A loophole created by the exception of OTC derivatives from the issuance principle in the European financial transaction tax (FTT) proposal needs to be closed as it could "prove detrimental" to the tax's success, a European Parliament report says.
The recommendation, released yesterday in a Parliamentary draft report on the European Commission's FTT proposal, would mean swaps issued within the FTT-zone would be taxed when traded, regardless of where the transaction occurs.
The report, drafted by Greek MEP Anni Podimata, was presented to Parliament's Economic and Monetary Affairs Committee (ECON), offering a few changes that she believes are necessary to prevent tax evasion and tax avoidance.
Podimata formally re-introduced the FTT to Parliament's agenda last year after an initial drive to form a pan-European tax fell through in 2011. Under the current initiative, 11 EU states are supporting the tax under the 'enhanced cooperation' legislative tool that lets a group of at least 9 states form binding EU law with European Commission support.
Podimata's report on the FTT proposal was developed after consultation with MEPs and represents ECON members' broad thinking on the tax.
In the report, Podimata said the exemption of swaps creates incentives to move trading from transparent markets towards OTC trading, and therefore undermines regulatory initiatives to derivatives markets.
"The FTT should have a wide scope even with the issuance principle including OTC derivatives in order to preserve a level playing field," she said.
"The exemption of OTC derivatives opens a loophole, which could prove detrimental for the success of the tax."
David Gubbay, partner of law firm Dechert, said the FFT was already being criticised for being too far-reaching, and Podimata's suggestion to add OTC derivatives to the mix was an "unwelcome extension" to the scope of the tax.
"It's looking incredibly wide and now if there is a proposal to extend it further, then that's generally unwelcomed news," he said.
Podimata also called for the re-introduction of the "ownership principle," inspired by the success of the UK's stamp duty. This would mean a financial transaction that has not been levied is not legally enforceable and does not result in a transfer of legal title.
Even though the Commission has argued the ownership principle should not be included in the proposal because it would be tough to enforce, Podimata said it was a "key element" for the success of FTT.
"Member States are responsible for putting in place the necessary arrangements to make it work. The ownership principle is the key in raising the cost of tax avoidance to such a high level so as to effectively deter it," she said in the report.
Gubbay said the ownership principle would introduce huge commercial uncertainty to market.
"If anything, it would mean more and more business would be driven away from the 11 member states."
He said the new proposed principle would also be difficult to apply to instruments that are not issued in the FFT-zone.
"If the law of New York applies to the transaction, it's hard to see how this particular FTT provision could actually have any effect on whether the title has passed," Gubbay said.
Podimata also said the residence principle should be strengthened, clarifying that branches of EU institutions registered within FTT jurisdiction would be taxed as well.
An FTT committee was also on the list of suggestions as it would be crucial to ensure maximum efficiency of the tax.
"Weakness in one [member state] would undermine the success of the tax and might even lead to arbitrage within the FTT zone," Podimata said.
The European FTT, which covers 11 member states, has gained considerable criticism for its universal reach, which would also see tax transactions occurring on any venue in the world if a participant who is established in one of those member states is involved.
The draft report will continue to shape in the coming weeks as other members input changes, and ECON is expected to vote on the report at the end of May. A plenary vote is tentatively scheduled for July.
By Paloma Migone