The French government on February 8 presented to Parliament a draft bill that would introduce a financial transaction tax (FTT) in France, taking the lead on the domestic front as other EU-member countries debate the pros and cons of an EU-wide FTT. Many of France's main trading partners have been reluctant to adopt an FTT on a domestic basis.
With the presidential election less than three months away and an atmosphere of economic and financial uncertainty, President Nicolas Sarkozy has already expressed his support for the FTT legislation. As proposed, however, the FTT would apply from August 1, under the authority of the next president. François Hollande, Sarkozy's strongest rival, has indicated that he does not oppose the FTT, although he had made it clear that he would prefer an EU-wide FTT.
The FTT gained momentum after the G-20 raised the issue of the financial sector's contribution during the global financial crisis in contrast to the contributions of the member states. The IMF in June 2010 ruled out an FTT as not achieving the goals defined by the G-20 and instead proposed a financial activity tax (FAT) and a balance sheet tax (bank levy).
Shortly afterward, France, Germany, and the U.K. introduced domestic bank levies. However, despite the hesitation of the IMF, France and Germany were also quick to promote the adoption of an FTT on an EU scale.
The European Commission considered both an FTT and a FAT, eventually settling on an FTT. The commission released a proposal for a directive for a common system of financial transactions in September 2011. (For the draft directive, see Doc 2011-20607 or 2011 WTD 189-25.)
The proposed EU FTT would apply to sales and purchases of financial instruments by EU financial institutions or equivalent operations with the transfer of the associated risk and the conclusion or modification of derivatives agreements.Transfers are taxable whether they are carried out on an organized market or over the counter.
The definition of an EU or deemed-EU financial institution is very broad and is not restricted to investment companies and credit institutions, but also includes undertakings for collective investment in transferable securities, authorized investment funds, insurance or reinsurance undertakings, pension funds, and so on, whether acting on their own account or for the account of another person, or in the name of a party to the transaction.
Exclusions exist to protect the raising of capital by households and small and medium-size enterprises that are not actively investing in financial markets, and for transactions with central banks in the EU and with the European Financial Stability Facility.
The FTT rate would be determined by each member state but could not be lower than 0.1 percent for all transactions except those involving derivatives instruments, with a minimal rate of 0.01 percent assessed on the nominal value.
The FTT would take effect on January 1, 2014, provided that the directive is unanimously adopted by all the member states, unless at least nine member states request the adoption of the EU FTT on a smaller scale through the enhanced cooperation procedure. On February 7, nine member states - Austria, Belgium, Finland, France, Germany, Greece, Italy, Portugal, and Spain - asked the European Commission to finalize a first review of the proposal in the first half of 2012 in order to accelerate the adoption of an EU-wide FTT. The European Parliament is expected to release its survey on an EU FTT in March.
The EU FTT proposal comes at a time when France's financial markets have been paralyzed, to some extent, by the reform of the transfer tax on sales of French listed shares on regulated markets and multilateral trading facilities (MTFs), if documented. The tax was not so much a concern for trading on French and foreign markets until the January 1 reform removed the €5,000 cap on the tax and extended its scope to instruments executed abroad (on the sale of French listed stocks). The tax, which previously was 3 percent, now applies progressively at 3 percent, up to the fraction of the price reaching €200,000; 0.5 percent from €200,001 to €500 million; and 0.25 percent above €500 million.
In light of the increased exposure, certainty became crucial, and professional organizations sought advance clearance from the tax authorities to confirm that most of the trades on markets do not give rise to a taxable instrument and that most temporary transfers of ownership such as stock lending and repos were exempted.
The authorities released the ruling on February 6, and it seems to provide the requested reassurance.The adoption of the domestic FTT would raise a question about the survival of the French transfer tax on the documented sale of French listed shares (and on documented sales of foreign listed shares).
The draft bill provides that once the FTT is adopted, the rules previously in place for the transfer tax on documented French and foreign listed shares would be restored, with the €5,000 tax cap and the nontaxation of sales documented overseas.
