The economic impact of the COVID-19 pandemic has been significant. Governments across the globe have deployed emergency stimulus packages to help curb the worst impacts of the social and economic lockdown. With much of the relief and recovery plans now agreed upon and being dispersed, the question of how to pay for these programs comes into sharper context. The ideas on revenue generation will be of great interest to global asset managers as funds and the wider investable market could be asked to make contributions.
Nowhere has balancing the books been more keenly focused than in Europe. The recently agreed upon EU budget was hard fought with a cohort of EU member states — known as the “Frugal Four” — eager to see that all members contribute and that money borrowed would be repaid in due course. The set seven-year EU budget spans from 2021 to 2028, and, in that time, it has committed to borrowing up to 2 percent of EU Gross National Income on the financial markets, which it further proposes repaying in future EU budgets between 2028 and 2058.
Tax is one of life’s two great certainties and remains the greatest source of revenue for nearly all governments. The EU’s budget looks to address the pandemic recovery, but the EU has also made significant multiyear financial commitments in relation to the EU Green Deal. Let’s not forget that the EU must also prepare for the loss of their second largest budget contributor, the United Kingdom.
To help repayments, the EU has asked member states to give it the ability to raise money itself through certain taxation mechanisms designed to increase revenues and reduce tax leakage.
Due to different sensitivities among member states, these ideas may be of fierce debate. The implementation of these tax mechanisms, however, would have direct impacts on asset managers and their investment portfolios. Here we look at four significant tax initiatives ongoing within the EU:
1. DAC 6 – Reduce Tax Leakage and Avoidance
Asset managers, management companies, and fund boards are already assessing whether their transactions, including some dating back to June 2018, are reportable under the EU’s Sixth Directive on Administrative Cooperation more commonly known as “DAC 6.”
DAC 6 seeks to increase and harmonize tax transparency across the EU with the knock-on effect of reducing transactions structured to avoid taxation. The directive primarily targets overly aggressive tax arrangements at multinational corporations, but asset manager activities are also in scope for the reporting of certain cross-border transactions and screening transactions for “hallmarks” that might be considered suspicious.
Another recent drawback for asset managers was that while most member states recently granted an extension to DAC6 reporting deadlines on historical arrangements until November 30, Germany did not, leaving funds with just a matter of weeks to meet the August 31 deadline. For some asset managers, the inconsistent and staggered nature of national implementation may present headaches when implementing DAC 6.
The fact that the hallmarks are so broad means that an abundance of asset managers cross-border transactions for funds, including alternative funds like real estate and private equity with multiple layers of ownership in their transaction structures, come into scope. With so many transactions now in scope, screening and reporting volumes – especially as some managers report in more than one country – will be an ongoing issue.
2. EU Financial Transaction Tax – Back on the Table?
The EU Financial Transaction Tax (EU FTT) is a policy idea that has bounced around in Europe for more than a decade. With funding of the €750 billion recovery package to be considered, it appears that it is now back on the table, or at least up for debate. The initial EU FTT plan was such a bad idea to some that the UK, its biggest detractor, even went to court to stop it. A group of countries, however, proceeded under a procedure known as “enhanced cooperation,” which requires at least nine member states to cooperate. The full agreement on its scope, particularly OTC derivatives and how the money raised would be spent was never fully settled. As such, full support and implementation never actually came to fruition.
Although unsuccessful at the time, the UK case did highlight the fact that the FTT idea wouldn’t raise as much revenue as purported and such a tax would generally not be borne by banks or asset managers, but rather by fund investors, savers, and pension plans themselves. Far from being a “Robin Hood” tax to reallocate wealth from the haves to the have nots, it would in effect be a burden on long term savers and investors.
EU Member State tax policy remains very much in the ambit of national governments and is staunchly guarded as a result. Any harmonization requires unanimous approval of all 27 member states. For now, EU FTT remains a collation of the willing and whether or not it actually proceeds this time is still uncertain. However, it is certainly one to watch for asset managers operating in Europe as its effect could be significant.
