Documents considered by the Committee on 26 October 2011 - European Scrutiny Committee Contents


4 Taxation: a financial transaction tax

(33179)

14942/11

+ ADDs 1-20

COM(11) 594

Draft Directive on a common system of financial transaction tax and amending Directive 2008/7/EC

Legal baseArticle 113 TFEU; consultation; unanimity
Document originated28 September 2011
Deposited in Parliament30 September 2011
DepartmentHM Treasury
Basis of considerationEM of 12 October 2011
Previous Committee ReportNone
To be discussed in CouncilNot known
Committee's assessmentLegally and politically important
Committee's decisionNot cleared; further information requested

Background

4.1 In October 2010 the Commission presented a Communication, Taxation of the financial sector, in which it discussed the possibility of a financial transaction tax (FTT) or a financial activities tax (FAT) for the EU. It concluded that:

  • an FTT could be an appropriate option as a revenue raiser if applied globally, whereas there were significant avoidance and competitive risks for an EU only FTT;
  • an FAT, in its most extensive form, could be interpreted as a tax on a proxy for total value added generated by financial sector companies; and
  • there was potential for an FAT in the EU context.[3]

4.2 In February 2011 the Commission opened a public consultation on an FTT and the Government responded to this on 19 May 2011.

4.3 In June 2011 the Commission presented its proposals for the Multiannual Financial Framework for 2014-2020. These included the idea of a FTT as a new resource to finance the EU Budget.[4]

The document

4.4 This draft Directive would introduce a FTT. The Commission says that the objective of the proposal is to:

  • avoid fragmentation in the single market for financial services, in the context of the increasing number of uncoordinated national tax measures in place;
  • ensure that the financial services sector makes a fair contribution to covering the costs of the recent crisis and to ensure a level playing field with other sectors from a taxation perspective; and
  • create appropriate disincentives for transactions that do not enhance efficiency of the financial markets and complement regulatory measures aimed at avoiding future crises.

The Commission adds that the proposal also has the aims of:

  • opening up a new revenue stream to gradually displace an element of current national contributions to the EU Budget, as suggested in its proposals for the Multiannual Financial Framework for 2014-2020; and
  • contributing to the international debate over how a FTT could be effectively designed and implemented.

The Commission suggests that a FTT could raise €57 (£49) billion per year.

4.5 The main provisions of the draft Directive are that it would:

  • apply to a very broad range of financial instruments, consistent with the definitions contained in the Markets in Financial Instruments Directive (secondary trading in equities and bonds, together with equity, interest rate, foreign exchange and commodity derivatives);
  • not apply to primary markets, or currency spot transactions, with the aim of ensuring that the tax would not contravene the free movement of capital;
  • not apply directly to day to day financial activities relevant for citizens and businesses, for example, mortgage lending, insurance contracts or payment services;
  • not apply to transactions with the EU, the European Atomic Energy Commission, European Central Bank, the European Investment Bank and central banks of Member States;
  • apply to a broad definition of financial institutions (including banks, insurers, asset managers, pension funds), with definitions drawn from existing Directives;
  • not apply to central counter parties, central securities depositories and international central securities depositories, when exercising such functions;
  • apply on the basis of residence — the tax would be collected directly from EU financial institutions involved in transactions of the relevant financial instruments, for example, a transaction involving a French bank would necessitate the collection of the tax from that French bank;
  • provide that a financial institution be treated as established in a Member State where it had been authorised by a Member State to act as a financial institution, had a registered seat in a Member State, its permanent address or usual residence was located in a Member State, it had a branch within that Member State or was acting on behalf of a financial institution established in a Member State;
  • apply where at least one of the parties to the transaction was established in a Member State — so the transaction itself would not have to be undertaken within the EU for the tax to apply;
  • provide that where this proposal and the Capital Duties Directive (concerning indirect taxes on the raising of capital) fall into conflict, this proposal would take precedence;
  • place the responsibility on individual Member States to collect the tax where the financial institution is established in their jurisdiction and to ensure that the tax is levied accurately to prevent evasion, avoidance and abuse; and
  • allow the Commission to adopt delegated acts to specify measures on the prevention of evasion, avoidance and abuse.

4.6 The Commission proposes that:

  • Member States would set minimum tax rates of 0.1% (10 basis points) of the value of equity and bond transactions and 0.01% (one basis point) on the notional value of derivatives transactions;
  • this tax rate would apply to all financial institution counterparties to the transaction established in the EU;
  • if, for example, a derivatives transaction took place between two EU financial institutions, this would mean that the tax rate applied to the transaction would be 0.02% (two basis points); and
  • if a derivatives transaction took place between an EU financial institution and a non-EU business the tax applied would be on the EU financial institution and, therefore 0.01% (one basis point).

