France's Transaction Tax Proves Pretty Taxing
In just one week France will become the first Eurozone country to impose a transaction tax -- and address the operational complexities involved.
Effective August 1, investors will be taxed on the purchase of French equities and naked sovereign credit default swaps. The French securities association AFTI has published a white paper detailing a set of recommendations on how the tax should be applied by custodian banks, but it has yet to be determined whether American Depositary Receipts of French corporations, or swap contracts will be affected. Also unclear is how the tax would be addressed in the event a trade fails to settle on time or whether buy-side firms can claim rebates if they purchase shares through one broker and sell the same shares with another. The tax, initially envisioned at 0.1 percent, has just been hiked to 0.2 percent.
The tax -- the brainchild of former French President Nicolas Sarkozy -- also has the blessings of the newly elected President Francois Hollande, but is opposed by the securities commission and some financial firms on the grounds it will lead to an exodus of trading from the French market. So far, the UK doesn't seem to have suffered that fate when it comes to its stamp duty reserve tax, but in the case of France there is plenty of concern that trading could shift to ADRs, rather than French-listed equities if ADRs are exempt from the tax.
Ironically, most high frequency trading firms -- which the tax was set to target -- are expected to avoid the tax partially, if not entirely. That is because the tax is based on a net daily buying position at the end of each day, rather than individual gross trades. Case in point: an investor has bought 100,000 French equities and sells 80,000 of the same equities the same day. The investor will pay a tax only on 20,000 shares. Even so, only 108 French equities will be affected and those are in companies with a market capitalization of over 1 billion Euros. Market making activities, as well as securities lending and borrowing activities, among others would be exempt.
"All of the uncertainty makes preparing back office systems pretty difficult," says Rebecca Healey, senior analyst for research firm Tabb Group in London. Custodian banks and broker dealers will have to charge their clients and if they don't know which assets will be exempt they cannot code their systems appropriately. There has been some market talk that derivatives will be exempt in a similar way as CFDs for UK equities, but until the final details are announced, no one knows for sure. How they expect this to be implemented by August 1 is anyone's guess right now."
Order management; portfolio management; custody and shareholder recordkeeping systems would need to be adapted to code any transaction in an affected French security. Without complete information it's going to be pretty difficult to do that and make any additional adjustments even with an anticipated grace period. Executing brokers, who are legally responsible for calculating and collecting the tax, will likely pass down the cost to their clients so client account and reporting systems must also be adjusted.
Unlike the UK's stamp duty collection system, France's transaction tax is not connected to France's settlement system. France's central securities depository Euroclear France will rely on a "standard declarations approach" it manages. The reason: "France's central securities depository does not have a complete view of all the taxable transactions," explains Dan Toledano, a director at Euroclear France. The tax applies to a larger scope of firms than are members of the depository and a significant number of the trades are internalized or netted on the books of Euroclear France's clients. The declarations will consist of a list of taxable or exempted transactions with details such as the trade date, settlement date, international securities identification number of the security involved, the amount of the tax in euros; and the reasons for any applicable exemptions.
Euroclear France's members will inform the French securities depository of how much tax they will pay Euroclear France, which in turn credits the tax to France's tax authority. In most cases the tax will be calculated by the executing broker based on the net buying position for each end investor each day; the information will then be sent by the executing broker to its settlement agent bank -- a member of Euroclear France -- to report to Euroclear France if the broker isn't a direct member of the securities depository. By contrast, the UK and Ireland's central securities depository Euroclear UK & Ireland is responsible for calculating UK stamp duty based on transactions settling on its books.
"We are prepared to start receiving the declarations as of August 1 and anticipate low activity at the start," says Toledano. "The financial transaction tax system is already in place on our testing platform and has been used by clients to sent tax declarations and verify their status. It is likely that the French tax authority will give firms until November 1 to start sending Euroclear France declarations and pay the central securities depository the transaction tax."
Taxable entities -- typically the executing broker -- can send Euroclear France tax declarations each day or one related to trading activity each month. At the latest, the payment must be sent to the French securities depository on the fourth day of the month after the eligible securities are bought.
Written by Chris Kentouris, Editor-in-chief (Chris can be contacted through Chris.Kentouris@hotmail.com)