Getting to grips with new tax requirements

Author: | Published: 18 Mar 2015
Email a friend

Please enter a maximum of 5 recipients. Use ; to separate more than one email address.

Inge Heinrichsen of Ernst & Young examines some of the effects and challenges that the asset management industry may have to face in relation to the proposed EU transaction tax.

In September 2011, the European Commission proposed a draft directive on a broad financial transaction tax (FTT) across all member states, the overall objective being to increase the financial sector's contribution to the EU's common finances. An estimate for revenue was in the area of €30 billion to €35 billion. In 2011, the European Fund and Asset Management Association (EFAMA) estimated the revenue on the investment funds alone at €38 billion.

The proposal reached a deadlock situation due to disagreement on the tax's implementation among member states. However, a number of states wished to continue the FTT work and further details were passed through the Commission in February 2013, scoping a broader FTT.

On May 6 2014, the finance ministers of Austria, Belgium, Estonia, France, Germany, Greece, Italy, Portugal, Slovakia, Slovenia and Spain issued a joint statement on their aim to create a harmonised FTT regime within the EU. The 11 countries intend to implement the FTT on a step-by-step basis with an initial focus on shares and some derivatives, with the initial steps to be implemented by January 1 2016 at the latest.

There have been recent political developments in respect of EU FTT indicating greater urgency to complete negotiation.

Early adopters

Some EU member states have already implemented local FTTS - so called early adopters.


France introduced a FTT on French equities on August 1 2012, together with a tax on high-frequency trading and naked sovereign credit default swaps. The French FTT applies a 0.2% tax on the purchase price of equities (or American depositary receipts, global depositary receipts or Crest depository interest) of French publicly-traded companies with a market value over €1 billion on December 1 preceding the year of taxation. French FTT does not apply to debt securities.


Italy has also introduced a FTT, which came into effect on March 1 2013 for cash equities and September 1 2013 for equity derivatives and structured notes. For over-the-counter transactions in cash equities, the rate applied is 0.22% for 2013 and 0.20% in 2014. For on-exchange transactions in cash equities, the rates applied are 0.12% and 0.10% for 2013 and 2014, respectively. The amount of Italian FTT on derivatives is determined by reference to the type of financial instrument involved and the relevant notional value – which is a maximum of €200 on derivatives, payable by both counterparties to the transaction. The amount of FTT on derivatives is reduced to 1/5th for transactions that are executed on-exchange.

Portugal and Spain

Both Spain and Portugal propose local rules, but the proposals were put on hold awaiting the outcome of the EU FTT. Neither country has suggested they will react to the delay on EU FTT by resurrecting these proposals.

What is the EU FTT?

It is proposed that the EU FTT is levied on secondary market security transactions (broadly: buying, selling, and collateral). In scope, the products are shares, fund units, bonds and derivatives. Up until the January 2015 statement it was thought that the 11 EU countries were likely to narrow this down at least initially to equities and some derivatives.

"Ways of doing business in the asset management industry would need rethinking under the FTT"

Financial institutions in the 11 EU countries are liable, as are outside financial institutions doing transactions with the 11 countries. Financial institutions are broadly defined, and no exemptions are contemplated for pension funds or life insurance companies.

Every transaction triggers taxation, with a cascade effect (subject to a limited market maker exemption). No netting principles are applicable, and rates are 0.1% for equities and 0.01% for derivatives (stated as minimum rates where states may levy higher).

The asset management industry has raised concerns regarding technical aspects of the FTT, such as how it will impact the product range, as well as the compliance and administrative burdens it implies.

Will the FTT change the product range?

The commercial scope and ways of doing business in the asset management industry would need rethinking under the FTT, not only in terms of investment and hedging strategies for large institutional investors, but whole business methodologies would need to be adjusted to minimise the impact of the FTT. The whole concept of fund structures, investment strategies for fund and trading patterns and distribution models will have to be rethought.

The residence principle in the EU FTT implies that wherever there is a financial institution with so-called nexus within the 11 EU states, tax is levied. What this would entail for the asset management industry is business potentially moving outside the relevant EU zones, and increased interest in non-EU securities simply for tax reasons, thus creating huge inefficiencies in trading and investment patterns in the industry. Domestic fund structures in the 11 countries will become much less attractive for investment from outside. It is notable that the traditional asset management centres of Luxembourg and Ireland are not part of the 11. Changes in trading patterns may lead to less frequent trading, as was one intention of the FTT's political agenda, but this may not necessarily be of benefit in a sound and healthy financial services environment. Frequent trading is often necessary for prudent financial management of funds, and the high-frequency trading of underlying assets is a key factor in various asset management strategies. The FTT may lead to tax – rather than commerciality – being the key driver, therefore creating tax lock-up effects.

