By Francesca Amaddeo, Researcher, Tax Law Competence Centre (SUPSI), Manno, Switzerland
On 30 April, the European Court of Justice released its long-awaited judgment in Société Générale SA (C-565/18), concluding that Italy’s financial transaction tax on derivatives of equity transactions is compatible with EU law.
Under the ECJ’s lens was the compatibility of the Italian financial transaction tax, the so-called Tobin Tax, with the non-discrimination principle (article 18 TFEU) and freedom of movement of services (article 56 TFEU) and capital (article 63 TFEU).
The tax, introducd by Law n. 228/2012, applies to transfers of shares and certain participating financial instruments issued by companies that have their registered office in Italy, as well as derivatives whose value is more than 50% linked to such shares and instruments, regardless of the State of residence of the issuing entity.
This tax, levied at the rate of 0.2% of the transaction value, is due irrespective of the place of conclusion of the transaction and the State of residence of the contracting parties.
Background, question of preliminary ruling
The main proceeding started in 2014 when the Italian branch of Société Générale, a French company, presented a tax return to Italian tax authorities which included a financial transaction tax of approximately USD 60,000.
Later, in August 2014, the taxpayer requested a refund of the tax paid, arguing that the tax violated domestic constitutional principles of ability to pay (art. 53 Italian Constitution) and equality (art. 3 Italian Constitution), international provisions, and European Union law.
More specifically, regarding the last point, Société Générale argued that both the tax burden and reporting obligation of the financial transaction tax might discourage foreign investors from investing in derivative financial instruments based on assets governed by Italian law.
Given the silence of the Italian tax administration, which implies a refusal, Société Générale appealed unsuccessfully the issue before the Tax Court of Milan and, on the second instance, appealed before the Regional Tax Court of Lombardy.
This time, the judges made a referral to the ECJ for a preliminary ruling, ex art. 267 TFEU, asking if articles 18, 56, and 63 TFEU preclude national legislation charging a financial transactions tax irrespective of the State of residence of the financial market participants and the intermediary, which is payable by the counterparties to the transaction and consists of a fixed amount which rises incrementally in ranges and trading values and which varies according to the type of instrument traded and the value of the contract, and which is due by virtue of the fact that the taxable transactions concern the trading of a derivative based on a security issued by a company resident in the State imposing such a tax.
Legal basis and ECJ’s analysis
In the instant case, the taxpayer contested the application of the financial transaction tax on derivative financial instruments which have as underlying assets a financial instrument governed by Italian law.
Under derivative contracts, parties agree on future cash flows depending on the value of underlying assets. Thus, derivatives are considered both in light of their hedging function, namely, their management of economic or financial risks associated with adverse changes in the price of the underlying asset, and their speculative function for investment purposes.
Investors speculate either on the underlying asset’s price change or on arbitrage, namely, the mismatch between the value of an underlying asset and its derivative.
Given this premise, derivatives fall under EU law concepts of free moment of services and free movement of capital.
The court noted that even if the reason why a taxpayer issued, sold, or purchased derivatives is not apparent, this kind of instrument always represents an investment. In contrast, derivatives involve hedging only in some circumstances.
This implies that the core issue is the compatibility of the tax with the free movement of capital (ex art. 63 TFEU), while the free movement of services must be considered as secondary.
Under the taxpayer’s reasoning, the limitation of this freedom derives from the Italian financial transaction tax’s discrimination between resident and non-resident investors.
It is worth noting that the law states that financial transaction tax is linked to Italian jurisdiction even if the transaction is concluded outside the residence state of the parties or, eventually, of the intermediary involved. Thus, the tax regime is applied equally to residents and nonresidents.
Indeed, the relevant factors for determining the amount of the tax are the value and the type of financial instrument used; no discrimination occurs based on national or cross-border transactions, the court observed.
Moreover, from the perspective of investors, the tax in question does not constitute discrimination since that tax applies independently of their nationality or place of residence.
As such, the ECJ concluded that article 63 TFEU must be interpreted as not precluding national legislation from charging a tax on financial transactions relating to derivative financial instruments to a tax imposed on the parties to the transaction, irrespective of the place where the transaction is concluded or the State of residence of these parties and of any intermediary intervening in its execution, where these instruments are based on a derivative/security issued by a company established in that Member State.
The administrative and reporting obligations associated with this tax and imposed on the non-residents must not, however, go beyond what is necessary to collect such tax, the ECJ said.
Tax competition, if not harmful, must be considered licit even if it may result in some fiscal disadvantages: the states’ discretionary power in levying taxes shall not be deemed as limited by other jurisdictions’ tax regimes, provided that it would not be discriminatory, as stated in article 18 TFEU, and so resulting in a limitation of fundamental freedoms, the court concluded.