Impact of the EU11 Financial Transaction Tax Proposal on CIVs and REITs

Transcription

1 International Hein Vermeulen* Impact of the EU11 Financial Transaction Tax Proposal on CIVs and REITs The author describes the impact of the financial transaction tax, as proposed under the EU11 Financial Transaction Tax Proposal, 1 on collective investment vehicles and real estate investment trusts Introduction After a brief introduction to the topic of collective investment as opposed to individual investment, this article will briefly examine whether collective investment vehicles (CIVs) and real estate investment trusts (REITs) fall within the scope of the EU11 financial transaction tax by testing the requirements which trigger financial transaction tax, i.e. a financial institution engaging in a financial transaction involving a financial instrument. As the outcome of that examination leads to the preliminary conclusion that CIVs and REITs indeed fall within the scope of the EU financial transaction tax, that analysis is then used when the article focuses more deeply on CIVs and REITs. This includes separate consideration of the relation between the investor and the CIV or REIT on the one hand, and the relation between the CIV or REIT and its investments on the other. 2. Collective Investment versus Individual Investment 2.1. General In the world of collective investment, i.e. investment through investment funds, a general distinction is made between individual and collective investment. An individual investment, also called a direct investment, is characterized by having a single investor invest in a certain investment. It is the investor itself that selects and makes the investment. A collective investment, also called an indirect investment, is characterized by having multiple investors invest jointly in certain investments through an intermediary vehicle, namely an investment fund. Now the investors do not select and make the investment, but rather that is done by the manager of the investment fund, the investment manager or management company. By doing so, the investors may benefit from the advantages of collective investment, such as economies of scale, risk diversification and access to the fund manager s expertise. * Professor, University of Amsterdam; researcher, Amsterdam Centre for Tax Law and the Amsterdam School of Real Estate; and associated with PwC. The author can be contacted at h.vermeulen@uva.nl. 1. COM(2013) 71 final. 2. This article is based on a presentation delivered at the Conference Issues and Challenges Concerning the Introduction of a Financial Transaction Tax in the European Union, held in Madrid on 17 February From economic double taxation to singular taxation Governments take a specific interest in collective investment, as it is of increasing importance in a society with a proportional rise in the ageing population, as a means for the public to save for later. 3 This has led governments to enact laws to ensure that the tax consequences of a collective investment are not worse than those of an individual investment. Such government action is required, as in the case of an individual investment, the taxation is limited to that of the investor, 4 as this typically leads to a singular taxation at the level of the investor. In the case of a collective investment, i.e. through an investment fund (the OECD typically names these funds collective investment vehicles (CIVs) or real estate investment trusts (REITs), depending on whether these vehicles invest in stocks, bonds or other securities on the one hand, or in real estate on the other), the investors are confronted with an additional level of taxation. The reason is that the CIV or REIT is typically treated as a corporate taxpayer and, as a consequence, is subject to corporate tax. Thus, the collective investment leads to economic double taxation. In addition to the taxation at the level of the investor, there is also the taxation at the level of the CIV or REIT. In order not to hamper collective investment, governments have introduced legislation that takes away this economic double taxation. These CIV and REIT laws are aimed at achieving a singular taxation, typically by eliminating entity-level taxation. The principle that underpins these pieces of legislation set forth here by the governments is the principle of tax neutrality on collective investment. This principle is recognized by many states, as well as the OECD, 5 the EU and the European Court of Justice (ECJ). An example within the EU is article 135(1)(g) of the EC VAT Directive. This provision stipulates that EU Member States must exempt the management of special investment funds as defined by Member States. The European Court of Justice held that the purpose of this exemption is to facilitate investment in securities by means of CIVs and REITs by excluding the cost of VAT. 6 This exemption is thus 3. For a more comprehensive description of collective investment, see H. Vermeulen (ed.), The Tax Treatment of Collective Investment Vehicles and Real Estate Investment Trusts (IBFD 2014), at Besides the taxation at the level of the investments. The author will not take into account this taxation at the level of the investments. 5. OECD, Centre for Tax Policy & Admin., Report on Tax Treaty Issues Related to REITs, (OECD 2008); OECD, Centre for Tax Policy & Admin., Report of the CFA on the Granting of Treaty Benefits with Respect to the Income of Collective Investment Vehicles (23 Apr. 2010). 6. E.g., UK: ECJ, 4 May 2006, Case C-169/04, Abbey National plc s(with Inscape Investments Ltd as Joined Party) v. Commissioners of Customs & Excise, ECJ Case Law IBFD; UK: ECJ, 28 June 2007, Case C-363/05, J.P. 176 DERIVATIVES & FINANCIAL INSTRUMENTS JULY/AUGUST 2014 IBFD

