European Parliament Approves Financial Transaction Tax for Eleven EU Member States

By a vote of 533-91, the European Parliament approved a financial transaction tax for eleven EU countries, including France and Germany, which account for about 90 percent of Eurozone GDP. EU Tax Commissioner Algeria Semeta has noted that, in addition to being a new source of revenue from a currently under-taxed sector, the financial transaction tax will encourage more responsible trading. Thus, aside from its revenue raising potential, a financial transactions tax could reduce harmful and speculative short-term and high speed trading and thereby link a trade more closely to the underlying fundamental economic market conditions and make financial markets less volatile.

The financial transaction tax will be applied to all financial transactions, in particular those carried out on organized markets such as the trading of equity, bonds, derivatives, and currencies. The tax would be levied at a relatively low statutory rate and would apply each time the underlying asset was traded. The tax collection or the legal tax incidence should be, as far as possible, via the trading system which executes the transfer.

The proposed EU Directive on which the tax is based defines a financial transaction as the purchase and sale of a financial instrument before netting and settlement, including repurchase and reverse repurchase and securities lending and borrowing agreements; the transfer between entities of a group of the right to dispose of a financial instrument as owner and any equivalent operation implying the transfer of the risk associated with the financial instrument; and the conclusion or modification of derivatives agreements.

           

For stocks and bonds the value of the transaction would constitute the tax base. For example, if an investor buys 20 shares of a corporation worth EUR 100 per share the tax base would be EUR 2,000. In this sense, it is easy to define tax bases for transactions where the asset price is determined by the market at the time when the transaction is executed.

For derivatives, the determination of the transaction value is more complex. In principle, one could argue that the value of the notional or underlying value could be the tax base. Given the sometimes high leverage of certain derivatives this would have two effects. On the one hand, taxing the notional value creates a very large tax base. On the other hand, the tax payment is large compared to the actual price paid for the contract. While this could reduce leverage taken by means of these contracts, noted EC staff, it would also increase the costs for companies when hedging risk. Also, taxing the notional might lead to double taxation in the case where the underlying is traded and taxed at the spot market if for example an option is executed. Instead of taxing the notional, an alternative way of taxing derivatives could be to tax the actual price only.