The Commission suggests that the proposed rates are low enough to minimise delocalisation risks.

4.7 The draft Directive is accompanied by an impact assessment, which together with its annexes and an executive summary runs to over 1,200 pages.

The Government's view

4.8 The Financial Secretary to the Treasury (Mr Mark Hoban) reminds us that, in the context of the Multiannual Financial Framework for 2014-2020, the Government strongly opposes any new EU taxes to fund the EU Budget and opposes the Commission's proposal in this area. The Minister then comments on fundamental rights compliance and subsidiarity. On the former he says that adoption of an FTT could be challenged, notably under Article 1, Protocol 1 of the European Convention on Human Rights (peaceful enjoyment of possessions).

4.9 On subsidiarity the Minister says that:

  • the Government is concerned that the subsidiarity principle has not been applied correctly by the Commission in drafting this proposal;
  • the Commission argues that FTTs must be adopted by the EU and not on a national basis because "an EU definition is essential to avoid the relocation of transactions and market participants";
  • it argues that a uniform definition at EU level is necessary to ensure the proper functioning of the single market and to avoid distortions of competition within the EU — thus the FTT proposal satisfies the subsidiarity principle;
  • first, it is unclear why the Commission feels that an EU FTT would deliver on its stated objectives better than domestic taxes;
  • there also appears to be a contradiction in that the proposal sets minimum rates for FTTs, with the aim of avoiding relocation;
  • financial services are not confined to an EU marketplace — EU financial institutions are global concerns;
  • to introduce an EU wide tax would not avoid the relocation of transactions and market participants — only a global tax could retain a level playing field for the financial sector and retain the competitiveness of EU financial institutions;
  • imposition of the tax would also heighten the risk of relocation within the EU; and
  • for these reasons the Government believes that the proposal violates the subsidiarity principle.

4.10 The Minister introduces his remarks about the policy implications of the draft Directive by saying that:

  • the proposal has wide ranging policy implications for the UK and EU, given the broad scope of the proposed tax;
  • the UK has the largest financial sector of any EU economy; and
  • this therefore implies that the UK will face the most significant economic impacts as a consequence of the tax.

4.11 The Minister next discusses the Commission's impact assessment accompanying the proposal, saying that:

  • it assesses the impacts of the proposed tax in a range of areas and is supported by a range of annexes examining specific aspects of the tax in more detail;
  • in some cases views presented in the assessment do not seem consistent with evidence provided in the more detailed annexes;
  • the assessment does not provide an overall estimate of the impact of the tax on the financial services sector in the EU;
  • it acknowledges, however, that risk of relocation of activity is significant;
  • in calculating revenue potential of the tax the assessment assumes a 10% relocation of equity and bond markets and a 70% or 90% relocation of trading in derivatives;
  • it acknowledges that regulatory measures are likely to be more effective than an FTT in promoting financial stability and that there is no clear evidence that an FTT would reduce market volatility;
  • although the Commission's explanatory memorandum estimates revenues from the tax at €57 (£49) billion per year, the assessment gives a central estimate of €37 (£32) billion per year;
  • the difference may be due to the assessment assuming total tax rates of 0.1% for equity and bond trades and 0.01% for derivative trades, while the Commission assumes these rates apply to both sides of the transaction;
  • these revenue estimates do not take account of any reduction in other tax receipts caused by the introduction of a FTT, for example the impact on corporation tax receipts;
  • the Commission does not attempt to calculate individual Member States' contributions to revenue raised;
  • the Government, however, estimates that over 50% of revenues raised across the EU would derive from activity in the UK;
  • the UK share of revenues raised is sensitive to assumptions on the extent of relocation of derivatives markets — a lower level of relocation of derivatives market activity would increase the UK's share of total revenues raised;
  • the Commission asserts that the GDP loss associated with its FTT proposal is expected to be limited to around 0.5% in the long-run;
  • the assessment, however, does not include an assessment of the overall GDP impact of the FTT as proposed;
  • GDP figures in the assessment are derived from a model of a more limited tax applying only to equities and bonds;
  • this model is unable to capture relocation effects;
  • with a tax rate of 0.1% the model finds that EU GDP drops 1.76% in the long-run, with an accompanying drop in employment of 0.2%;
  • a tax rate of 0.2%, as implied by the Commission's explanatory memorandum, leads to a 3.43% long-run drop in EU GDP and 0.34% drop in employment;
  • these effects stem from the increase in business's cost of capital caused by the tax;
  • the assessment points out that the significant economic impact of the tax derives from the cascading effect of the tax, whereby transactions in the same production chain are taxed several times; and
  • taking these figures in turn and before taking into account relocation effects, in real economic impacts it can be estimated that a reduction of 1.76% of EU GDP equates to a fall in economic output of €216 (£186) billion, a fall in employment of 0.2% equates to a loss of 478,000 jobs, a 3.43 % fall in EU GDP equates to a fall in economic output worth €421 (£362) billion and a 0.34% fall in employment equates to a loss of 812,000 jobs.