2 Impact of the EU11 Financial Transaction Tax Proposal on CIVs and REITs intended to ensure that VAT is fiscally neutral as regards the choice between individual, direct investment in securities and collective, indirect investment in securities through CIVs and REITs. The same holds true for investment through CIVs and REITs in other asset classes than securities, such as real estate Financial Transaction Tax in the Field of CIVs and REITs The question addressed here is whether CIVs and REITs are within the scope of the financial transaction tax. In order to have a taxable event under the financial transaction tax, there must be (i) a financial transaction regarding (ii) a financial instrument to which at least (iii) a financial institution is a party. 8 These elements are discussed below Financial institution The question addressed here is whether a CIV or REIT is a financial institution. The financial transaction tax employs a broad definition of what constitutes a financial institution. 9 The Explanatory Memorandum confirms this. It also regards collective investment vehicles and their managers as financial institutions. 10 Pursuant to article 1(8)(e) and (g) of the EU11 Financial Transaction Tax Proposal, the following entities are regarded as financial institutions: (1) an undertaking for collective investment in transferable securities (UCITS); (2) a management company of a UCITS; (3) an alternative investment fund (AIF); (4) an AIF manager (AIFM). A UCITS is an undertaking: (a) with the sole object of collective investment in transferable securities or in other liquid financial assets referred to in Article 50(1) of capital raised from the public and which operate on the principle of risk-spreading; and (b) with units which are, at the request of holders, repurchased or redeemed, directly or indirectly, out of those undertakings assets. 11 A management company is defined as a company, the regular business of which is the management of UCITS in the form of common funds or of investment companies (collective portfolio management of UCITS). 12 The management company mentioned under (2), above, thus is the (portfolio) manager of a UCITS, hereinafter also: UCITSM. Morgan Fleming Claverhouse Investment Trust plc & The Association of Investment Trust Companies v. Commissioners of HM Revenue & Customs, ECJ Case Law IBFD. 7. The Dutch Supreme Court recently asked the ECJ for a preliminary ruling in this regard. NL: SC, 1 Nov. 2013, 11/04540, ECLI:NL:HR:2013: M.P.J.C. Steinbusch, Financial Transaction Tax bij beleggingsfondsen: de deelnemers betalen het gelag, Vp-bulletin 3 (2013), at 12-1; M.P.J.C. Steinbusch, De EU Financial Transaction Tax bij beleggingsfondsen: de tweede ronde, Vp-bulletin 4 (2013), at See art. 1(8) EU11 Financial Transaction Tax Proposal. 10. COM(2013) 71 final, at Art. 1(2) Directive 2009/65/EC of the European Parliament and of the Council, OJ L 302, 17 Nov. 2009, at Art. 2(1)(b) Directive 2009/65/EC of the European Parliament and of the Council, OJ L 302, 17 Nov. 2009, at 32. AIFs are collective investment undertakings, including investment compartments thereof, which raise capital from a number of investors, with a view to investing it in accordance with a defined investment policy for the benefit of those investors and are not UCITS. 13 An AIF manager is defined as a legal person the regular business of which is managing one or more AIFs. 14 It follows from these definitions that both CIVs and REITs are financial institutions falling within the scope of the financial transaction tax. The same holds true for the managers of these CIVs and REITs, in cases where these funds are externally managed Financial transaction In addition to the broad definition of a financial institution, the financial transaction tax employs a broad definition of what constitutes a financial transaction. 16 A financial transaction includes the purchase and sale, 17 (intragroup) transfer and exchange of financial instruments. 18 In the author s opinion, it should be clear what constitutes an (intragroup) transfer or exchange of financial instruments. It is not or at least not at first sight clear what is meant by the purchase and sale of a financial instrument. From the Explanatory Memorandum, it follows that the purchase and sale of a financial instrument does not per se include the transfer of legal title of a financial instrument: 19 It is also not limited to the transfer of ownership but rather represents the obligation entered into, mirroring whether or not the party concerned assumes the risk implied by a given financial instrument ( purchase and sale ). In the author s opinion, the purchase and sale thus resembles some form of the concept of economic ownership. This concept is, for instance, used in the realm of permanent establishments falling within article 5 of the OECD Model Convention (OECD Model). By nature, a head office cannot transfer the legal title of a financial instrument to its permanent establishment. However, by applying a concept of economic ownership, a so-called dealing between the head office and the permanent establishment will be recognized under the separate entity approach laid down in article 7(2) of the OECD Model. 13. Art. 4(1)(a) Directive 2011/61/EU of the European Parliament and of the Council, OJ L 174, 1 July 2011, at Art. 4(1)(b) Directive 2011/61/EU of the European Parliament and of the Council, OJ L 174, 1 July 2011, at See art. 5(1)(b) Directive 2011/61/EU of the European Parliament and of the Council, OJ L 174, 1 July 2011, at 1. ( The AIFM shall be either [ ] where the legal form of the AIF permits an internal management and where the AIF s governing body chooses not to appoint an external AIFM, the AIF itself, which shall then be authorised as AIFM ). 16. See art. 1(2) EU11 Financial Transaction Tax Proposal. 17. This does not per se include transfer of legal title. See the Explanatory Memorandum, COM(2013) 71 final, at 8 ( It is also not limited to the transfer of ownership but rather represents the obligation entered into, mirroring whether or not the party concerned assumes the risk implied by a given financial instrument ( purchase and sale ).) In the author s opinion, this resembles the concept of economic ownership. 18. See art. 1(2)(a), (b) and (d) EU11 Financial Transaction Tax Proposal. 19. COM(2013) 71 final, at 8. IBFD DERIVATIVES & FINANCIAL INSTRUMENTS JULY/AUGUST

3 Hein Vermeulen 3.3. Financial instruments In the Explanatory Memorandum it is mentioned that the financial transaction tax aims at covering transactions relating to all types of financial instruments, including units and shares in UCITS and AIFs. 20 Legally, a financial instrument is either a structured product or a financial instrument within the meaning of the Directive on Markets in Financial Instruments (MIFID). 21 As the name of that Directive already indicates, it contains a rather broad definition of a financial instrument (see section ). Structured products are: tradable securities or other financial instruments offered by way of a securitization within the meaning of Article 4(36) of Directive 2006/48/EC of the European Parliament and of the Council or by way of equivalent transactions involving the transfer of risks other than credit risk. 22 The latter Directive defines securitization as: a transaction or scheme, whereby the credit risk associated with an exposure or pool of exposures is tranched, having the following characteristics: (a) payments in the transaction or scheme are dependent upon the performance of the exposure or pool of exposures; and (b) the subordination of tranches determines the distribution of losses during the ongoing life of the transaction or scheme. According to the Explanatory Memorandum, structured products are comparable to any other financial instrument and thus need to be covered by the term financial instrument. 