UNITED KINGDOM: STAMP DUTY ON SHARE TRANSACTIONS

UK Stamp Duty on Share Transactions
By Robert Lee, London

Staging its annual ritual Stamp Dance in early 2006, the London Stock Exchange urged Chancellor Gordon Brown to abolish stamp duty on share deals, arguing that it is destroying the competitiveness of London as one of the world's top three financial centres.

During the market downturn in 2001 and 2002, the LSE argued that the abolition of stamp duty was just the tonic that the market needed. Brian Mairs of the Association of Private Client Investment Managers and Stockbrokers told the BBC that even the abolition of the tax on small cap companies such as those quoted on the AIM or OFEX would act as "a huge psychological boost". The 0.5% rate at which stamp duty is paid in the UK is far higher than that of Germany and the US, and therefore threatens the LSE's position as one of the world's top three stock exchanges.

However, Mr Brown was never likely to make such a generous gesture given the worsening fiscal situation he has been facing in recent years. It is estimated that ending stamp duty on share dealings would cost the government somewhere in the region of £2.5 billion a year. Despite the fact that the issue was conspicuous by its absence in the chancellor's pre-budget report in 2005, investors, city opinion formers, and big business concerns were nonetheless hopeful one more time that Gordon Brown would announce changes to the antiquated concept of stamp duty in this year's budget, but they were, as usual, disappointed.

The UK is the last major world economy to impose this level of taxation on share purchases, and the 0.5% tax (which on a £5,000 transaction would cost the investor £25) is the highest in Europe. Germany, Italy, Spain, the Netherlands, and Luxembourg no longer impose stamp duty, France has a rate of 0.13% and effectively exempts transactions under £5,000 from the tax, and even the US rate of 0.003% is set to decrease in stages over the coming years.

Stamp duty used to be something of a 'hidden' cost, with a 0.5% surcharge on the purchase side of a share transaction hardly noticed amid all the other commissions and fees involved. However, technological advances, such as the possibility for online trading, and the fierce competition among brokers, have combined to drive down trading costs, making stamp duty an ever more significant and obvious factor in the overall cost of a transaction.

Stamp duty brought the Exchequer in excess of £3.7 billion in revenue in the 1999-2000 tax year, and is one of the easiest taxes to administer, which goes a long way to explaining why the Treasury has wanted to continue levying this 17th Century tax into the new millennium. All UK share transactions are settled through the London Stock Exchange's electronic settlement system, CREST, and it is CREST that collects the tax as a surcharge on every purchase, and transfers it to the coffers of the Exchequer. Until recently, UK Treasury officials were of the opinion that the actual damage caused by the tax was relatively small, but repeated calls for its abolition by the finance industry's movers and shakers, and recent trends in trading seem to prove them wrong.

The groups attempting to negotiate changes with Mr Brown in the pre-budget period represented a fair cross-section of the British finance industry, and included the London Stock Exchange, the Association of Private Client Investment Managers and Stockbrokers (APCIMS), the National Association of Pension Funds, and the Quoted Companies Alliance, which represents the concerns of small and medium sized companies.

Although these, and other City groups, ideally wanted to see the tax scrapped in its entirety, following its non-appearance in the 2005 pre-budget report they indicated a willingness to compromise, asking instead for a reduction. The campaign proposed halving the duty from 0.5% to 0.25%, and importantly, exempting transactions of less than £5,000 altogether, along with stock acquired as the result of a merger or acquisition.

Outgoing chairman of the LSE, Don Cruikshank, predicted in 2003 that if changes weren't made to stamp duty legislation, total losses of trading could be as much as £1 trillion.

He was quickly proved right, when in May 2004 Inland Revenue figures showed that revenues from the tax on share trading fell from GBP4.5 billion in the 2000/2001 tax year to GBP2.6 billion in 2003/2004. The UK government has thus foregone GBP2.5 billion in revenues from stamp duty on shares as fund managers and investors turn towards derivatives to escape the tax. Given the recovery in the stock market over the previous year, it is estimated that the Treasury should have received around GBP5.1 billion from the levy in the tax year just passed.

Figures published in January, 2005, confirmed the picture, showing that revenues from the United Kingdom's stamp duty tax on share trades is likely to remain flat in 2005 at £2.6 billion, despite a sharp increase in the volume of shares traded on the London Stock Exchange.

It seems the major reason for this is that investors are increasingly shunning traditional share purchases, which attract a transaction tax of 0.5% - a levy now almost unique in the industrialised world - in favour of derivatives known as contracts for difference (CFDs), which do not attract the tax.

CFDs allow investors to profit on the movement of a share price without actually owning the physical stock. Similar to other derivative instruments such as futures contracts, two parties enter into an agreement to settle at the close of their contract the difference between the opening and closing price of a company's share price.

Firms that offer CFDs are able to hedge their exposure to the contracts by physically buying the underlying stock, and by doing so enjoy a tax concession that means they do not have to pay stamp duty.