4.12 Turning to the Government's own view, the Minister tells us that it has identified a range of issues for concern, which it is actively seeking to understand more fully and to carefully consider the implications. He outlines these for us, saying that:

  • the Commission has chosen a legal base, Article 113 TFEU, which relies upon demonstrating that this tax is necessary to ensure the continued functioning of the single market;
  • this poses particular problems if some Member States wished to progress this through enhanced cooperation;
  • the Commission proposal admits that the tax would be likely to lead to significant relocation of financial activity away from the EU, while the potential impact of the tax on activity carried out by EU institutions in other jurisdictions risks damaging the international competitiveness of the EU's financial services sector;
  • the migration of business away from London, and other EU financial centres (including Paris, Frankfurt), would also see negative impacts on the infrastructure in place to support these activities, such as legal, administration, IT and accountancy;
  • making the EU's financial sector internationally uncompetitive is inconsistent with aims for growth and job creation;
  • the Government does not believe that it is right to impose a tax which will clearly impact on economic growth across the EU, with the UK bearing a disproportionate share of this impact;
  • the impact on market volatility is difficult to confirm — there is no clear evidence that the proposal would improve market stability or that it would effectively target, for example, high volume currency derivative trading;
  • to attempt this would first require agreement on what transactions should be targeted in trying to reduce market volatility;
  • even if agreement could be reached on defining a set of efficiency undermining transactions, it would then be necessary to understand if the proposal could effectively do this, while not detrimentally impacting on transactions that do enhance the efficiency of the financial markets;
  • the Commission's proposed tax rates fail to take any such conditions into account, only that they are significant compared to typical current transaction costs in the markets concerned and in many cases would lead to transaction costs more than doubling;
  • this would not only potentially dis-incentivise transactions that do enhance efficiency of the markets, but would be likely to lead to a dramatic reduction in market liquidity, impacting on ordinary investors;
  • it is unclear whether the proposed tax would be an economically efficient way of raising revenue;
  • the impact assessment refers to a 2010 study for the European Parliament which "concludes that other taxes would be more promising as a tool for raising revenue";
  • in its report to the G20 last year, the IMF did not offer an endorsement of a FTT;
  • the tax would increase not just direct costs of trading itself but also costs related to complying with the tax, such as administrative burdens;
  • there are serious doubts about whether the proposed tax would be a sustainable source of revenue;
  • Sweden introduced a FTT in the 1980s, which led to the volume of bond trades falling by 85% and futures trades by 98%;
  • it also did not deliver a sustainable revenue stream, and in fact the revenue it did deliver was largely offset by declines in revenue from other taxes;
  • the tax would not just affect banks and bankers, but also increase costs for consumers through this tax being paid by insurers, asset managers, pension funds, industry including manufacturing and the broader service sector;
  • the Commission proposal would forbid Member States from maintaining existing national transaction taxes, such as the UK's stamp tax on shares regime;
  • abolition of this tax would deny the UK a simple, effective and sustainable revenue stream of over £3 billion per year;
  • the stamp duty differs from the EU proposal in that the UK's carefully targeted stamp tax on shares (STS) is fundamentally different from the Commission's all-encompassing and poorly designed FTT;
  • STS is efficient, enforceable and minimises impacts on market liquidity;
  • the FTT as currently proposed by the Commission is inefficient, easy to avoid through relocation and would lead to dramatic reductions in market liquidity;
  • the Government has already introduced a bank levy which reflects the risks banks pose to the financial system and the wider economy;
  • the Commission's argument that the FTT is justified to ensure financial institutions make a fair contribution to recovering the costs of the crisis takes no account of existing national measures to achieve this objective, such as the UK bank levy;
  • to the extent that the FTT would cause certain types of trading to cease to take place in the UK, this would have negative impacts on revenues from existing tax regimes, such as corporation tax and income tax; and
  • the provision that the Commission could adopt delegated acts to specify measures on prevention of evasion, avoidance, and abuse causes concern, because the Commission might seek to use this power to agree important aspects of the regime, rather than just focusing on the methods through which the draft Directive would be complied with.

4.13 Finally, the Minister summarises the Government view, saying that:

  • the proposal creates a number of areas of concern for the UK; and
  • whilst the Government is not opposed to FTTs in principle, these should only be contemplated at a global level.

Conclusion

4.14 We are clear that this proposal needs to be debated. However, we do not wish to recommend such a debate until we have an indication from the Government as to whether this proposal is being dismissed out of hand or whether the text will be discussed before the matter is voted on (at which point we presume the Government would veto the proposal, unless a similar measure had been adopted globally).