As of February 9, the National Assembly's finance commission had proposed preserving the current regime but with reduced rates of 0.65 percent, 0.4 percent, and 0.15 percent, respectively. In any event, the question would have to be readdressed if an EU FTT is adopted because it would prevent member states from applying an FTT on their own.
The French FTT
According to the draft bill, the objective of the FTT is threefold:
- It would ensure fair participation by the financial sector in France's economic recovery from the financial crisis caused mainly by the dysfunctioning of the financial markets. The tax is also being presented as a precursor of an EU FTT.
- A specific FTT would target harmful high frequency trading behaviors such as "layering" (the issue of orders before cancellation).
- It would discourage speculation on sovereign debt through credit default swaps (without owning the related bonds or risk) by French operators.
The FTT would apply to acquisitions of listed stock issued by companies whose legal seat is in France with a market capitalization above €1 billion on January 1 of the year during which the acquisitions take place. This could affect about 100 French companies.
Taxable transactions would involve French-issued equity securities as defined above, but also securities that may give rise to equity rights(1) (for example, preferred stocks, convertible bonds and any other bonds that may give rise to equity rights, warrants, options, stock futures, and so on).
Although it still must be clarified, it seems that the acquisition of options, futures, and convertible bonds is taxable. With the tax due at the time the stock is delivered at maturity (if not issued by the company), double taxation may arise.
The FTT may also apply to instruments equivalent to the French listed stock or stock rights even if issued by another issuer under a foreign law (for example, American depository receipts).(2)
The term "acquisition" includes a transfer of ownership through a purchase, exchange, contribution, or the exercise of an option, or through a futures contract.
To be subject to the FTT, the stock (as defined under section L 212-1 A of the monetary and financial code (MFC)) or equivalent instruments (as defined under section L 211-41 of the MFC) would be negotiable on a regulated market in France or the European Economic Area or on some limited non-EU regulated markets(3) such as in Switzerland (Bourse Suisse) and Montreal (Bourse de Montreal Inc.). The NYSE is not included. Stocks listed on a multilateral trading system are also outside the scope of the tax.
Exclusions appear to be motivated by the impact of the FTT. All French listed stock issued by companies with a market capitalization lower than €1 billion at the beginning of the year would be exempt. Also excluded are acquisitions on primary markets and certain acquisitions by clearing houses or a central depositary system, mostly when stocks are transferred as a guarantee on futures. Also, acquisitions in the course of market making activities by credit institutions, investment firms, issuers or entities of a foreign country (sovereign funds, presumably), and local entity members of a trading negotiation platform of a foreign market may be exempted.
Acquisitions realized between affiliated companies (groups in which the parent company holds more than 50 percent of the capital of its subsidiaries) and also within the course of a reorganization (whose scope is defined) and of management buyouts may also be exempt from the FTT.
Temporary transfers, as defined in European Commission regulation (EC) 1287/2006 that consist of securities financing transactions such as stock lending or stock borrowing, a repurchase or reverse repurchase transaction, or a buy-sell-back or sell-buy-back transaction would also be free of FTT. It seems, however, that acquisitions in connection with reuse rights by the entity's beneficiary are not exempted. This point remains to be clarified.
The rate would be 0.1 percent of the acquisition price and would be payable by credit institutions, investment firms, and management firms that carry out acquisitions on their own account or for other persons whether established in France, Europe, or elsewhere or, if not, as the account holder and issuer (if it is the account holder).
In most cases, the burden of reporting and payment is on the central securities depository (CSD)or on the taxpayers, in limited circumstances.
A monthly declaration and payment would be required before the 15th of the month following the transactions. Penalty and late-payment interest could apply in cases of improper reporting. Failure to transfer the relevant information to the CSD would trigger a penalty of 40 percent of the tax.
While the tax would become effective on August 1, the first returns and payments would not have to be made until November 30, 2012.
The first concern with the proposed FTT is the risk of relocation of trades. Subject to further clarification, one may anticipate that every acquisition on a market or OTC should be taxable if the stock is listed on an eligible market.Therefore, acquiring French stock on the NYSE, if the company is listed in the U.S., may prove efficient only to the extent that the same stock is not also listed on an eligible market.
For a French company tempted by an initial public offering, the use of a controlling foreign entity for listing purposes may be considered.