23 Examples mentioned in the Explanatory Memorandum include notes, warrants and certificates, as well as banking and insurance securitizations. 24 In the author s opinion, there is some overlap between financial instruments and structured products, as for instance notes which the Explanatory Memorandum mentions as structured products will also qualify as financial instruments under the MIFID. In conclusion the shares and units in a CIV or a REIT fall within the definition of a financial instrument. Further, typical investments in which a CIV or a REIT would invest will also be regarded as financial instruments, although an investment in directly held real estate will not be regarded as a financial instrument Preliminary conclusions The author concludes that CIVs and REITs are within the scope of the financial transaction tax. In the field of CIVs and REITs, financial transaction tax will have an impact, as the three elements explored here above, namely (i) financial transaction, (ii) financial instrument, and (iii) financial institution, play a significant role in the operations of CIVs and REITs. The exact impact will be further explored below. 20. COM(2013) 71 final, at Section C of Annex I to Directive 2004/39/EC of the European Parliament and of the Council, OJ L 145, , at See art. 1(7) EU11 Financial Transaction Tax Proposal. 23. COM(2013) 71 final, at COM(2013) 71 final, at The Two Sides of a CIV and REIT When analysing tax issues in the field of CIVs and REITs, the author considers separately the relation between the investor and the CIV or REIT on the one hand, and the relation between the CIV or REIT and its investments on the other The investor and the CIV or REIT The author refers to the relation between the investor and the CIV or REIT as the top of the CIV or REIT. In this regard, it is worthwhile to reiterate that the financial transaction tax is not supposed to have an impact on households. 25 The Explanatory Memorandum mentions that most day-to-day financial activities relevant for citizens and businesses remain outside the scope of the financial transaction tax. 26 It gives the following examples of activities which should not be subject to financial transaction tax: 27 conclusion of insurance contracts; mortgage lending; consumer credit; enterprise loans; and payment services. The reasoning to support this statement can also be found in the preamble to the EU11 Financial Transaction Tax Proposal: With the exception of the conclusion or material modification of derivative contracts, the trade on primary markets and transactions relevant for citizens and businesses such as conclusion of insurance contracts, mortgage lending, consumer credits or payment services should be excluded from the scope of FTT, so as not to undermine the raising of capital by companies and governments and to avoid impact on households. 28 This is reiterated in the original press release 29 and the accompanying memorandum Transactions at the top CIV or REIT Acquisition of an existing share or unit If an investor acquires an existing share or unit in a CIV or REIT, either a UCITS or an AIF, either traded on an organized market or over-the-counter 31 from a financial institution, financial transaction tax is due as this constitutes a taxable event, in that there is (i) a purchase and sale of (ii) a financial instrument in the form of a unit in a collective investment undertaking and (iii) a financial institution (the CIV or REIT) is party to this financial transaction COM(2013) 71 final, at 17, preamble COM(2013) 71 final, at COM(2013) 71 final, at COM(2013) 71 final, at 17, preamble Press release, European Commission, Financial Transaction Tax: Making the Financial Sector Pay Its Fair Share (28 Sept. 2011), IP/11/ Press release, European Commission, Common Rules for a Financial Transaction Tax Frequently Asked Questions (28 Sept. 2011), MEMO/11/ COM(2013) 71 final, at See art. 3(1) j 1(2)(a) EU11 Financial Transaction Tax Proposal; Section C of Annex I to Directive 2004/39/EC, under (3). 178 DERIVATIVES & FINANCIAL INSTRUMENTS JULY/AUGUST 2014 IBFD

4 Impact of the EU11 Financial Transaction Tax Proposal on CIVs and REITs Alienation of an existing share or unit For equal reasons as mentioned, above, the same holds true if the investor decides to alienate this share or unit in a CIV or REIT. Financial transaction tax will then also be due Acquisition of a newly issued share or unit In principle, the acquisition of a newly issued share or unit in a CIV or REIT leads to the same result, in that financial transaction tax is triggered. Again, there is (i) a purchase and sale of (ii) a financial instrument in the form of a unit in a collective investment undertaking and (iii) a financial institution is party to this financial transaction. The Explanatory Memorandum, however, mentions two arguments, why in this particular case financial transaction tax should not be due. 33 Firstly, the Directive concerning indirect taxes on the raising of capital prohibits taxation. 34 In particular, article 5(1)(a) of that Directive prohibits subjecting capital companies 35 to any form of indirect tax whatsoever in respect of a contributions of capital. Secondly, and in the author s opinion, more principally, the Explanatory Memorandum mentions that the socalled single treatment of issuances by CIVs or REITs requires that no financial transaction tax be levied: Moreover, [ ] considerations of tax neutrality require the single treatment of issuances by all these [collective investment] undertakings. 36 This argument can also be found in the preamble to the EU11 Financial Transaction Tax Proposal: The provisions of Council Directive 2008/7/EC of 12 February 2008 concerning indirect taxes on the raising of capital continue to be fully applicable. Article 5(1)(e) and (2) of that Directive is relevant to the area covered by this Directive and prohibits, subject to Article 6(1)(a) of that Directive, the imposition of any tax whatsoever on the transactions referred to in its provisions. Transactions in respect of which Directive 2008/7/EC prohibits or could prohibit the imposition of taxes should therefore not be subject to FTT. Independently from the extent to which Directive 2008/7/ EC prohibits taxation of the issuance of shares and units collective investment undertakings, considerations of tax neutrality require a single treatment of issuances by all these undertakings. 