in one of the participating member states, every such transaction is taxable. Secondly, the issuance principle9 also applies in cases where, regardless of the participants’ geography, the transactions are taxable if the underlying is issued in the participating states.

    These are significant extensions to the country-specific FTT legislations in France and Italy that were focused solely on the issuance principle, regularly providing a revised list of securities from which the FTT is collected. In expanding the scope through these principles, the EC is trying to discourage businesses from relocating. It is worth noting that under the existing national legislation only the purchase transactions are taxed.

    Figure 2

    Impact Analysis

    The expected timeline for the disclosure and transfer into national legislation of the EU-11 member states is giving financial institutions more time to consider building a strategic solution for the EUFTT. Even though the tax calculation on financial products is straightforward, the end-to-end flow brings distinct implementation challenges. Firms’ tax infrastructures should be able to identify the products liable for taxation, calculate the tax, have correct accounting and payment structures and report the tax to the authorities. Firms should use the additional time given before the EUFTT comes into force to revisit the processes and systems that were implemented to address the French and Italian FTTs.

    Previous experiences in FTT implementations and the current definitions given in the proposal for the EUFTT suggest that it will impact many functional and technical units within firms, namely trading, sales, operations, process management, tax and legal departments, Know Your Customer (KYC), static data, IT, accounting and client communication. Figure 2 shows a sample of activities and topics covered by the different (business) functions.

    Given the current level of knowledge, it is difficult to predict the final, detailed design of the EUFTT at this stage. But assuming that the EUFTT will pose bigger challenges to the operations teams than to the tax experts and that it will have a very significant impact on almost all trading activities, firms should initially look at some selected aspects of the legislation and develop a strategic plan. This analysis should cover three distinct areas with the goals to identify the scope and develop a road map for further activities:

    At the outset, the business impact on trading activities should be evaluated.

    • Assuming current trading activities and trading volumes in the EU-11 countries, what is the expected tax liability on the basis of the currently proposed legislation?
    • What is the anticipated revenue impact and shift in business activity of the organization?
    • How does this influence existing client relationships and the business model (e.g., will front-office desks have to revisit their trading strategies)?

    Secondly, firms should scrutinize their current process landscape and systems architecture by doing the following:

    • Derive a high-level heat map of potential needs to meet projected future activity.
    • Define the potential risks and drivers of complexity in a future implementation project.

    Thirdly, firms should create a list of pain points with respect to the current legislative proposal that will likely be the most threatening in terms of potential impact or because they are the least clearly defined—”the known unknowns.” Compiling these lists can help firms identify weak or problematic areas of legislation and provide the backup they need to lobby industry associations to have them modified or removed.

    Figure 3

    How will the EUFTT Change Business and Operational Models?

    When trying to identify the pain points and “known unknowns,” a thorough understanding of the current characteristics of the EUFTT legislation is critical. The following section provides an adjustable prototype project and operational model in Figure 3. Plus, it includes a few examples that highlight the possible impacts of the proposed EUFTT.

    The prototype project and operational model can be used when digging into the EUFTT details. Ideally, the information gathered should be directly linked to the relevant project group/business function and the affected processing flow in the organization as shown in Figure 3.

    In order to get acquainted with some of the principles of the EUFTT described above, the following examples shed some light on the intricacies of their implementation.

    The Principle of Establishment 

    The following two basic transactions illustrate the Principle of Establishment:10

    1. A Danish bank (non EU-11) sells a stock issued in Denmark to a German bank (EU-11 establishment):
    • Due to the residence principle and the fact that the German Bank is an EU-11 member state, the Danish bank is considered to be established in Germany
    • The tax amount is to be paid by both parties to the German authority
    • In this case, it doesnít matter whether the stock is issued in Germany or Denmark

    2. Corporation X, based in Estonia (EU-11), manages the assets of its shareholders, who live in Estonia. Corporation X purchases Finnish government bonds at the price of €500,000 from Bank A in Finland (non EU-11):

    • Both parties (X and A) are assumed to be financial institutions and are both liable to pay FTT in Estonia
    • This is due to the principle of establishment, and specifically the counterparty principle, where the tax is applied irrespective of the location of the issuer of the traded product

    The Principle of Issuance

    The following are two examples that illustrate the Principle of Issuance and extra-territorial application:

    1. A Danish bank sells over the counter (OTC) a stock issued in Germany (EU-11) to a Polish bank, both non-EU-11 financial institutions:
    • This transaction would be liable to FTT paid to the German authorities because the financial product traded has been issued in Germany
    • Alteration: The counterparties are two US banks (non-EU) trading a stock issued in one of the EU-11 member statesóeither OTC or over a trading venue outside of the EU-11. The same transaction is also taxable

