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The Tobin tax: Myth or Plausible Reality?

28 Jan 2010

The prospect of emergence from the global financial crisis has set the scene for confrontation between those who want everything to go back to how it was before and those who claim that nothing will ever be the same again. Politicians, who generally adopt the second line of argument, try to give their views credibility by adopting a whole variety of initiatives. Alongside proposals for new regulations and the taxation of bonuses, they have brought back the idea of a Tobin tax, a widespread tax on financial transactions.

In the eyes of those in favour of this tax, it would only have benefits: it would discourage speculation without hitting the real economy and would make it possible to finance the development of emerging countries. Those who criticise the tax argue that it should be global - which seems impossible to realise - and that implementation in some countries only would simply lead to relocation of back offices.

Frederic Donnedieu, the Chairman of Taxand, examines the theory of Tobin tax, anticipates the form that it would take and exposes the potential technical problems that could arise should it be put into practice.

Click here for our technical analysis

Even in the ideal situation where all the countries in the world agree to create this tax at the same rate, there would still be problems of territoriality, as the tax would not be managed by an international organisation, but by each country. The rules of territoriality would therefore have the sole aim of determining to whom the tax should be paid, without any impact on its amount. In the more likely case where only a few countries were to create this tax, the importance of the rules of territoriality become completely different, as these rules will serve to determine whether the transaction is taxable or not.

The relentless pursuit of international tax income and the closure of tax havens is starting to have a significant effect on the global financial pecking order and spells disaster for some smaller countries. Without global cooperation, productive nations will continue to compete with tax havens for the global tax take and will continue to see a downward spiral in corporate tax rates as these havens battle to attract the large global companies to their shores.

The global recession has created a new world order in tax with a building wave of sentiment viewing tax havens and tax evasion as morally wrong. Whilst this sentiment will inevitably drive change, we must be careful to balance the global recovery and the long term implications of any actions taken in haste to protect revenue, which may simply backfire as firms look at increasingly innovative ways to limit their tax liabilities.

Our technical analysis...

As we are not economists, it would not be legitimate for us to take part in the discussion on the merits of this tax. On the other hand, as tax practitioners, we can contribute something to the debate: assuming that a decision is made to introduce a tax of this kind, we can anticipate the form that it would take and the technical problems that would arise. This approach is of interest to assess whether such an instrument is appropriate and even whether it is feasible.

We will adopt a very classical approach by addressing the type of tax, its scope of application, determination of the taxable person, basis of taxation and taxable event (the event which triggers payment of the tax), and finally the territoriality issues.

  1. Type of tax

Even if there is a distinct lack of clarity surrounding the technical aspects of a tax which is most often only evoked as a rather vague concept, it is obvious that the Tobin tax would take the form of a sales tax, as the idea is to impose a tax on transactions at a rate which would be equal to a percentage (in fact less than one per cent) of the value of the transaction.

This starting point is particularly important for a tax specialist, as he/she knows that the sales tax technique is not at all adapted to the world of finance. This is, moreover, the reason why in all countries where VAT exists, it is only very partially applied to financial activities. VAT specialists who work in banks or insurance companies will therefore not be surprised to discover all the problems which they are used to facing in the analysis which follows.

Similarly, French tax practitioners have experience of a general sales tax with a cascade mechanism (the social solidarity contribution) which concerns all companies, including banks and insurance companies. Despite the low rate of taxation (0.16%), this tax poses tough problems of practical application.

  1. Scope of application

Again, the whole situation is very vague. According to certain statements, it will involve a global system of taxation of financial transactions, which would include the foreign exchange market, interest rate market, cash market and doubtless also that for counterparty risks. But a number of accounts seem to indicate that the taxation will in fact be limited to the foreign exchange market. We will adopt this second conception in the remainder of this article - as even if it is restricted to this market alone, the subject is quite complex enough! Indeed, foreign currency transactions are not limited to the spot exchange market - there is also the forward exchange market and the option market. It is hard to imagine taxing only foreign exchange transactions in the strict sense and not currency-related financial instruments. This would be a complete paradox, as the avowed aim is to fight against speculation, where it is above all financial instruments that are used.

Furthermore, what transactions should be taken into account? Only those taking place in an organised market or also over-the-counter transactions? In the former case, this would encourage a shift away from organised markets to over-the-counter markets, which would not afford greater transparency and security, when organised markets already play an extremely marginal role in all foreign exchange transactions. In the latter case, it will be difficult to determine what exactly should be taxed.

  1. Determination of the taxable person

In the case of a sales tax, the person liable for the tax by law is the seller or service provider, save in exceptional cases. To determine the taxable person, it is necessary to analyse the transaction: is a foreign exchange transaction a delivery of goods or the provision of a service? A priori, the idea of treating a currency as a good may be considered surprising; however, it is even less satisfactory to treat a foreign currency transaction as the provision of a service: which of the two main figures is supposed to render a service to the other? What is the price for this service? Where the transaction involves a bank and its client, and there are two rates on display in advance, one for purchases and the other for sales, it may of course be considered that it is the bank which provides the service to the client and that the price of the service consists of the variance between the two rates. But this is only the case in a small minority of transactions. How should a case be handled where the two main participants are both banks or both companies? Furthermore, only taxing the margin would not make it possible to fulfil the objective sought (discouraging speculation without hitting the real economy).