4.15 We take this opportunity, however, to ask the Minister about the legal base of the proposal. The case law of the Court of Justice of the EU makes plain that the choice of legal base for an EU measure must rest on objective factors, which include the aim and content of the measure, to enable judicial review by the Court.[5] In addition, the Court has held that the legal base must enable a determination of whether the EU is competent to act, consistent with the principle of conferral of powers under Article 5(2) TEU.[6] However, it is only the predominant legal base that should be cited: where a measure has a twofold purpose but one is predominant and the other merely incidental, the measure must have a single legal base, corresponding to "the predominant aim or component".[7] Exceptionally, where a measure "pursues a number of objectives, or has several components", which are closely linked but none of which is secondary to the other, more than one legal base will have to be cited, unless the legislative procedures for each legal base are incompatible.[8]

4.16 With these rules in mind, in terms of the aim of the proposal we note that the first recital says that it "stems from the desire to ensure the financial sector contribute to covering the costs of the crisis and that it is taxed in a fair way vis-à-vis other sectors for the future; to dis-incentivise excessively risky activities by financial institutions; to complement regulatory measures aimed at avoiding future crises and to generate additional revenue for general budgets or specific policy purposes" — four aims in all, but none referring to the internal market. The second recital does, however, concern the internal market, but it serves as a justification for action at EU level rather than setting out an objective: it states that the features of the FTT should be harmonised at EU level in order to prevent distortions and thus ensure the proper functioning of the internal market through unilateral measures taken by Member States. The first two recitals are consistent with the introductory paragraph of the explanatory memorandum, where we note in particular that "[t]he purpose of the proposal is to provide a common European approach to this issue that is consistent with the internal market."

4.17 In a similar vein, we note that the "objectives" of the proposal in the Commission's impact assessment are stated to be, in order: "[r]aising revenue and adequate contribution from the financial sector to tax revenues"; "[l]imiting undesirable market behaviour and thereby stabilizing markets"; and last (and seemingly least) "[i]nternal market aspects (avoid double taxation and distortion of competition)".[9] This again is consistent with the two stated policy goals of the proposal in the impact assessment: "[f]irstly, the generation of additional tax revenue. Secondly, the use of taxes as a tool to improve the functioning of the financial markets in general."[10]

4.18 From the this contextual analysis we think there are strong arguments to conclude that the predominant aim of the FTT is not "to ensure the establishment and the functioning of the internal market and to avoid distortion of completion", as it must be should Article 113 TFEU be the correct legal base; rather it is to ensure the financial sector contributes to the economic losses it caused; to dis-incentivise excessively risky activities by financial institutions; and to raise revenue for the EU budget. We see nothing in the content of the proposed Articles to contradict this view.

4.19 So we ask the Minister to say whether he agrees with us that the proper functioning of the internal market appears to be a secondary aim of the proposal; and if he agrees, to say whether he thinks the EU has the powers conferred upon it to legislate for the purposes described in the paragraph above, which are also set out in the first recital.

4.20 If, however, the Minister thinks the internal market is the predominant aim, we ask him to say whether he is satisfied that the national financial transaction taxes adopted by ten Member States so far, and, we are told by the Commission, to be adopted by an unspecified number of other Member States, are likely a) to lead to future obstacles to trade in the internal market and b) that this proposal will prevent such obstacles arising, according to the test laid down by the Court of Justice.[11]

4.21 We are currently considering the compliance of this proposal with the principle of subsidiarity (the House has until 5 December 2011 to issue a Reasoned Opinion on non-compliance with subsidiarity). But we would be grateful for replies to our questions above before we come to a final conclusion on subsidiarity. Accordingly, we ask the Minister to respond in time for our meeting of 9 November 2011.

4.22 In the meantime the proposal remains under scrutiny.





3   (32095) 15282/10 + ADD 1: see HC 428-ix (2010-11), chapter 2 (24 November 2010) and Gen Co Debs, European Committee B, 7 February 2011, cols 3-23. Back

4   (32986) 12478/11 + ADDs 1-2 (Section 2.2 of the Commission's Explanatory Memorandum, Section 2 of ADD 1 and Part III of ADD 2) (32994) 12475/11 + ADDs 1-3 (Section 3): see HC 428-xxxv (2010-12), chapter 1 (7 September 2011). Back

5   See Case C-155/07, para 34, for example. Back

6   Case C-370/07, paras 46 and 47. Back

7   Case C-155/07, para 35. Back

8   As above, paras 36 and 37. Back

9   Section 4.1-4.3, pp. 25-28. Back

10   Section 3, p. 9. Back

11   See C-301/06, paras 63, 64 and 71. And C-58/08, para 33 (cited in the impact assessment at p. 23). Back


 
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