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Taxing Financial Transactions: An Assessment of Administrative Feasibility

Taxing Financial Transactions: An Assessment of Administrative Feasibility. September 22, 2011 Washington, D.C. Background. In preparing the IMF’s G-20 report on financial sector taxation, FAD produced two papers on the financial transactions tax

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Taxing Financial Transactions: An Assessment of Administrative Feasibility

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  1. Taxing Financial Transactions:An Assessment of Administrative Feasibility September 22, 2011 Washington, D.C.

  2. Background • In preparing the IMF’s G-20 report on financial sector taxation, FAD produced two papers on the financial transactions tax “Taxing Financial Transactions: Issues and Evidence” (Matheson, WP11/54) Main conclusion: Tax instruments other than an FTT are better suited to revenue-raising and mitigating financial market failures “Taxing Financial Transactions: An Assessment of Administrative Feasibility” (Brondolo, WP 11/185) Main conclusion: An FTT is administratively feasible but the ease of administration differs across financial instruments 2

  3. FTT Basics • An FTT is a tax on transactions in financial instruments • They can be structured in a number of ways: • Applied to the initial issuance of a financial instrument, subsequent transactions in the instrument, or both. • Assessed on the basis of the amount of money that changes hands in the transaction, the notional value of the transaction, or a variety of other valuation methods. • Designed to exempt certain types of transactions or categories of persons. • Taxed at a single tax rate or multiple rates, either on an ad valorem (percentage) or specific (flat amount) basis. • Levied on the buyer, the seller, or both. • Collected by exchanges, clearinghouses, or market participants.

  4. Scope of Analysis • In assessing the administrative feasibility of an FTT, we looked at how an FTT could be applied to three broad and partially overlapping categories of financial instruments: (1) exchange-traded instruments—easiest to tax; (2) over-the-counter instruments (OTC)—more difficult to tax; (3) foreign exchange instruments (FX)—most difficult to tax • But in recent times collecting an FTT on even the hard-to-tax instruments (OTC and FX) has been facilitated by some developments.

  5. Basic Administrative Design Issues • A number of technical issues need to be considered in assessing the feasibility of applying an FTT to different financial instruments. • For any tax to be administratively feasible, it must be possible to carry out five basic tasks: (1)define the types of transactions subject to the tax; (2) establish the timing of the tax liability; (3)  determine the tax base; (4)  identify the taxable persons; and, (5)  devise efficient workable methods for assessing and collecting the tax. • Each of these tasks faces conceptual and practical challenges, but there also are workable solutions.

  6. Key Compliance Risks • The viability of a tax requires more than just putting in place an effective and efficient collection apparatus. • For a tax to be administratively viable, the tax agency must also be able to ensure that taxpayers comply with their obligations. • An FTT, like all taxes, faces 3 main compliance risks: • Under-reporting • Asset substitution • Asset migration • Strategies are needed to control each of these risks

  7. Strategies for Mitigating Under-Reporting • Provide taxpayers with clear tax legislation and practical guidance on the application of the legislation, • Backed up by a credible enforcement and penalty regime, • Supported by linking the legal standing of a financial transaction to the payment of the tax.

  8. Strategies for Controlling Asset Substitution • Best approach is by extending the FTT to those instruments that are close substitutes for taxable ones • Although this still leaves open some substitution possibilities, the foregone revenue may not be very large to the extent that the cost of using increasingly complex substitutes may eventually exceed the cost of the tax itself. • In addition, tax agencies could use the anti-avoidance provisions to re-characterize as taxable those transactions that have “no real business purpose” (other than avoiding tax)

  9. Controlling Cross-Border Migration Risks • Introduction of an FTT almost certain to result in some migration of transactions, but difficult to predict the amount of migration & resulting revenue loss. • Safe to say the revenue leakage would be largely a function of the benefits and costs from relocation • Therefore, the prospects for the FTT would be enhanced if the tax rate were to be kept low and jointly introduced by major financial center countries.

  10. Concluding Points for Policy Makers • Countries that are considering introducing a broad-based FTT should take into account its policy objectives and administrative feasibility. • The ease of implementing an FTT varies across financial instruments. • Coherent legislation is essential for the effective administration of an FTT. • There are major advantages to collecting an FTT through exchanges or clearinghouses. • Appropriate mitigation methods are required to address the compliance risks facing an FTT. • The implementation of an FTT requires careful preparation and planning.

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