Friday, February 15, 2013

Excise Duty on Securities

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As usually the case, the Verkhovna Rada (Ukrainian Parliament) decided to make a gift to taxpayers and improve the tax legislation for the New Year. One of the most striking products of this "improvement" is special tax on transactions in securities and derivatives (hereinafter - the "Special Tax").  The tax has been introduced by the Act of Ukraine "On Amendments to Tax Code of Ukraine with regard to Further Improvement of Administration of Taxes and Duties" of 6 December 2012 and has been effective since 1 January 2013.

It should be noted that, despite its name, the Special Tax is not a distinct tax, but merely a sort of excise duty. The proponents of the Bill have decided not to bother themselves with creating a new Chapter of the Tax Code of Ukraine for the introduction of the Special Tax qua separate tax. They have slighted the arguments put forward by the respective parliamentary committee in support of the fact that the proposed tax is a new and separate tax on financial transactions and cannot be considered an excise duty in terms of its economic substance.

Below is the brief description of the Special Tax.

Taxpayers. The Special Tax is chargeable on individuals and legal entities (irrespective of their residency). There are two types of the taxpayers: (i) those carrying out transactions in derivatives and (ii) those alienating securities. The taxpayers of the Special Tax are not subject to separate registration in the tax authorities.

Scope of the charge. By analogy with the taxpayers there are two groups of taxable transactions: (i) transactions in derivatives and (ii) transaction related to alienating securities (any form of disposal involving the transfer of the title). The taxable base is the contractual value of the securities or derivatives specified in the primary accounting documents.

Tax rates

Taxable transaction
Tax rate
Selling securities on a stock exchange with regard to which a stock exchange rate is calculated.

Transactions in derivatives conducted via a stock exchange.
Selling listed securities outside a stock exchange

Selling unlisted securities outside a stock exchange (securities not admitted to the trading on a stock exchange, or though admitted but traded as unlisted securities).
The execution of derivatives outside of a stock exchange.
5 tax-exempt incomes of citizens (UAH 85) for each executed derivative.

The mode of payment. The Special Tax should be withheld and remitted to the tax authorities by the tax agent by the deadline prescribed for a quarterly taxable period. The duties of tax agents are imposed on securities traders and the issuers of the securities of open-end investments funds (for the placement, redemption and repurchasing of such securities only). With regard to derivatives, the above fixed tax in the amount of 5 tax- exempt incomes of citizens is directly paid by the parties to derivatives (at least, such a conclusion can be drawn from reading the pure law, not yet covered by the clarifications of the tax authorities).  It is noteworthy that each party to the derivative is subject to the aforesaid fixed tax.

Risks and problems. The Act to the extent to which it concerns the determination of tax rate cannot brag about its unambiguousness which can naturally result in some problems and risks for the taxpayers.

First, the law is not completely clear on the point whether the taxpayer is eligible for the zero rate where the stock exchange rate has been calculated, but the securities of the taxpayer have not taken part in this calculation (the stock exchange rate has been calculated based on the bids/asks of other persons selling the same securities on the stock exchange). This may, for example, arise where the securities have been sold by the taxpayer based on the addressed bids/asks that are not taken into account when calculating the stock exchange rate.

It may be assumed that the tax authorities will pursue the position on the applicability of the zero rate only to those securities that have actually participated in the calculation of the stock exchange rate.

Secondly, in order to apply the zero rate to the transactions in securities traded on a  stock exchange the legislator requires  the stock exchange rate of such securities to be calculated in accordance with the requirements established by the National Securities and Stock Market Commission (hereinafter - "Commission") and approved by the central executive body in charge of financial policy. To date, the following requirements though set by the Commission (decision of 22 November 2012 1688), but without any approval on the part of the above-mentioned central executive body (probably, the Ministry of Finance of Ukraine).

So, on formal grounds (the lack of the approval referred above) the tax authorities may not recognize the entitlement to the zero rate in respect of any transaction in securities carried out on the stock exchange.

Thirdly, the legislators have, for unknown reasons, forgotten to set forth a tax rate for transactions in securities conducted on a stock exchange with regard to which the stock exchange rate has not been computed. This may, for example, occur when during the trading session of a stock exchange in the course of which the taxpayer sold his securities there were less than three unaddressed bids and less than three unaddressed asks pertaining to the respective securities. Under the Procedure for Determining Stock Exchange Rate of Securities approved by the above decision of the Commission, in order for a stock exchange rate to be calculated there must be not less that the above specified number of the unaddressed bids and asks in relation to such securities.

If the stock exchange rate of securities has not been computed, but they have been sold on a stock exchange, then, on the one hand, there are no grounds to apply the zero rate, and, on the other hand, there are no grounds for the application of other rates (0.1% and 1.5%) either. The latter are relevant for transaction in securities carried out outside a stock exchange only.

How to act in this situation seems to be a sophisticated question. It is logical to argue that because the rate is not specified, the tax should not be levied at all. Not surprisingly, the tax authorities may have their separate opinion on this matter.

Policy considerations. Finally, here are some speculations on the policy consideration underlying the launch of the Specific Tax. Given that the exemption (zero rate) is granted to transactions in securities and derivatives traded on a stock exchange, it is not difficult to guess that one of the key objectives was to support the business of stock exchanges. But is this really the main purpose?

Perhaps, by enacting the Act the legislator intended to strike a blow to tax avoidance (tax mitigation). It is not a secret for anybody that securities are widely used in tax avoidance schemes. If the blow to tax avoidance has been stricken indeed, this will hold true only for securities that cannot be traded on a stock exchange at all (e.g. promissory notes).

“Tricks” with promissory notes with 1.5% tax charged at each stage of the sale may be too expensive to afford. In the meanwhile, as for shares and bonds, there should be no serious problems. In order for the zero rate to become applicable, it suffices to include the securities in the list of a stock exchange as unlisted securities which can be done almost anytime and even with reference to securities of rather dubious quality.