Although there is a long way to go before FTT becomes a reality in the EU, family offices should begin to think about its potential impact.
From increased costs to clients resulting in diminished returns, to potentially having to explore new marketplaces for products -the introduction of FTT could present significant challenges.
Recently, the European Commission (EC) proposed a broad based tax on many financial transactions named Financial Transaction Tax (FTT). Since its proposal, FTT has triggered intense debate within the financial industry and among the political leadership across jurisdictions both within and outside of the European Union (EU). The FTT (also known as a Tobin or Robin Hood tax) has received unprecedented media coverage for what is ostensibly a tax-related matter. This is unsurprising however, considering the significant impact that FTT could have on the financial services industry and those who have a stake in it – including family offices. Family offices need to understand the scope and implications of FTT in order evaluate the extent to which they and their customers are impacted.
If adopted in its current form, FTT would apply across the EU. Given the opposition of certain EU countries, however, it is possible only a subset of EU countries might proceed with its introduction. For simplicity’s sake this article refers to FTT’s introduction in an EU wide context.
An EU wide debate on the merits of an FTT began in October of 2010 with the EC’s communication ‘Taxation of the Financial Sector.’ Draft FTT legislation was published on 28 September 2011.The EC estimates that FTT could raise €57bn each year in revenue, but there has been no agreement, even among the strong supporters of this tax, on how to spend it. The goals of an FTT are varied and include: reducing what the EC sees as undesirable financial transactions (such as high-frequency trading), repaying the significant public support for the financial industry during the financial
crisis and raising funds for the EC’s own budget. However, it is unclear whether FTT could achieve any of the stated goals.
FTT: The Basics
FTT is designed to apply to a wide range of financial transactions where one party is
‘established’ in the EU for the purposes of the tax and one of the parties is a financial institution. This could mean that non-EU financial institutions transacting with EU counterparties would be subject to FTT.
The definition of a financial institution is intentionally wide-ranging and catches banks, broker-dealers, hedge funds, insurance companies, pension funds and their managers, leasing companies, holding companies and exchanges. Interestingly, there is a ‘catch-all’ provision in the legislation which states that any undertaking can be considered a financial institution if a significant part of its overall activity,
in terms of volume or value, consists of carrying out financial transactions (including trading for own account or for the account of customers) In practice, this could mean that family offices could be considered a financial institution for FTT purposes where a major part of what they do is deal on own account or for their customers.
FTT would apply to the following transactions:
• the purchase and sale of
covered financial instruments;
• transfers of risk in a financial instrument between group companies; and
• derivatives.
Financial instruments affected include:
• shares, bonds, futures, structured products and units in a unit trusts and other collective investment schemes;
• sale and repurchase (repo) agreements and stock lending transactions,
even where these are treated as secured financing trades.
Certain financial transactions/products are exempted from FTT including spot foreign exchange transactions, mortgages, insurance and loans.
FTT would be charged at a minimum rate of 0.1% on the consideration paid in respect of all covered transactions except for derivatives. Derivatives would be subject to FTT at a rate of 0.01% based on the notional value of the derivative irrespective of the length of the contract or likely payment profile.
Implications for Family Offices
While it remains unclear if or when FTT would be implemented, it is not too early to think about how it could affect family offices.
For family offices, the implications could be wide-ranging and include:
• lower returns for clients;
• increased challenges in finding the best prices for financial transactions; and
• increased administrative and tax complexity for the family offices themselves.
Economically, rather than absorbing the cost of FTT, financial institutions are likely to pass it on to the end consumer. FTT could, therefore, represent an increased cost for each transaction in a financial product that a client of a family office undertakes. Accordingly, this would decrease the rate of return clients see on their respective portfolios. It could also increase the cost of hedging risks such as interest rates or currency exposure.
In addition, although the headline rate for most covered transactions is 0.1% the actual rate incurred by the end consumer could be higher, as the tax cascades throughout a transaction chain and applies to each financial transaction in a chain of trades with no exemption for financial intermediaries. Furthermore, FTT applies on both the sale and purchase of a covered financial product. Therefore, this can result in multiple FTT charges in connection with the same end product.
Sourcing products
Should FTT become law, the pricing of financial instruments may differ across jurisdictions, specifically between EU and non-EU markets. As a result, family offices may have to shop around for the best pricing – and may have to look outside of the EU to find the best price for a particular financial product.
Family offices – financial institutions?
Depending on the exact activities of a financial office, it is possible a family office could constitute a financial institution for the purposes of the FTT legislation. This would have negative consequences for family offices. For instance, this would add a significant compliance and risk burden to family offices if they were required to implement operational processes such as calculating, collecting and paying FTT to meet the compliance burden associated with being a financial institution.
It could also mean it would be cheaper for customers to deal directly with the market rather than through a family office. For example, if a French resident individual were to purchase a structured product directly from a bank in Hong Kong there would be no FTT charge as no EU financial institution is involved. Conversely, if a French family office which falls within the definition of financial institution were to purchase the same product, there could be two charges to FTT: one for the family office as the buying EU financial institution and one for the bank selling to an EU financial institution. In this situation, it would be necessary to consider carefully the role and set-up of family offices.
Being offshore would not necessarily insulate a family office from FTT. A family office may still economically suffer a charge to FTT if it deals with EU financial institutions. If a non-EU family office itself were to be a financial institution, it would face FTT payment and accounting obligations when transacting with customer and counterparties in the EU.