37 The author interprets these quoted passages on so-called single treatment such that the principle of tax neutrality on collective investment which requires that the tax consequences of a collective investment not be worse than those of an individual investment, mentioned in section 2.2. is also acknowledged in the field of the financial transaction tax. This would mean that also in the field of financial transaction tax should the tax consequences of collective investment be equal to those of individual investment. 33. COM(2013) 71 final, at Council Directive 2008/7/EC of 12 February 2008 concerning indirect taxes on the raising of capital, OJ L 46, 21 Feb. 2008, at The author takes it that companies also include entities that take a different form than companies with separate capital, such as limited partnerships with tradable units. 36. COM(2013) 71 final, at COM(2013) 71 final, at 17, preamble 9 (emphasis added). However, the author finds that this principle is afforded a narrow scope. Under the EU11 Financial Transaction Tax Proposal, only the acquisition of a newly issued share or unit in a CIV or REIT does not trigger financial transaction tax. The acquisition of an existing share or unit in a CIV or REIT will trigger financial transaction tax and so will the redemption of such an interest trigger financial transaction tax. The reason is that article 3(4)(a) of the EU11 Financial Transaction Tax Proposal stipulates merely that primary market transactions, including the activity of underwriting and allocation of financial instruments in the framework of their issue, are outside the scope of the EU11 Financial Transaction Tax Proposal. This provision thus has an eye solely on primary market transactions (such as issuance, allotment or subscription) in financial instruments falling within Article 4(1)(18)(a) and (b) of the MIFID. 38 Under the MIFID these financial instruments are defined as transferable securities. 39 In the author s opinion, this includes both shares in capital companies and units in a CIV or REIT that takes the form of a contractual or fiduciary arrangement, provided that these meet the condition of transferability. 40 This is more or less implicitly confirmed in the Explanatory Memorandum, where it is stated that: 41 the issue of units and shares of UCITS and AIF is no longer considered not to be a primary market transaction. Here it is stated that the issue of units and shares of UCITS and AIFs, which may take the form of a company, trust or contractual or fiduciary arrangement, are principally considered to be a primary market transaction, to which the EU11 Financial Transaction Tax Proposal, however, does not apply pursuant to a specific exception to the principal rule under article 4(4)(a) of the EU11 Financial Transaction Tax Proposal Redemption of a share or unit Where the issuance of new units and shares of UCITS and AIFs does not trigger financial transaction tax due to the above-mentioned primary market exemption, the redemption of a share or unit in a CIV or REIT conversely will trigger financial transaction tax. This is also confirmed in the Explanatory Memorandum: 42 The redemption of shares and units thus issued are, however, not in the 38. Regulation (EC) 1287/2006, implementing Directive 2004/39/EC of the European Parliament and of the Council as regards recordkeeping obligations for investment firms, transaction reporting, market transparency, admission of financial instruments to trading, and defined terms for the purposes of that Directive, OJ L 241, 2 Sept. 2006, at See art. 4(1)(18)(a) and (b) Directive on Markets in Financial Instruments ( Transferable securities means those classes of securities which are negotiable on the capital market, with the exception of instruments of payment, such as: (a) shares in companies and other securities equivalent to shares in companies, partnerships or other entities, and depositary receipts in respect of shares; (b) bonds or other forms of securitised debt, including depositary receipts in respect of such securities.). 40. See also H. Vermeulen & C. Grundmann-van de Krol, Enige opmerkingen over het financieel instrument en de VBI, Weekblad fiscaal recht 2010/6845, at COM(2013) 71 final, at COM(2013) 71 final, at 9. IBFD DERIVATIVES & FINANCIAL INSTRUMENTS JULY/AUGUST

5 Hein Vermeulen nature of a primary market transaction and should thus be taxable Sale of issued share or unit between private individual investors The trading of an existing share or unit in a CIV or REIT will trigger financial transaction tax if a financial institution is a party to the transaction. As a consequence, the sale on a stock exchange will trigger financial transaction tax, as a financial intermediary must be used to have an investor selling his interest in the CIV or REIT. However, if an existing share or unit in a CIV or REIT changes hands from the one private individual investor to another private individual investor without the assistance of a financial intermediary, in the author s opinion, no financial transaction tax should be due, as no financial institution is party to the transaction. 43 In practice, this will rarely occur, in the author s opinion Dividend payments If a CIV or REIT makes a dividend payment in cash, which could well be required under distribution requirements set by an applicable legal statute on such a CIV or REIT, no financial transaction tax will be due, as the mere payment of a dividend does not constitute a financial transaction within the meaning of article 1(2) of the EU11 Financial Transaction Tax Proposal. If, however, a stock dividend is made, for instance because the CIV or REIT lacks liquidity, financial transaction tax could be due if the shares or units so issued are not newly issued, but rather are existing shares or units held in stock Preliminary conclusions In the relation between the investor and the CIV or REIT (top of the CIV or REIT), financial transaction tax plays an important role, as the typical transactions in that sphere trigger financial transaction tax, such as the acquisition, sale or redemption of shares and units of CIVs and REITs and the payment of stock dividends. Only the issuance of new shares and units of CIVs and REITs falls outside the scope of the financial transaction tax due to the primary market exemption. In the author s opinion, the principle of tax neutrality on collective investment is thus afforded only a very narrow scope. This can be justified when taking into account that the Directive concerning indirect taxes on the raising of capital prohibits taxation insofar as it prohibits subjecting capital companies to any form of indirect tax whatsoever in respect of a contribution of capital. However, the narrow scope cannot be justified by the principle of tax neutrality on collective investment. The Explanatory Memorandum does not make clear why that principle should be taken to limit the non-levying of financial transaction tax to primary market transactions only. The author would expect that any transaction between the investor and the 43. See art. 3(1) EU11 Financial Transaction Tax Proposal. 