Financial Transactions Tax—Spain and Beyond

After a challenging year, banks now have another operational challenge to confront at the start of 2021. In October, the Spanish Senate approved a bill that introduces a tax of 0.2% on the purchase of shares in Spanish-listed companies with a market capitalization above 1 billion euros ($1.9 billion). With the implementation of this new financial transactions tax (FTT) in January, financial institutions have less than two months to update their internal systems to meet the new requirements.

Hungary and Portugal are also considering their own FTTs; Germany and France are leading a 10-country push for an EU-wide FTT; individual U.S. states are weighing their own measures; and jurisdictions around the world are looking at FTTs as a potential source of funds to replenish budgets ravaged by the global pandemic. The increase in such moves indicates an evolving need for global market technology solutions to address these taxes and the nuances involved.

Issues Around Implementation

Many assume that the only cost comes from the tax itself. However, as with other regulations, the implementation of a new tax regime comes with a “soft cost” related to the implementation of new operational processes and software. These extras can potentially dwarf the cost of the tax itself. For example, the 871(m) protocol in the U.S. generated very small amounts of IRS revenues from dividends paid to foreign investors in equity derivatives. However, it required enormous internal bank expenditure for operational and compliance purposes.

Upon closer inspection, banks have historically operated in silos, their tax systems following suit. With the introduction of the French and Italian FTTs in 2012 and 2013 respectively, many financial houses implemented two different tactical solutions, adapting workarounds to accommodate the individual rule sets that applied to in-scope securities in France and Italy. Spain’s new rules stand to put additional pressure on already stretched tax operations teams, so a piecemeal approach for managing different FTT rule sets is simply not scaleable, nor is it sustainable.

While individual tax systems may mirror one another on a fundamental level, the specific requirements of each system complicate coding and data processing. For example, the Italian FTT covers derivatives as well as cash equities, while the French and Spanish systems have their own rules around netting, which are unlike the Italian system. Reporting and register requirements vary across all three systems. Apply these differences to hundreds of securities being processed across separate platforms and the picture easily becomes complex.

Initially, the number of countries introducing FTTs was considerably smaller, and there was uncertainty about the longevity of the rule. This led many financial houses to stick with a tactical approach, while internal sponsors moved on. However, as the above taxes are introduced in the coming years, there will be a surge in the volume of securities that fall under various transaction tax regimes. Moreover, most finance houses will need centralized technology to process and manage large streams of data across this range of taxes, as opposed to the fragmented setup many houses currently have in place.

Banks and asset managers will need to process and manage all the relevant data on the taxable security, then process this data against a range of rules to determine appropriate tax or exoneration rationale, irrespective of a zero-tax calculation. A central pane of glass, through which the tax data is processed, can help create the necessary conditions for achieving this transparency, on top of which these houses can then apply analytics capabilities, such as AI and machine learning, to optimize the process of tax calculation.

Managing Other Taxes in Parallel

Adding to the operational complexities overall are managing DAC6, capital gains tax (CGT) and Cum-Ex related withholding taxes in parallel with FTTs. The CGT functions in a similar way to the FTT and, therefore, may be treated similarly.

However, in the case of Cum-Ex, there is renewed pressure on the part of regulators and authorities in Europe to clamp down on the fraudulent activity that captured headlines in recent years. The authorities require market participants to prove that the correct counterparty or intermediary is claiming the withholding tax, even if they were only acting as a market maker in the trading of that security. In addition, they must prove they are the only party that is claiming the tax. To achieve compliance, houses need full oversight of the trading lifecycle in any in-scope security, in the form of position management using first-in first-out rules, and from the safe harbor point—approximately 12 months prior to the dividend payment date—up to the 45-day post-dividend window.

Looking Ahead

This seems like a tall order, but it can be addressed by a central, automated tax solution that addresses FTTs and other transaction-based taxes. Creating a center of excellence around tax, one that manages the calculation, payment and recovery of tax, and one that is scaleable for the potential introduction of new and existing tax rules, can help financial houses come to grips with the requirements in both a cost and operationally efficient way. Given the current cost pressures facing many financial houses, this is more important than ever.

Looking ahead it seems certain that there will be more taxes. The taxes will come in different shapes and sizes, and because of their extra-territorial reach, they will also come with global implications. These predominantly European taxes will affect U.S. firms just as much as European firms, as EU FTTs will not be limited to those within a territory. A U.S. financial house is not necessarily out of scope for EU FTTs. That is, if a house outside of Spain is buying and selling shares in an in-scope Spanish company, it is not exempt from paying the relevant tax. Most importantly, that house must also prove its tax exemption for reasons such as fulfilling market-making functions or other specific reasons.

The tactical systems used today by many financial houses will not be sufficient or scale enough to meet the expanding processing requirements and additional taxes brought on by the new Spanish FTT. Now is the time to consider a strategic overhaul to industrialize this process. While software projects for other regulations may currently be at the top of the agenda, it is time for tax to sit alongside them.

The author’s views are not intended as tax or legal advice to be relied upon by any specific person or client and the author is not practicing law in any specific jurisdiction.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Daniel Carpenter is Head of Sales & Marketing at Meritsoft (a Cognizant company).

The author may be contacted at: capitalmarkets@meritsoft.com