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Tackling the complexities of the Financial Transaction Tax

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Posted in: Institutional Capital Markets
Published: 20/05/2021

GBST’s Head of Capital Markets, Denis Orrock, talks about how non-compliance is simply not an option, and potentially very costly.

 

 

What does the Financial Transaction Tax involve and who is in scope?

The concept of a Financial Transaction Tax (FTT) isn’t new. It was first introduced as a European-led exercise with 10-member states initially committing. France was the first country to proceed and join in its current format during 2012. Since then, other EU markets have introduced the tax following political pressure to ensure the financial sector contributes to budget holes created by the financial crisis, and now the COVID pandemic.

In its simplest form, a FTT is a tax payable on the purchase or sale of eligible financial transactions. The growing complexity lies in determining eligibility, ensuring the tax is collected and remitted accurately, and reported correctly to counterparties and tax authorities. Since France introduced its FTT, Italy, and now Spain, have introduced their own FTTs.

Future global tax legislation is inevitable with governments looking for new revenue streams. There are currently more than 40 transaction taxes active globally, with EU driving the hardest for new FTTs. Up to eight countries are suggested to follow soon, including Germany, Portugal, Austria, Belgium, Estonia, Greece, Slovakia, and Slovenia. Each country can have differing rules, which are susceptible to change at any moment, however, the general concept operates in a similar manner globally and is applicable to all FTTs.

Any financial institution involved with eligible securities, within their business or on behalf of clients, can be affected by FTTs. This impacts everyone involved in the transaction chain, including investment bank brokerage organisations, custodians, and wealth management firms.

FTT can be payable on certain traded financial instruments, based on whether the instrument has been provided by an issuer who has a registered office in a specific region, the transaction is ordered or executed by a financial institution residing in certain locations, and if at least 50% of the structured product’s underlying assets are from a member state.

Processing FTTs generally consists of four main components for each market:

  1. Identifying eligible FTT transactions such as equities, derivatives, loans, and corporate action outcomes
  2. Calculating whether the transaction is taxable or exempt according to the tax jurisdiction rules
  3. Establishing tax optimisation by recognising netting opportunities
  4. Creating a monthly declaration of all transactions and payments in the format required by the tax authority or reporting agent.

 

What are the biggest challenges around FTT?

While there are several challenges associated with FTTs, there are four key issues that businesses need to be focused on. These include audit and control, cost and timeliness, netting and rebates, along with the volume and scale required to apply the tax.

System audit and control is one of the main concerns for executives responsible for FTT processing. They often lack confidence in the systems or spreadsheets which are handling growing volumes, tax liabilities, and the fiduciary responsibly of managing a client’s funds. Miscalculations could result in being held liable for incorrect submissions.

The cost and effort involved in implementing systems and processes for new FTT markets is another challenge. In Spain, the expectation from market participants was that it would be relatively simple due to its similarities to the French FTT. In practice, its execution was considerably more complicated. Spain’s monthly transaction declaration required more detail for each transaction record, plus the inclusion of the calculations used to determine the netted quantity and principal. Further to this, any adjustments to a declared transaction needs to reference previously declared adjustments. These requirements had significant implications on the FTT processing systems, which is evident by Iberclear’s postponement of the go-live dates from January to April, to July.

To achieve tax optimisation for both the organisation and its clients, netting can be performed according to the tax jurisdiction rules. This occurs outside of the settlement system and does not affect settlement obligations. However, not all organisations benefit from this due to the nuances of the netting algorithms between tax jurisdictions and products. When completed correctly, the difference between the net and gross tax amount, the rebate, can be attributed to clients and refunded to them at the end of the month.

As more EU markets implement FTTs, the volume of the transactions going through systems and processes will only grow and become more complex. Solutions such as Excel are not scalable and are highly manual. Without system automation, there’s only so far human resources can scale.

 

How will automation transform the FTT reporting process?

FTT processing is ideal for automation, as it’s clearly defined by a series of rules. Complete automation from capture, tax calculations or exemption, netting, monthly declarations, client rebates, to post declaration adjustments is achievable. The challenge is accomplishing this in a cost-effective manner. Building a system to deliver this reliably, and in a way that can be scaled and expanded as regulations change and new markets onboard, is of paramount importance. The rule books for each tax jurisdiction aren’t trivial.

The key to system automation is delivering it in a way that users can easily understand system calculations. If those performing a tax operations role don’t trust or know what the system is doing, then it’s making the problem worse.

 

What opportunities would automation for FTT reporting provide?

Incorrectly submitting too much tax won’t see an organisation being informed, however, submitting insufficient tax will result in a fine. Automating and auditing all aspects of the tax calculation, exemptions, netting, and reporting will ensure optimal tax is declared with an audit trail to prove it. With complete automation, changes identified several months after transactions have been declared can still be processed and rectified easily with adjustments submitted for reclaims or additional tax payments.

Further automation savings can be achieved by consolidating multiple FTT processing systems into a single system for custody, asset servicing, and investment banking divisions. An effective FTT system processing solution should be able to process any FTT eligible transactions. It should also be indifferent as to whether this is an equity or derivate brokerage trade from an investment bank, a corporate action outcome, a loan from the custody division, or even a client trade from the private wealth division.

 

How is GBST working in this space?

GBST is currently helping organisations form business cases for strategic FTT processing solutions that evaluate the benefits and advantages of GBST’s FTT processing solution, compared to an in-house system.

GBST is committed to building, developing, and supporting regulatory changes for all new and existing EU FTT markets. This insures clients against the unknown future costs and risk of building their own in-house version for each new FTT market.

This unique offering is made possible by GBST’s purpose-built Syn~FTT platform that can rapidly accommodate new markets and regulatory changes, and also scale to meet volume needs of both the smallest and largest market institutions. Syn~FTT can be up-and-running as a SAAS offering within weeks if required.

When delivering to new markets, GBST will build, test, and deliver the system changes to the exact regulatory specifications. This enables our clients to focus on internal processes and peripheral system changes to support the new FTT regimes, leaving GBST responsible for FTT capture, tax and exemption rules, netting algorithms, and monthly reporting requirements in the format prescribed by the tax authorities.

 

What is next for FTT? How will this expand/develop in the future?

FTTs will become more prevalent as countries turn on the tax taps. What would previously have not gained any traction, is now beginning to be taken seriously. As an example, contingency planning for how New Jersey in the US would accommodate such a tax if it were to eventuate, has been considered. Based on its procedural similarities with the EU FTTs, GBST’s FTT solution would be able to conciliate the US state’s requirements with an out-of-the-box deployment.

Organisations processing FTTs within the EU will be relieved that the Spanish FTT rollout is nearing completion, but also reflecting on the costs and efforts expended to reach this outcome. Spain has become the catalyst for organisations engaging in a wider FTT strategy review and this has enabled them to be ready for the next FTT announcement.

Outside of the EU, the processing of other major global FTTs comes with the inherent organisational challenges of complicated flows from multiple entities and settlement systems. This is a focus area in which GBST is working with the industry to help organisations form a strategy and business case for an efficient global tax processing solution.

GBST is a strategic partner with in-depth tax and big data experience, and practical operational insight. With over 35 years of industry experience, the company is well positioned to implement software solutions to manage new FTT requirements.

 

This article was published in Asset Servicing Time’s 2021 Regulatory Handbook.

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