44. See art. 3(1) EU11 Financial Transaction Tax Proposal. CIV or REIT should be outside the scope of financial transaction tax, given that in the case of a direct investment, there would not an intermediary which triggers financial transaction tax. This would be in line with the multiple statements that households will not be affected by financial transaction tax The CIV or REIT and its investments The author refers to the relation between the CIV or REIT and its investments as the bottom of the CIV or REIT. The author takes as a working assumption that investors pool moneys in a CIV or REIT by acquiring newly issued units or shares in these investment funds. As a primary market transaction, such pooling of funds will as discussed above not lead to the levying of financial transaction tax. 46 As a consequence of the pooling of moneys, the CIV or REIT then possesses funds that will be invested at the discretion of the manager of the CIV or REIT. The question at hand is whether such investment will trigger financial transaction tax. The author will first look at the investments and then assesses the CIV and REIT separately, followed by a discussion on the cascading effect that occurs as soon as intermediate structures are used Financial instruments As described above (see section 3.1.), a CIV or REIT will be regarded as a financial institution falling within the scope of the financial transaction tax. The question remains therefore, as to whether the investment of the pooled moneys by these institutions constitutes financial transactions involving financial instruments under the financial transaction tax. Given the broad description of a financial transaction (see section 3.2.) and the additional working assumption that regulatory framework typically demand that any legal title to investments be secured to protect the investors, the author supposes that any investment by a CIV or REIT will qualify as a financial transaction. This leaves open the question as to whether the investment selected by the CIV or REIT constitutes a financial instrument. As described in section 3.3., these are foremost financial instruments within the meaning of section C of Annex I to the MIFID. That section contains an impressive list of what constitutes financial instruments. 47 In addition, the 45. Press release. European Commission, Financial Transaction Tax: Making the Financial Sector Pay Its Fair Share, 28 Sept. 2011, IP/11/1085, Press release, European Commission, Common Rules for a Financial Transaction Tax Frequently Asked Questions, 28 Sept. 2011, MEMO/11/640, COM(2013) 71 final, at 17, preamble Art. 4(4)(a) EU11 Financial Transaction Tax Proposal. 47. Section C of Annex I to Directive 2004/39/EC defines financial instruments as: (1) Transferable securities; (2) Money-market instruments; (3) Units in collective investment undertakings; (4) Options, futures, swaps, forward rate agreements and any other derivative contracts relating to securities, currencies, interest rates or yields, or other derivatives instruments, financial indices or financial measures which may be settled physically or in cash; (5) Options, futures, swaps, forward rate agreements and any other derivative contracts relating to commodities that must be settled 180 DERIVATIVES & FINANCIAL INSTRUMENTS JULY/AUGUST 2014 IBFD

6 Impact of the EU11 Financial Transaction Tax Proposal on CIVs and REITs category under (1), transferable securities, entails a broad range of instruments. Consider the definition in article 4(18) of that Directive: Transferable securities means those classes of securities which are negotiable on the capital market, with the exception of instruments of payment, such as: (a) shares in companies and other securities equivalent to shares in companies, partnerships or other entities, and depositary receipts in respect of shares; (b) bonds or other forms of securitised debt, including depositary receipts in respect of such securities; (c) any other securities giving the right to acquire or sell any such transferable securities or giving rise to a cash settlement determined by reference to transferable securities, currencies, interest rates or yields, commodities or other indices or measures. It follows from this definition of financial instruments and the fact that the category transferable securities include shares, bonds and comparable instruments, that the MIFID contains a rather broad definition of a financial instrument. Nomen est omen. For the sake of completeness, the author notes that this is a different definition than that of transferable securities or other liquid financial assets referred to in article 50(1) of the UCITS Directive CIVs The OECD CIV Report, as adopted by the OECD Committee on Fiscal Affairs, contains the following definition of CIVs: [f]unds that are widely-held, hold a diversified portfolio of securities and are subject to investor-protection regulation in the country in which they are established. 48 Taking this definition as a reference, the investment of the CIV will be in securities. In the author s opinion, these will fall under the extensive definition of financial instruments within the meaning of the MIFID. The result is that in cash or may be settled in cash at the option of one of the parties (otherwise than by reason of a default or other termination event); (6) Options, futures, swaps, and any other derivative contract relating to commodities that can be physically settled provided that they are traded on a regulated market and/or an MTF; (7) Options, futures, swaps, forwards and any other derivative contracts relating to commodities, that can be physically settled not otherwise mentioned in C.6 and not being for commercial purposes, which have the characteristics of other derivative financial instruments, having regard to whether, inter alia, they are cleared and settled through recognised clearing houses or are subject to regular margin calls; (8) Derivative instruments for the transfer of credit risk; (9) Financial contracts for differences. (10) Options, futures, swaps, forward rate agreements and any other derivative contracts relating to climatic variables, freight rates, emission allowances or inflation rates or other official economic statistics that must be settled in cash or may be settled in cash at the option of one of the parties (otherwise than by reason of a default or other termination event), as well as any other derivative contracts relating to assets, rights, obligations, indices and measures not otherwise mentioned in this Section, which have the characteristics of other derivative financial instruments, having regard to whether, inter alia, they are traded on a regulated market or an MTF, are cleared and settled through recognised clearing houses or are subject to regular margin calls. 