In the second of two articles, Bob Currie reviews how tax reforms are impacting securities financing markets and how tax authorities are reassessing transaction-based taxes as part of their revenue-generating powers
In the first part of this article, published two weeks ago in SFT 333, we noted how tax authorities are stepping up their efforts across European jurisdictions to eliminate dividend tax reclamation fraud and to seek recovery of funds lost through cum-ex and cum-cum trading.
Since the European Securities Market Authority (ESMA) and the European Banking Authority (EBA) launched investigations into such schemes — and directed member states to implement appropriate legislative and supervisory responses to such schemes within their respective legal frameworks — a wide array of legislation has been introduced with the objective of targeting tax abusive transactions that have the aim of avoiding withholding taxes.
This requires participants to implement robust tax governance frameworks for identifying, mitigating and reporting potential tax abuses. “Abusive cum-ex and cum-cum schemes have clearly got the attention of regulators and banks are expected to have adequate controls in place to manage such risks,” says Meera Khosla, chair of the Tax Steering Group at the International Securities Lending Association (ISLA).
Tax reform in Europe is having implications for securities lending and financing transactions that extend well beyond efforts to eliminate tax reclamation fraud, however.
UK stamp tax
Following on from the July 2020 Call for Evidence on the modernisation of stamp duties on shares, HM Revenue and Customs (HMRC) in the UK launched a consultation on proposals for a single new tax to replace stamp duty and stamp duty reserve tax (SDRT). This consultation ran from 27 April to 22 June 2023.
Proposals published on 27 April 2023 aim to replace ageing stamp duty legislation and practices with a new self-assessed digital tax, but without triggering market disruption through radical changes to the collection of tax on transactions which is currently processed through CREST, the settlement system of Euroclear UK and International, the UK central securities depository. According to audit, tax and financial advisory firm KPMG, the revised tax will apply features of SDRT and stamp duty land tax (SDLT), particularly in its administration.
HMRC, in its consultation document, examines whether it is beneficial to adopt a single tax framework for securities transactions, rather than the current arrangement where securities trades fall into scope of both the Stamp Duty and SDRT frameworks.
In publishing a response to the UK HMRC consultation on modernisation of stamp tax on equities trading and stock lending transactions, ISLA indicates that it supports the adoption of a single tax on UK securities and steps to modernise and simplify legislation, enabling firms to comply with a single, modern and simplified digital tax.
Specifically in its response, the trade association engages with content of the consultation document relating to stock lending and repurchase relief. It shares its concerns, along with the Association of Financial Markets in Europe (AFME) and some other trade associations, that the UK government is missing an opportunity by not intending to widen the geographical application of tax relief application for stock lending and repo transactions to regulated brokers and lending agents in countries that have a double taxation treaty (DTT) with the UK.
In its consultation paper, HMRC notes that relief from the 0.5 per cent Stamp Duty or SDRT charge is afforded to any person who enters into a stock lending arrangement, including repurchases. The goal of this relief is to promote liquidity in financial markets.
HMRC indicates that some respondents have put forward a case for widening the geographical application of this relief beyond the current scope of the UK, European Economic Area (EEA) and Gibraltar to make it easier for brokers based outside of those areas to be able to lend and repurchase UK stock. “However, the government does not consider that a strong case has been made for doing this,” it explains. “As such, the government does not propose to widen the geographical application of this relief.”
In responding to this position, ISLA proposes extending the geographical reach of tax relief for SFTs, outlining the expected benefits for the securities lending industry and the improved liquidity this will potentially deliver for UK-listed equities. It points out that the UK has taken a position which no other country has adopted relating to applying a geographical limit for securities lending trades.
In making this case, the Association encourages the UK government to fix the shortcomings in the alternative (pre-MiFID) relief detailed in s.88AA(3) Finance Act of 1986, which makes this tax relief difficult to obtain since it applies HMRC published practice dating from 10 years ago.
Commenting on this position, ISLA Tax Working Group chair Meera Khosla says that the Association welcomed HMRC’s consultation to modernise the Stamp Taxes on Shares framework and supports the objective to simplify and modernise the stamp tax legislation so that businesses can better understand and comply with their obligations.
The Tax Working Group specifically advocated for an extension to the geographical scope of the 2007 (post MiFID) stock lending relief for SDRT. Currently the 2007 relief applies where a party to the stock loan is authorised by the Financial Conduct Authority (FCA) in the UK or a financial regulator in the EEA to carry out MiFID investment business services. However, the UK is an outlier in that no other country applies a geographic limit on securities lending transactions.
ISLA believes that broadening the exemption to regulated brokers and lending agents in countries which have a DTT with the UK is likely to enhance the liquidity of listed UK shares outside the UK and EEA and, at the same time, would present little risk to HMRC’s ability to collect stamp tax.
The ISLA Tax Working group has also encouraged the government to fix the practical defects inherent in the alternative (pre-MiFID) relief, where taxpayers that utilise such relief rely heavily on HMRC published practice from nearly a decade ago.
The Investment Association, the UK trade body for investment management firms, indicates that it strongly supports the Government’s drive for simplicity, ease of use and certainty across the tax landscape.