The risk may also be for the eligible public company to delist from eligible market(s)or issue stock or securities on non-eligible markets. However, a delisting for being listed on the NYSE or HKSE exclusively, for example, seems unlikely. Delisting would be burdensome and costly, and should be justified.
Alternatively, the French company could transfer its seat of management outside France (for example, to Luxembourg) so it would no longer be regarded as a French company for FTT purposes. This option seems unlikely as well, because the tax treatment of the transfer of the seat may be detrimental unless the company maintains a permanent establishment in France that owns the French-based assets (such as shareholdings).
The issue of a different class of shares to be listed exclusively on a non-eligible market might be efficient. Achieving this, the company could also remain listed in France or on an eligible market.
Going further, some companies may envisage moving transactions off an exchange, resorting to securities listed exclusively on MTFs such as Alternext or AIM in London. That brings us back to the delisting concern unless only convertible bonds, for example, are listed on the MTF. That would not prevent the application of the FTT on delivery of the stock (if listed on an eligible market and not issued) but should preserve the payoff on the trade of the securities. Double taxation could then be avoided.
Last but not least, one may envisage structuring substitute securities with similar payoffs not listed on an eligible market, such as instruments developed in the U.K. to save the stamp duty. This may, however, prove difficult if those securities require the ownership of the stock because the definition of the term "equivalent instrument" is broad, as explained earlier.
Prevention of Harmful Behavior by High frequency Trading Operators
To prevent layering, France would impose an FTT of 0.01 percent of the value of canceled or modified orders exceeding two-thirds of the orders placed within the day by enterprises whose business is carried on in France, either through their seat of management or through a branch or PE. The definition of "enterprises whose business is carried on in France" is based on tax law.
For foreign investors using a server in France and committing layering, the issue might be determining whether they can be regarded as having a PE for purposes of the FTT. One of the main questions is whether the server could be viewed as being at the disposal of the investor. However, in the absence of employees or an attached workforce in France, a PE may be unlikely.
The operations covered by the FTT are high frequency trades characterized by the use of automated mechanisms for the fast execution of orders. Layering, for the purpose of the FTT, is defined as placing, canceling, or modifying orders on one French listed stock (as defined above) within a very short period of time not exceeding one second, and to be defined further by decree.
Systems used to optimize conditions for the execution of orders, for routing orders to one or more trading platforms, or to confirm orders would be excluded. Market making activities should also be exempt.
The tax would be due on the first day of the month following the operation and must be declared and paid before the 10th of that month.
High frequency trading is criticized as a possible contributor to market instability, and abuse. The scope of the FTT appears narrow for high frequency trading but still may be an invitation to French high frequency operators to relocate outside France's borders.
The FTT should prove costly to high frequency trading operators because they may be exposed to tax once on acquisition of the stock and later in the case of layering.
Taxes on Sovereign Naked Credit Default Swaps
An FTT of 0.01 percent would also apply to prevent speculation on sovereign risk and default and to restrict the acquisition of sovereign credit default swaps (CDS's) by French investors seeking to hedge a long position (and who have a sovereign bond or associated risk). The FTT aims to limit short selling. The measure echoes the ban on naked CDS introduced in the EU and effective November 1.
The FTT would be due on the acquisition of naked sovereign CDS's by individual tax residents in France, enterprises carrying on their activities in France as defined for French tax purposes (branch or PE), or an entity established or incorporated in France that does not hold the underlying bond or bear the associated risk. Acquisition of sovereign naked CDS's within the course of market making activities should be exempt.
The tax would be assessed on the notional value, defined as the CDS's face value or nominal value retained for the purpose of calculation of payments associated with the CDS. It should be effective on August 1.
The French FTT may look like another experiment with a financial securities tax or as a kicker for the introduction of an EU FTT. Even if the French government expects to raise € 1.1 billion per year, the administration is aware that only an EU-wide FTT may prove efficient for curbing speculation and relieving budget deficits.
1. As defined in article L.212-1 A of the Monetary-Financial Code ("CMF").
2. See article L.211-41 CMF.
3. See articles L421-4, L422-1 and L.423-1 CMF.