3. Digital Taxation – Global or Local?
The EU continues to assess proposals for its digital tax strategy. Taxing internet derived revenues is in sharp focus globally with the continued rise of behemoths like Facebook, Google, Amazon, and others. However, the revenues from such digital taxation, remains notoriously difficult as a concept. Both the EU and the OECD are looking for international answers to the challenges of the online economy. Regulators are seemingly looking to adapt to digital shifts and so too are tax decision makers.
The debate for a global versus regionalized solution rages on. What seems certain is that some form of digital tax of internet-based companies is coming down the pipe. While the EU has pledged to act in tandem with the OECD, the European Commission has left open the possibility of acting on its own to establish its own parallel standards for digital tax, an idea that has also created certain tensions between the EU and the US politically.
There is no unanimity of opinion across EU members states. Major EU states such as France and Germany want to act now, but Ireland, for example, an EU hub for many of the internet giants such as Google, Facebook, and others, remain strongly against such a move. The other point of policy contention is whether tax should be levied on revenues or profits and certainty around the method of taxing online businesses where a vendor and customer may not be in the same country. The ongoing legal wrangling between Apple, Ireland, and the EU shows how complex the issues are with Europe’s second-highest court, the General Court, when it recently overturned the European Commission’s decision from four years ago that Apple owed Ireland €13.1 billion in back taxes. That ruling may still be appealed before the EU Court of Justice, the EU’s highest court, a process that will take another few years before an outcome is determined.
Since the EU relies on unanimity to establish tax policy, no one country can just impose a new system of digital tax. A minimum of 16 member states need to back an initiative for it to be passed and several countries still consider a long-term evidence based global solution, which aligns taxation to the location of value creation preferable. A long, complex, and uncertain road lies ahead, but given the size of the global ddigital giants in many of the significant global benchmarks, any tax impact on their business models could have significant consequence to portfolios, a topic of great interest to asset managers.
4. Carbon and Emissions Tax – ESG at the Heart of Europe
We have flagged how central the EU Green Deal is to the shape of the EU policy agenda. The EU has doubled down on its sustainable agenda with the onset of the coronavirus pandemic. Within the EU Green Deal are many ambitious and costly investments to aid the transition from a largely carbon-based, to sustainable sourced economy. All these lofty ambitions require funding. The private sector, asset managers, and funds have a large role to play, but it is expected that the EU and national governments will look to incentivize the change by increasing taxes on carbon, plastic, and emissions going forward. It is also interesting to consider whether the EU will stand alone as a “champion of sustainability” or if others join the ESG crusade.
The EU’s “Green Deal” aims to reduce the carbon footprint of the EU to zero by 2050. One of the devices proposed but not yet concluded upon, is the idea of having a “carbon border tax.” But a regional tax approach does present complexities. There is no uniform global carbon tax right now and it is unlikely that there will be an agreement reached in the medium term on such a tax.
In its own assessments, the EU has not come up with a price target for C02 emissions yet, but it is working on studies to assess what a “fair price” might look like. This carbon tax policy must be weighed delicately when considering existing global energy pricing, EU economic competitiveness, and the general economic recovery from the pandemic. Too much tax burden could hurt some industries, particularly European firms that produce rubber and plastic, oil refineries, and chemical industries. Too little, and the 2050 goals on Paris Accord alignment are unlikely to be reached due to lack of incentives.
The EU already has a tax on CO2 emissions and EU industrial firms already must buy emission certificates for every metric ton of CO2 they emit. Other countries like Australia, Canada, and even certain US states have forms of carbon tax; however, the EU carbon taxes are the most extensive and therefore, imported goods generally do not adhere to the EU’s CO2 emission standards. To deal with the discrepancy, the EU plans to impose a carbon border tax (the border being between EU and non-EU countries). The idea being that an EU carbon border tax would incentivize foreign producers to contribute to the fight against global warming by reducing emissions in line with EU standards given the size and significance of the EU single market. It will also provide an additional source of revenues to fund the Green Deal. Lastly, it is a mechanism that protects the EU to a degree by creating a level playing field for European firms against foreign competition at least within the EU single market and discourages European firms from moving production outside the EU.
With all of these evident benefits, it remains true that a carbon border tax risks undermining EU companies’ competitiveness against non-EU markets who do not adopt similar carbon emission taxes, so still there remains a delicate balance to be found.