“There is keen interest across our membership to ensure that this review results in remedying operational issues related to Stamp Duty and Stamp Duty Reserve Tax, collectively Stamp Taxes on Shares, after years of fragmentation,” it says.
In responding to whether the government should change the geographical application of stock lending and repurchase relief, the Investment Association — in a response filed with its head of tax, Anshita Joshi, as its principal contact — considers that stock lending relief should be made available to any party, regardless of location or business activity providing the essential conditions of the relief remain. The IA also proposes that clear guidance should be provided regarding tax relief application for collective investment schemes that enter into stock lending arrangements.
More broadly, the IA believes that it is important that any review of stamp tax application on equities is made in the context of the wider UK Listings Review which, it suggests, aims to transform the UK into a leading global market of choice for issuers, intermediaries and investors. The Listings Review was launched in November 2020 as part of UK government efforts to strengthen the UK as a financial centre and as a destination for initial public offers (IPOs) and capital raising.
The current project on modernisation of Stamp Taxes on Shares project predates much of this wider Listings Review work, the IA argues, and it would be a missed opportunity for the UK to modernise its tax regime without considering its future relevance. Therefore, it is important to evaluate the need for Stamp Taxes on Shares more fully and to understand their role in the UK’s competitiveness in the race for international listings.
The IA notes that, unlike many other major markets, the UK maintains a form of financial transaction tax on the transfer of main-exchange UK-listed shares via the Stamp Duty and SDRT rules. The UK rate of 0.5 per cent for the transfer of standard equity shares is higher than that of France (0.3 per cent), Hong Kong (0.26 per cent) and India (0.2 per cent). In contrast, the US does not impose any form of financial transaction tax on its main exchanges.
Further, the reach of Stamp Duty and SDRT is not consistent across all classes of equity and, in the IA’s view, can incentivise investment into derivatives linked to UK-listed shares.
“We support this new single tax on securities with a design based on the current SDRT regime rather than Stamp Duty,” concludes the IA. This is because the majority of financial market transactions no longer transfer shares by way of physical documents and to change the well-established status quo with CREST would cause financial market disruption. The IA continues to be supportive of the initiatives to simplify the UK tax on securities transactions.”
Responding to HMRC’s consultation on Stamp Taxes on Shares, Richard Stone, chief executive of the Association of Investment Companies (AIC), says: “We believe stamp duty on investment trust purchases is a long way past its sell-by date. It is particularly frustrating that investment trust investors are compelled to pay stamp duty, but buyers of open-ended funds do not pay this tax.
“The abolition of stamp duty for investment trust purchases would help meet the government’s objective of encouraging investment in UK markets and the real economy rather than speculative purchases of cryptocurrency.”
The AIC represents a broad range of closed-ended investment companies, incorporating investment trusts and other closed-ended investment companies and VCTs.
EU Financial Transaction Tax
In 2013, the European Commission issued an initial proposal for the introduction of a Financial Transaction Tax (FTT), which would apply a 0.1 per cent tax on all types of financial instruments apart from derivatives trades, where a 0.01 per cent rate would apply.
Ten years later, this FTT proposal appears to have moved little closer to enactment. However, the European Commission has announced a proposal for a new EU-wide Financial Activities Tax (FAT) which will replace the languishing EU-FTT proposal. This plan arrives in the context of an increasingly urgent push to find new EU-level tax resources to fund its escalating post-Covid, post-Ukraine spending plans.
In a text adopted by the European Parliament in Strasbourg on Wednesday 10 May, policymakers explored options for raising revenue to contribute to the debts generated through emergency-support programmes set in place during the Covid-19 pandemic and to raise funds to finance new spending requirements (see box below).
Meera Khosla, ISLA’s Tax Working Group chair, indicates that in developing a Financial Activities Tax, the Commission is inevitably nervous of placing the bloc’s financial sector at a competitive disadvantage — raising questions about how to capture services offered to EU customers from outside the bloc, and about how to ensure that tax authorities are able to scrutinise those third-country activities for enforcement purposes while remaining World Trade Organisation (WTO)-compliant.
“The proposal is still in its early stages,” explains Khosla. “However, if it develops, ISLA will advocate for a stock lending exemption, which is common in all markets with FTTs, to promote liquidity.”
Financing the NextGenerationEU programme: plans for a financial transaction tax?
On 27 May 2020, the European Commission put forward a proposal for a recovery plan from the Covid-19 pandemic, creating a €750 billion recovery programme called NextGenerationEU. To finance this initiative, the Commission proposed tax initiatives including:
• New corporate tax based on operations and levied on companies that draw significant benefits from the EU single market and that survived the Covid-19 crisis
• A digital tax for large companies
• A Carbon Border Adjustment Mechanism
• An Emissions Trading System-based resource, including a possible extension to maritime and aviation sectors
On 21 July 2020, the European Council agreed on the recovery plan and the EU budget for 2021 through to 2027. The agreement also stated that the EU would, in coming years, work to reform the “own resources system”. Under this initiative, the Council agreed to the introduction of an FTT, which did not previously form part of the Commission’s early proposals announced in May 2020.