Some fund types may be affected by the FTT more than others. Exchange Traded Funds (ETFs) are likely to be more heavily impacted as the first issue will typically be to a large financial institution and therefore not qualify for the issuer exemption. Each further transaction on the exchange will then trigger further transaction taxes.

Money Market Funds will not generally benefit from the issuer exemption, as they tend to buy short term. As the margins in the money market are low, high trade turnover is part of the earnings strategy triggering multiple times transaction taxes.

Funds investing in asset classes that are not a typical high-frequency trading security may not be affected as seriously as the typical investment fund with listed shares or listed bonds or similar types of securities.

Funds investing in real estate assets or infrastructure assets are typically more illiquid in nature, closed-ended, with a smaller number of institutional investors. Or, in some cases, the funds themselves may be listed, such as real estate companies where the sale and purchase of shares in the company itself may be subject to FTT. As the FTT comes into effect, funds with traditional securities in shares and bonds for example, will become more expensive and therefore less attractive to investors – institutional and retail alike.

Fund-of-funds may be affected differently, depending on their structure and investment area.

Pension fund concerns

Pension funds across Europe manage their assets using various investment strategies and approaches according to different asset classes. Since the FTT does not hold any exemptions for pension funds, they would be subject to the FTT on every transaction of FTT-liable securities. Considering the large amounts of securities in the portfolios of pension funds, the impact will be considerable.

A pension fund would directly hold large portfolios of equities, debt instruments, financial instruments and various other asset classes. It would also actively manage this large investment portfolio of securities and trade to generate yields for the benefit of pension holders. Various strategies on how to generate and optimise returns on these portfolios would now entail the tax element of the FTT and need to factor this in the pension fund investment strategy.

"The compliance burden and cost of FTT administration could pose a significant burden on custodians"

The impact of the FTT would not only relate to the investment portfolio securities themselves but also to the hedging strategies, as financial instruments are also within the scope of the FTT. Pension funds use financial instruments in various ways, such as covering investment portfolio risks or hedging their liabilities.

In some instances, a pension fund would hold certain types of assets in an entity managed by an external investment manager. In this case, the pension fund would bear the cost of the FTT in the same manner as other investors in investment funds: it would lack any specific exemption for investment funds wholly owned by pension funds or even general exemptions for pension funds.

The overall objective of a pension fund's management of the investment portfolio is to increase the returns and pension yield for the benefit of the pension holders – so ultimately, the pension holders will bear the cost of the FTT.

Potential effects of the EU FTT
  • Potential destabilisation of the single European market, as only a subset of the 28 EU member states will implement the tax.
  • Significant shift in asset class appetite (some sources cite a reduction of up to 90% in relation to derivatives volumes) exacerbated by the inclusion of so-called issuance principles.
  • Curbing of high-frequency trading.
  • Changes to legal entity models and location strategies by firms seeking to reduce their exposure to the tax.
  • Exposure to different credit risks as counterparties change their legal entity models.
  • Significant impact on funds as costs are passed on to end users.
  • Reduction in liquidity.
  • Increased cost of managing risk (such as using derivatives to hedge).
  • Increased complexity of operations, resulting in lower rates of straight through processing and therefore higher cost per trade (even before application of the tax).
  • Front-to-back changes to applications and their business rules to be able to compute and reflect the EU FTT throughout the transaction life cycle from order management through to settlement and accounting.
  • Dependency on data quality, particularly counterparty reference data and instrument static.

Administrative and compliance issues

Where the FTT cannot be avoided, it will have an economic impact, and in some cases a significant one. The compliance burden and cost of the FTT administration could pose a significant burden on custodians, administrators and other market participants. In the end, the costs would be priced within the products and there will be just one payer – the unit holder in case of an investment fund or pension holder in case of a pension fund investor for example. This will make savings products less affordable for savers and reduce the attractiveness of long-term saving products.

The operational challenges with regard to the administration of the EU FTT are also burdensome. Each financial institution will need to deal with the mapping of transactions, systems implementation, legal framework, collection and reporting methods.

Depending on the scope of the EU FTT, examples of its effects could include:


Inge Heinrichsen
Tax Partner, Head of FS Tax, Nordic Management Team, FS Tax

Ernst & Young P/S
Osvald Helmuths Vej 4,
2000 Frederiksberg,
D: + 45 73233761
M: + 45 25293761

Next steps

The EU proposal does not provide further guidance on the mechanisms of collection.

An independent report by Ernst and Young for the European Commission (October 2014) provides insight on existing collection mechanisms and considers the challenges the EU FTT poses with regard to collection models and data requirements. It suggests that a centralised collection mechanism could perform various functions on collection and reporting. Whilst the report may well help policy makers in considering the best methods of tax collection, in the first instance, the EU 11 need to decide what they will tax and how. If the EU 11 reach a political agreement, and this is far from certain, then asset managers across Europe will need to urgently assess the likely effects on their business.