This therefore brings us back to the analysis which was initially found surprising: the foreign exchange transaction is a delivery of goods. But who is the seller and who is the buyer? Where the transaction concerns the currency of an operator (the currency in which he keeps his accounts) and a foreign currency, it is possible to consider that the operator's currency is a means of payment and the foreign currency is therefore the "good". But how should a transaction be analysed when it involves two foreign currencies? It is easy to see that it is impossible to treat the transaction other than as an exchange of two goods: the two currencies are "goods"; the two operators are both sellers (of the currency they deliver) and buyers (of the currency they receive). There are therefore two taxable transactions and two taxable persons for the same transaction! This surprising solution is nevertheless that which is applied to a transaction (a much rarer case) in which two companies are liable for the payment of a sales tax exchange for "ordinary" goods. Of course, this systematic double taxation should be taken into consideration when the rate is set.

  1. Basis of taxation and taxable event

For a spot foreign exchange transaction, the basis of taxation is relatively easy to calculate: for each of the operators, it amounts to the value of the currencies delivered converted into the currency used in the accounts according to the standards it usually applies. The taxable event is the delivery of the currency.

For a forward foreign exchange transaction, the basis of taxation is the same. The taxable event should be the delivery of the foreign currency and not the conclusion of the contract.

For a forward foreign exchange contract, it appears to be logical, by analogy, to tax the nominal amount of the contract and to consider that the taxable event occurs on the date of unwinding of the contract by delivery of the currency. On organised markets, contracts are often unwound through the payment of a balance and not through delivery of the currency. Nevertheless, it would be essential to have the two players pay the tax on the basis of the gross amounts exchanged virtually to ensure neutrality of taxation of the various tools used on foreign exchange markets, but this takes us further away from the notion of delivery of goods and would no doubt be very difficult for those involved to understand!

The most important issue posed by organised markets is elsewhere: instruments are in fact traded on such markets. The same contract may therefore change hands several times before being unwound on the maturity date. The issue is therefore whether it should be considered that a taxable event occurs at the time of each transaction or solely on maturity. The second solution would obviously run counter to neutrality between the different markets and tools. On the other hand, it would be a potent way of favouring organised markets which only play a very marginal role today.

For options, the situation is fairly similar to that of forward contracts where the option is exercised on maturity: in this case, there is an effective exchange of the nominal amounts. A situation where the option is not exercised is more delicate to handle as its exercise price is less favourable than the spot market price. In this case, nothing happens on the date of exercise. It would however be necessary to tax the gross amounts of this "non-exchange" if a major inconsistency is to be avoided: options would be taxable where the buyer earns something on them and non-taxable when he doesn't! But taxing the "non-exchange" has two disadvantages: it appears to be inexplicable and there is also no accounting entry on which the taxable event may be based.

  1. Territoriality

Even in the ideal situation where all the countries in the world agree to create this tax at the same rate, there would still be problems of territoriality, as the tax would not be managed by an international organisation, but by each country. The rules of territoriality would therefore have the sole aim of determining to whom the tax should be paid, without any impact on its amount.

In the more likely case where only a few countries were to create this tax, the importance of the issue of the rules of territoriality becomes completely different, as these rules will serve to determine whether the transaction is taxable or not.

In the event of an exchange of "intangible goods" (where the existence of exchanged currencies results from entries recorded by the custodian banks), the most operational criterion appears to be the seller's place of establishment. This is where the accounting entry, which forms the basis for the taxation, will be found.

That said, for an operator present in several countries (through branches or subsidiaries) the place where the transaction is recorded in the accounts may not be considered an absolute criterion to determine its location. When it does not coincide with the place of recognition for accounting purposes, it is the place where the decision to enter into the transaction was made which should prevail. Otherwise, it would be too easy to escape the tax by recording the accounting entries with regard to the transaction in a country which has not put in place the tax even though the decisions were taken somewhere else. This is a familiar problem in the field of corporate income tax and is also well known to those who have had to handle a stock market tax.

But the criterion of the place of decision-making has a dual effect: on the one hand, it slows the relocation of the taxable item, but, on the other, it may also incite the physical relocation of back offices!

An even more serious issue: by analogy with the systems of this type that already exist, it may be anticipated that the alternative criterion would only come into play in a way which is unfavourable to the taxpayer. It would not make it possible to avoid the tax where the transaction is recorded in the accounts in a country which has adopted the tax by proving that the place of decision-making is elsewhere. The consequence is paradoxical: the only persons who would remain subject to the tax are operators involved in hedging transactions as, at the end of the line, one end of the contract would have to be located in the books of the entity which holds the risk to be hedged. Thus, contrary to the originally stated aim, the tax would only be levied on the real economy, as all speculative positions could be located somewhere else!

It is beyond doubt that the creation of a global 'Tobin tax' would raise a vast array of issues with regard to implementation. The complexities of such proposals are so huge that serious questions can be raised as to the tax's feasibility.

There is potentially an end game to the moves by the G20 to introduce these international taxes, of which financial transaction tax could be the thin end of the wedge, and to kill off the tax haven that has not yet been considered, that being the creation of a level playing field that allows the main protagonists to use low taxes to fight for the affections of international businesses.

Vote now!
Do you think we should have an international tax on transactions (Tobin Tax)?

Your Taxand contacts for further queries are:
Frederic Donnedieu
T. + 33 1 70 38 88 01

Michel Taly
T. +33 1 70 39 43 59

Taxand's Take



It can be seen from the above that if the creation of the Tobin tax were to be decided, it would be very complex to implement. It would even be so complex as to raise doubts as to its very feasibility. This would however be of no surprise to anyone who has had to manage a sales tax in the banking and insurance industry.

Original articles written for and published in Tax Journal and l'Agefi hebdo.

Taxand's Take Author