Subsequently, in December 2020, the European Parliament, the Council and the Commission reached an agreement under which the repayment of the NextGenerationEU must be financed by the European Union’s general budget and by proceeds from new own resources introduced after 2021.
To meet this commitment, the Commission presented a new package of “own resources” in December 2021, proposing three sources of revenue to be introduced by early 2023:
1. 25 per cent of the revenue generated by EU emissions trading
2. 75 per cent of the revenue generated by Carbon Border Adjustment Mechanism
3. 15 per cent of the share of the residual profits of the largest and most profitable multinational enterprises that are reallocated to EU Member States under the global agreement (EY, Tax News Update 23 June 2023, European Commission proposes adjusted package for the next generation of new resources)
The Commission also announced that it will present a proposal for a second basket of new own resources by the end of 2023, which will include an FTT and an additional own resource linked to the corporate sector.
Closing thoughts
In its high level statements, the European Commission suggests that it is the will of EU countries, and their citizens, that the financial sector “pays its fair share of taxes”. This is why tax administrations are examining ways to tax the financial sector, for example by introducing bank levies and national financial transaction taxes.
Through its February 2013 proposal to introduce an FTT — revisited more recently as part of plans to finance the EU’s emergency support measures during Covid — the Commission indicates that its focus is on “harmonising uncoordinated Member States’ financial tax initiatives, which could otherwise lead to fragmentation of the Single Market for financial services and to double taxation taking place”.
There is a clear need for further harmonisation of European tax procedures — this was one of 19 objectives highlighted by the Giovannini Group as far back as 2003 — and industry participants have encouraged steps to standardise and simplify tax application across the EU. But FTT application has been accompanied by concerns for market liquidity, competitiveness and a jurisdiction’s attractiveness as a trading location. The French FTT applied on certain types of transaction, introduced in August 2012 under Amended Finance Law 2012, provides a useful case study. Policymakers need to be clear that the benefit of these additional tax raising powers outweigh potential impairment to the market.
For example, a European Central Bank working paper published in February 2017 by Jean-Edouard Colliard and Peter Hoffmann, “Financial Transaction Taxes, Market Composition and Liquidity”, found little indication that the French FTT regime has improved market quality by enhancing the composition of trading volume. “We find no evidence for the composition effect through which an FTT is supposed to improve market quality,” they conclude. “Instead, our results support the existence of a liquidity effect through which such a tax worsens market quality and indirectly affects even exempted traders.”
Specifically, Colliard and Hoffman’s empirical analysis found that average trading volume decreased by around 10 per cent following the introduction of the French FTT in 2012 and this development was accompanied by a moderate decline in market quality.
“While the most liquid stocks were largely unaffected, less liquid securities were subject to considerable adverse effects,” they conclude. They also find that the effects impacted a wide range of trading parties and trade types. “We show that high-frequency traders were strongly affected by the decline in market liquidity, even though these agents were effectively tax-exempt because the French FTT does not apply to intraday trading,” say Colliard and Hoffman.
Looking across the findings of this two-part article, it is evident that the number of legislative and regulatory regimes targeting tax abusive transactions has mushroomed. Some of these are targeted towards specific and aggressive forms of securities lending and some are more general in their application, with an increased focus on transparency and reporting within and between Member States.
These efforts by tax authorities to eliminate dividend reclamation fraud are to be commended and strongly supported. But a number of ongoing legal cases in Europe relate to historical transactions that were executed 10 years ago or more. Many firms have reinforced their oversight and control procedures to reduce potential for tax fraud — and tax authorities have progressively closed loopholes that made dividend arbitrage possible.
Against this background, it is therefore important that policy changes fit with current market practice guiding cross-border corporate actions and withholding tax reclaims — and not historical market practices that were in place when many of these tax abusive trades were executed 10 or 20 years ago.
In fulfilling the essential task of tightening up on illicit tax rebate claims, policymakers must also evaluate potential unintended consequences that may impair the safe and efficient operation of securities lending markets and other market functions which bring liquidity and risk mitigation. While rightfully clamping down on dividend withholding tax fraud, these unintended consequences may damage the interests of EU citizens and taxpayers — for example pension and insurance scheme members or retail investors in collective investments schemes — by impairing their capacity to save for the future.
“Some perfectly sensible initiatives have been introduced at speed — however, unfortunately with limited consultation,” notes ISLA’s director of regulatory affairs Farrah Mahmood. ISLA advocates that wider independent studies should be done on the economic impact of such initiatives to ensure a balance is struck to eliminate the risk of abusive transactions while maintaining an effective functioning securities lending market. “Securities lending and derivatives play a crucial role in supporting market liquidity, investability, an ability to finance equity and debt positions and satisfying regulatory requirements,” she says.
“There needs to be a holistic analysis of the impact of certain measures and actions of Member States on the liquidity, viability and competitiveness of EU markets,” adds Mahmood. “Aggressive rules based on ‘edge’ cases can have a wider and potentially detrimental impact on ordinary market making”. With this in mind, ISLA will be focused on educating policymakers on the importance of securities financing to the wider capital markets and how legal uncertainty in tax rules can impact the provision of supply in secondary markets.