48. See OECD, Ctr. for Tax Policy & Admin., The Granting of Treaty Benefits with Respect to Income of Collective Investment Vehicles (23 Apr. 2010), International Organizations Documentation IBFD. nearly any investment by a CIV can be regarded as a financial instrument. In addition, if a CIV engages in securities lending, which represents a potential valuable stream of income for CIVs, financial transaction tax will also be due. Securities lending is defined in article 2(1)(3) of the EU11 of the Financial Transaction Tax Proposal. Further, it is acknowledged in the Explanatory Memorandum that securities lending is within the scope of the financial transaction tax: 49 Exchanges of financial instruments and repurchase and reverse repurchase and securities lending and borrowing agreements are explicitly included into the scope of the tax. According to research of the Alternative Investment Management Association (AIMA), this leads to an opportunity cost for CIVs. 50 Only in some instances will the CIV not be confronted with financial transaction tax, e.g. if the CIV holds liquid assets in a bank account or acquires newly issued shares REITs The OECD REIT Report contains the following description of REITs: A REIT may be loosely described as a widely held company, trust or contractual or fiduciary arrangement that derives its income primarily from long-term investment in immovable property, distributes most of that income annually and does not pay income tax on the income related to immovable property that is so distributed. 51 Using this description, the investment of a REIT will be in immovable property. A REIT that limits its investment to directly held real estate will not engage in a transaction involving financial instruments and will consequently not be confronted with financial transaction tax. The same conclusion may be drawn if the investors in the REIT would have made an individual investment in directly held real estate However, REITs may also invest in other ways. The US REIT, for instance, may also invest in mortgages secured by real estate and shares of other REITs, cash or government securities. 52 The same goes for the Dutch REIT, 53 which also may invest in indirectly held real estate, i.e. in shares of companies which, in turn directly or indirectly own the real estate. In many cases, therefore, the REIT will still be confronted with financial transaction tax, e.g. when it acquires shares in a real estate company, government bonds etc., as there is a financial institution engag- 49. COM(2013) 71 final, at AIMA research note Financial Transaction Tax: an assessment of the European Commission s proposed Financial Transaction Tax, at 18. This note can be found on OECD, Ctr. for Tax Policy & Admin., Tax Issues Related To REITS, (30 October 2007), approved of in the 2008 OECD update, International Organizations Documentation IBFD. 52. W.A. Taylor & H. Vermeulen, What Do We Have in Common? What Can We Learn from Each Other? A Comparative Study of US and Dutch REITs, 67 Bull. Intl. Taxn. 12 (2013), at Taylor & Vermeulen, supra n. 52. IBFD DERIVATIVES & FINANCIAL INSTRUMENTS JULY/AUGUST

7 Hein Vermeulen ing in a financial transaction involving a relevant financial instrument Cascading of the tax 1.0 and 2.0 The investment trough CIVs and REITs will lead to two types of a cascade of the tax: cascading of the tax 1.0 and Cascading of the tax 1.0 A transaction, such as a regular sale, between two financial institutions triggers double financial transaction tax. The author defines this effect as cascading of the tax 1.0. The reason for this double financial transaction tax is that all conditions are met twice simultaneously. 54 The financial transaction tax only prohibits that any side of a single transaction be taxed more than once. 55 Consider also the Explanatory Memorandum, in which it is stated that: [ ] the scope of the tax is focused on financial transactions carried out by financial institutions acting as party to a financial transaction, either for their own account or for the account of other persons, or acting in the name of a party to the transaction Cascading of the tax 2.0 In addition to this type of cascading of the tax, another type of cascading of the tax can be identified. This cascading of the tax 2.0 is the result of the use of a chain of intermediaries that fall within the broad definition of a financial institution, and the fact that almost any transaction performed by a financial institution will be recognized as a taxable event. According to the Explanatory Memorandum, it does not matter in which capacity the financial institution acts: However, the scope of the tax is focused on financial transactions carried out by financial institutions acting as party to a financial transaction, either for their own account or for the account of other persons, or acting in the name of a party to the transaction. 57 However, some relief is offered under article 10(2) of the EU11 Financial Transaction Tax Proposal: Where a financial institution acts in the name or for the account of another financial institution only that other financial institution shall be liable to pay FTT. This clause is discussed in the Explanatory Memorandum as follows: However, in order to avoid a certain cascade of the tax, when a financial institution acts in the name or for the account of another financial institution, only that other financial institution should pay the tax. 58 Article 10(2) of the EU11 Financial Transaction Tax Proposal was already included in the original proposal, in article 9(2). Then no remarks were made on the certain cascade of the tax, as is done in the current proposal. The 54. See also M.P.J.C. Steinbusch, Financial Transaction Tax bij beleggingsfondsen: de deelnemers betalen het gelag, Vp-bulletin 3 (2013), at COM(2013) 71 final, at 18, preamble COM(2013) 71 final, at COM(2013) 71 final, at COM(2013) 71 final, at 9. original proposal gave rise to significant criticism because of the cascading effect of the tax. 59 Multiple layers of financial transaction tax will thus firstly be charged in the intermediary chain of intermediaries that are needed to facilitate the transaction of an investor. Secondly, it is common practice to work with multiple layers of CIVs, such as master-feeder structures and fundof-funds structures. The EU11 financial transaction tax offers an escape from the cascading effect if a financial institution acts in the name or for the account of another financial institution. However, this supposes that these financial institutions act on a disclosed agent basis. This is not common practice, as can be derived from the note of the European Fund and Asset Management Association (EFAMA) on the potential impact of the (new) EU11 Financial Transaction Tax Proposal. 