CFDs have rapidly grown in popularity in recent years, and this has been reflected in government revenues from stamp duty, which have traditionally been one of the largest contributors to the Treasury's coffers.

According to Howard Flight, the Conservative Party's special envoy to the City of London, the figures strengthen the case for a review of the tax, and even its complete elimination.

"Many people think this is a tax on the rich. It is not. Wealthy individuals and institutions have access to sophisticated derivatives that enable them to avoid the tax. The ordinary person and his pension fund do not,” he observed.

The UK is acknowledged to have the highest rate of share trading tax among its competitors and the London Stock Exchange has suggested that the cost of stamp duty can make up as much as two-thirds of the cost of a typical transaction.

Stamp duty charges pose a serious threat to the LSE's ability to compete with rival exchanges, but the consequences of no change for the UK economy are more far reaching than that. Not only does the tax disadvantage companies registered in the UK, it also acts as a major disincentive for overseas and multinational companies who might otherwise have registered in the United Kingdom, and listed on the London Stock Exchange. Why should a pan-European company want to register in a country where stamp duty is charged on the trading of its shares when other duty-free countries are competing for the business?

In its pre-budget submission to the Chancellor in October, 2005, the LSE pointed out the damage being done to the Exchange's ETF sector by the tax:

'It is evident that Stamp Duty legislation is preventing the growth of the ETF market in the UK. The catch all nature of the legislation means that Stamp Duty is payable, at 50 basis points, on ETFs that include normally exempt foreign securities. Since the average total cost for trading equity ETFs in Europe is 44 basis points, stamp duty more than doubles the cost of dealing in overseas ETFs in the UK. We believe that an ETF incorporated anywhere (UK, Dublin or overseas) should not be stamped in secondary market trading if its basket contains no stampable securities.

'It is difficult to believe that the Government intended to extend the duty to normally exempt stocks in such a manner, nevertheless the consequences are that it further damages the ETF market in the UK. There is no revenue gain from the inclusion of overseas ETFs in the stamp duty regime since it is sufficient to prevent the market from starting. If the Government does not remove stamp duty on UK shares, it should, at the very least, exempt ETFs containing overseas securities.'

As cross-border trading continues to develop, especially through on-line exchanges which can be based in low-tax jurisdictions of their choice, UK and international companies will have access to the same international pool of investors wherever they are registered and listed. Eventually, this will drive business to the lowest-cost and most liquid exchange - that won't include a stamp duty jurisdiction.

Research conducted by independent consultants, such as Charles River Associates, suggested that if the chancellor chose to abolish the tax, such a move would be revenue neutral, or even beneficial for the economy, because it would bring other tax gains to the Exchequer, a fact that Mr Brown has seemingly chosen to ignore. The Charles River findings suggested that the knock-on effects of stamp duty abolition would be that:

• Enhanced share values would provide an initial increase in Capital Gains Tax revenues of approximately £6 billion;
• The volume of UK companies' shares traded on the London Stock Exchange would increase by around 40%;
• Income and Corporation tax revenues would increase significantly;
• The FTSE All-share index would increase by up to 5%;
• There would be overall net efficiency gains to the economy of around £3 billion.

Even a partial abolition, for example as suggested a recent campaign for transactions under £5,000, would only have cost the Exchequer £157 million in lost revenue per year, and abolishing the levy would have sent a powerful message about the government's commitment to dismantling an antiquated and irrelevant tax.

The UK Treasury is of course more likely to tax the upcoming alternatives to share trading than to abolish the tax.

In April, 2006, is became clear that the Irish Inland Revenue, which collects 1% stamp duty on stock exchange transactions, was planning to extend the tax to Contracts For Differences (CFDs), which currently don't come in for stamping because they don't involve buying the underlying shares.

Irish Stock Exchange officials met the Revenue to try to persuade them that Ireland's CFD business, which is said to underly EUR3bn a month in trading on the Irish exchange, would simply decamp to London if the tax is imposed.

CFD trades are effectively bets on the future movement of shares, up or down, and can be highly leveraged. Traders can make their deals either with the equivalent of a brokerage (call it a bookie?) or direct with other punters. Either way, because they do not actually buy the shares whose price is the object of the trade, it has been assumed by all concerned in the UK and Ireland that stamp duty cannot apply.

In December 2006, it emerged that the UK government would be abolishing stamp duty on non-resident exchange traded funds (ETFs) in an effort to boost London's competitiveness as an international financial hub.

A brief look into the (distant) past of Stamp Duty

Stamp duty was introduced in Holland in 1624, when the need for a new form of tax resulted in the idea of requiring stamped paper for legal documents. It was first levied in England in 1694, and although stamping was initially confined to documents processed by the legal profession, in the eighteenth century, the rationale behind imposing stamp duties changed, and they became a means of controlling undesirable activities such as gambling and newspaper reading (!)