    2. A UK investment fund enters into an OTC contract for difference (CFD) with a UK bank using a French equity as the underlying reference security. The transaction is not hedged with the underlying equity:

    • This transaction is not taxable because no financial institution was deemed to be established in an EU-11 country
    • If the same transaction were to be hedged with the French equity, it becomes taxable

    These examples illustrate that there are a number of considerations and challenges, including the following:

    • A clear categorization is required for clients in financial/non-financial institutions
    • Decision support is required during pre-trade activities to evaluate the tax impact
    • A review of the type of cross-border business is required
    • Brokers might have to consider a principle-agent approach to change their business model
    • Market-making activities are not tax exempt as they are in the French and Italian FTTs
    • Intraday trade netting is not allowed
    • There may be missing implementation rules (like uniform methods of tax collection and payment, possibly via Central Securities Depositories (CSD), accounting and reporting obligations)


    Most financial institutions that will be impacted by the EUFTT have already implemented French and Italian taxes to some extent. Even though the European version of the tax will require additional analysis and implementation effort, the experience with nationalized versions will help firms assess the challenges beforehand and develop an implementation project plan that addresses the impacted processes.

    The EUFTT could potentially have a huge impact on trading volumes, market liquidity, trading strategy and subsequently the business model of many financial services firms. In fact, the EC estimates a 75% drop in derivatives and financial bets when modelling the expected market reaction.11 The proposed extension to the FX business will most likely have a huge impact on margins and trade volume.12 The EC itself is estimating a tax amount of about €31 billion per year.13

    Besides the tax levy, the EUFTT will also create many associated indirect costs. And despite the best efforts of the EC to prevent tax avoidance through relocation, it remains to be seen whether the EUFTT will trigger a massive transfer of financial firms to other jurisdictions.

    References from article EUFTT: the tax that is dividing a union:

    1. European Commission, “Implementing “enhanced cooperation” in the area of Financial Transaction Tax,” February 14, 2013
    2. European Commission, “Proposal for a Council Directive implementing enhanced cooperation in the area of financial transaction tax,” February 14, 2013, p. 2
    3. ECP (EU-11) countries: France, Germany, Italy, Portugal, Belgium, Austria, Spain, Estonia, Slovakia, Greece and Slovenia
    4. Coalition Accord, “Deutschlands Zukunft gestalten; Koalitionsvertrag zwischen CDU, CSU und SPD — 18. Legislaturperiode,” December 2013, p. 64
    5. European Commission, “Financial Transaction Tax: Time to engage, compromise and deliver Financial Transaction Tax,” Algirdas Semeta, SPEECH/14/92 – 04/02/2014 — EC press release, Strasbourg, February 4, 2014
    6. R. Buergin/B. Parkin: “Merkel Coalition Signals Retreat on Broad Financial-Market Tax,” Bloomberg, February 3, 2014. See also: French, German ministers want progress on FTT by May,, April 7, 2014 and “Finanztransaktionssteuer bald da,” April 8, 2014,
    7. European Commission, “Proposal for a Council Directive implementing enhanced cooperation in the area of financial transaction tax,” February 14, 2013, Article 2 1.(3), p. 20, reference to MiFID (European Parliament and European Council: Directive 2004/39/EC of the European Parliament and of the Council, April 21, 2004, on markets in financial instruments), Annex I, Section C, 5
    8. European Commission: “Proposal for a Council Directive implementing enhanced cooperation in the area of financial transaction tax,” February 14, 2013, Chapter 3.3.2, p. 9
    9. European Commission, “Proposal for a Council Directive implementing enhanced cooperation in the area of financial transaction tax,” February 14, 2013, Chapter 1.3, p. 5
    10. European Commission, “How the FTT works in specific cases and other questions and answers,” other_taxes/
    11. European Commission, “Implementing enhanced cooperation in the area of Financial Transaction Tax – Features, impacts, illustrations,” February 13, 2013, p. 15
    12. GFMA, J. White/A. De Souza, “EU’s Financial Transaction Tax risks damaging international trade and investment through increases in the costs of foreign exchange transactions,” July 7, 2013, p. 1
    13. European Commission, “Proposal for a Council Directive implementing enhanced cooperation in the area of financial transaction tax,” February 14, 2013, Article 2 1.(3), p. 14
    The Authors
    Ajay Mathur

    Ajay Mathur 
    is a Manager of Business Consulting based in the London office. He has a wealth of experience in capital markets ranging from middle-office operations, clearing and collateral to trade life cycle management. In Sapient Global Markets, he has worked with tier one investment banks and brokerage houses undertaking business analysis, current state development and change management for various regulatory projects including EMIR, Dodd-Frank and FTT.

    Thomas Zimmermann

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