60 In addition, the CIV Report discussed below shows that the use of so-called omnibus accounts is also common Intermediaries It is important to understand the operations of a CIV in practice. The OECD has done some work in this regard through the Informal Consultative Group on the Taxation of Collective Investment Vehicles and Procedures for Tax Relief for Cross-Border Investors. Its report, on Possible Improvements to the Procedures for Tax Relief for Cross Border Investors, 61 describes the use of intermediated structures in the field of CIVs and REITs. It refers to intermediated structures as the holding of securities, including interests in CIVs, through one or more financial intermediaries. The Report addresses issues in any situation in which payment is not made directly from the issuer to the investor. 62 It states as follows on the use of intermediated structures: 4. The international financial system is built around financial intermediaries. Investments worth tens of trillions of U.S. dollars are held through financial intermediaries worldwide. This intermediation takes many forms, from global custodians, to omnibus accounts maintained by securities dealers, to pooled vehicles for pension funds, to classic, widely-held mutual funds. 5. In all of these intermediated structures, there may be a number of layers between the issuer of a security and the beneficial owner. Small investors deal with their local financial institutions, which may purchase and hold securities on their behalf. The investor knows that payments on those securities, or gains from the sales of those securities, are credited to their accounts with those local financial institutions, but in most cases likely is unaware of the 59. AIMA research note, Financial Transaction Tax: an assessment of the European Commission s proposed Financial Transaction Tax; M.P.J.C. Steinbusch, Financial Transaction Tax bij beleggingsfondsen: de deelnemers betalen het gelag, Vp-bulletin 3 (2013), at 15 (referring to the AIMA research note). This note is available at European Fund and Asset Management Association (EFAMA), Note: Potential Impact of the New Version of the FTT on the UCITS Industry (14 Mar. 2013), available at OECD, Report of the Informal Consultative Group on the Taxation of Collective Investment Vehicles and Procedures for Tax Relief for Cross-Border Investors on Possible Improvements to the Procedures for Tax Relief for Cross Border Investors (12 Jan. 2009). See ties/ pdf. 62. OECD, CIV Report, supra n. 61, at DERIVATIVES & FINANCIAL INSTRUMENTS JULY/AUGUST 2014 IBFD

8 Impact of the EU11 Financial Transaction Tax Proposal on CIVs and REITs Diagram: process by which payments on the securities flow to that account. In fact, there are a number of different patterns, as the local financial institution has a number of options regarding how it will hold the securities on behalf of its clients. 6. In most markets, the vast quantity of publicly traded securities are held or immobilized in one or more Central Securities Depositories ( CSDs ). However, the number and identity of intermediaries between the CSD and the ultimate investor may vary greatly. ( ) 7. The above summary is not exhaustive and various other intermediaries may be interposed between the investor and the security issuer, including private banks, investment managers and CSDs in the investor s country of residence. Separate contractual agreements will normally be in place between each party in the chain (e.g. between the investor and the global custodian, between the global custodian/icsd and the local agent, etc.). 8. In addition, most intermediaries have, where possible, adopted the practice of holding securities on a fungible basis in omnibus accounts which contain securities pertaining to several beneficial owners in order to maximise the efficiencies of the multi-tiered holding structure. As a result, the ultimate investor s ownership interest frequently may not be shown in the books of the issuer, the (I)CSD or other upstream intermediary, except the particular intermediary with which it has a direct contractual relationship. The investors direct intermediary will typically hold the security in an omnibus account with the CSD or other intermediary at the next level up the multi-tiered structure. 9. Income payments arising from securities typically will flow from the issuer to its paying agent and from the paying agent through the relevant intermediaries to the end investors OECD, CIV Report, supra n. 61, at 6-8. The Report further contains the above Diagram to explain the use of intermediaries. 64 It follows from this Diagram that income payments arising from securities typically will flow from the issuer to its paying agent, and from the paying agent through the relevant intermediaries to the end investors. When a private individual places an order with his or her bank to acquire units in a certain CIV or REIT, the following chain of intermediaries can be found: 65 [Client Bank Distribution Platform Custodian Broker Clearing House] Between each link in the chain, one could recognize (i) a financial transaction, (ii) a financial instrument and (iii) one or more financial institutions. The author also refers to Van Veen, who gives the following description: Another common example is a broker/clearer which acts on instruction of an asset manager that acts for and on behalf of a depositary, which depositary acts on behalf of a pooling vehicle, which pooling vehicle acts for and on behalf of its participants, after which the trade order entered by the broker is novated by the central counterparty into a direct contract with the buyer and the seller. 66 Unless article 10(2) of the EU11 Financial Transaction Tax Proposal applies or the exemption for central coun- 64. OECD, CIV Report, supra n. 61, at See presentation by M.P.J.C. Steinbusch on financial transaction tax, 9 Dec. 2011, ACTL Conference, Taxing the Financial Sector: the Financial Transaction. 66. W.J. van Veen, How the Financial Transaction Tax Affects Pension Funds, 15 Derivs. & Fin. Instrums. 5a (2013), at 16. IBFD DERIVATIVES & FINANCIAL INSTRUMENTS JULY/AUGUST

9 Hein Vermeulen terparties (where exercising the function of a central counterparty) 67 or central securities depositories and international central securities depositories (where exercising the function of a central securities depository or international central securities depository) 68 applies, the cascading effect will lead to multiple financial transaction tax in a chain of intermediaries. 69 Peters notes that clearing members fall outside this exemption. 70 In this regard, Steinbusch mentions research of the abovementioned Alternative Investment Management Association which shows that the financial transaction tax burden may rise to 2.2% as a result of the use of intermediaries. 71 The amount of 2.2% represents the lifetime effective financial transaction tax rate, taking into account an investor s buying, holding and selling a unit in a CIV, assuming notably, that the CIV s portfolio is static. 72 In real life, however, the portfolio of a CIV is dynamic, which is required by sound investment practice that, among other things, demands diversification and hedging for risk management purposes Multiple layers CIVs and REITs In addition, the cascading of the tax will also arise if a CIV has multiple layers which are used to achieve economies of scale, for instance in master-feeder structures. In such a structure, on top of the CIV one or more feeder funds are in place which channel the funds of certain investors. An example would be a master fund for private individuals, with one feeder fund for exempt investors (such as pension funds) and another feeder fund for taxable investors (such as insurance companies). Further, asset pooling will also be adversely affected by the cascading effect. Finally, socalled fund of funds, where the CIV invests in other CIVs, will be confronted with an additional cascade of financial transaction tax, in addition to the cascade that occurs through the use of intermediaries. The author doubts whether in these cases article 10(2) of the EU11 Financial Transaction Tax Proposal provides a solution Preliminary conclusions In the relationship between the CIV or REIT and its investments (the so-called bottom of a CIV or REIT), financial transaction tax also plays an important role, as a CIV or REIT will typically invest the moneys that it has under management in financial instruments. Only, a mere 67. See art. 3(2)(a) EU11 Financial Transaction Tax Proposal. 68. See art. 3(2)(b) EU11 Financial Transaction Tax Proposal. 69. The author notes that a secondary liability applies to these parties. See art. 9(3) EU11 Financial Transaction Tax Proposal. 70. M.J. Peters, Capita Selecta of the Financial Transaction Tax Proposed under EU Council Directive 2011/594, in D.M. Weber & O.C.R. Marres (eds.), Taxing the Financial Sector: Financial Taxes, Bank Levies and More (IBFD 2012), at 25 et seq. 71. M.P.J.C. Steinbusch, Financial Transaction Tax bij beleggingsfondsen: de deelnemers betalen het gelag, Vp-bulletin 3 (2013), at 15, (referring to AIMA research note, Financial Transaction Tax: An Assessment of the European Commission s Proposed Financial Transaction Tax, available at AIMA Research Note, Financial Transaction Tax: An Assessment of the European Commission s Proposed Financial Transaction Tax, at 18, available at deposit in a bank account or an investment in directly held real estate will be outside the scope of financial transaction tax, as no financial instruments are involved in such case. In addition to a CIV or REIT incurring financial transaction tax on its investments, the phenomenon of the cascading of tax is a serious result, due to the intermediation of the financial industry, which is often required under regulations that seek to protect investors. It may be questioned whether article 10(2) of the EU11 Financial Transaction Tax Proposal is a suitable remedy for this phenomenon. Research shows that the financial transaction tax burden is increased heavily in this regard. Due to typical fund structures, the cascading of tax will also occur in multiple layer CIVs and REITs. 5. Conclusion The author concludes that CIVs and REITs are within the scope of the financial transaction tax. In the field of CIVs and REITs, financial transaction tax will have an impact, as the three relevant financial transaction tax elements, namely (i) financial transaction, (ii) financial instrument and (iii) financial institution, play a significant role in the operations of CIVs and REITs. In the relation between the investor and the CIV or REIT (top of the CIV or REIT), financial transaction tax plays an important role, as typical transactions in that sphere trigger financial transaction tax, such as the acquisition, sale or redemption of shares and units of CIVs and REITs and the payment of stock dividends. Only the issuance of new units and shares of CIVs and REITs falls outside the scope of the financial transaction tax under the primary market exemption. In the author s opinion, the principle of tax neutrality on collective investment is thus afforded only a very narrow scope. This can be justified when taking into account that the Directive concerning indirect taxes on the raising of capital prohibits taxation insofar it prohibits subjecting capital companies to any form of indirect tax whatsoever in respect of a contribution of capital. The narrow scope can, however, not be justified by the principle of tax neutrality on collective investment. The Explanatory Memorandum does not make clear why that principle should be taken to limit the non-levying of financial transaction tax to primary market transactions only. The author would expect that any transaction between the investor and the CIV or REIT would fall outside the scope of financial transaction tax, given that in the case of a direct investment, there would not be an intermediary which triggers financial transaction tax. This would be in line with the multiple statements that households will not be affected by financial transaction tax. In the relationship between the CIV or REIT and its investments (bottom of a CIV or REIT), financial transaction tax also plays an important role, as a CIV 184 DERIVATIVES & FINANCIAL INSTRUMENTS JULY/AUGUST 2014 IBFD