UK must pick the right time to fight EU financial transaction tax

London’s banks shouldn’t be worried just yet. EPA

“In capitalist countries, the bank robs you.” Rightly or wrongly, this phrase – a reversal of an internet meme – sums up many Europeans’ reactions to the bank bailouts and austerity of the last few years. The EU responded with a series of populist measures – a restriction on short-selling, criminal penalties for market abuse, and a proposal by 11 member states for a “Robin Hood tax” known as the Financial Transaction Tax (FTT).

The UK challenged the FTT in the European Court of Justice, fearing it could significantly damage the City. But now, as widely expected, European judges have ruled against the UK. So at first sight the news looks like a big blow for the City, and indeed the whole country.

But in reality it is no such thing. The UK will still be able to bring a separate legal challenge to the FTT, if and when it is finally adopted, and, for the reasons set out below, such a challenge would have a much better chance of success.

The first thing to point out is that EU law is not “one size fits all”. Indeed, there are a number of different possibilities for some states to go ahead and adopt measures without all the others joining in. This is known in EU jargon as “differentiated integration”. The single currency is the most obvious example of such differentiation.

But there is also a lesser-known option for some member states to go ahead without the others in any area of EU law. This procedure, known as “enhanced cooperation”, has been used only twice before: in divorce law; and to create a “unitary patent”, applicable across various member states. The third usage was to authorise a group of member states to adopt an FTT.

Enhanced cooperation works in two stages. First of all, the EU Council authorises a group of member states to go ahead in a particular area – divorces, patents, taxes. These authorisation decisions do not go into any detail about the law concerned. The EU institutions then negotiate the details of the legislation itself. This is known as the measure “implementing” enhanced cooperation.

When the enhanced cooperation procedure was used for the first time (in divorce law), the Council very quickly agreed on the implementation measure. However, on the second occasion when this procedure was used (the unitary patent), arguments over a Unified Patent Court meant it took nearly two years for the EU to adopt the implementing legislation.

Similar delays have occurred over the FTT. Legislation to set up the transaction tax was first proposed back in 2011. Enhanced cooperation has been authorised, but participating members each have a veto and they are struggling to reach agreement on rules of the tax itself.

It is easy to see why the UK objects to the proposal. It would not only tax transactions which take place in the financial markets of the participating member states (reasonably enough), but also those which take place in the financial markets of non-participating states – as long as one of the parties to the transaction is located in a participating state. To this end, the proposal would deem a British bank to be a French bank (for instance) in certain circumstances.

There is a very good argument that this proposal violates the EU’s rules on free trade in the internal market, and interferes with taxation sovereignty. EU treaties require any enhanced cooperation to be consistent with those rules. Indeed, it is widely known that the EU Council legal service believes that, for these reasons, the Commission’s proposal would be illegal – if it were in fact adopted.

Though these arguments have been rejected by today’s judgment at this stage of the process, this was simply because the final shape of the transaction tax has not yet been decided. It is entirely possible that those countries who do want the tax might never reach agreement on the details, or that they might agree on an arrangement which doesn’t violate EU law.

Even if they do agree to adopt the current proposal, the UK will be able to challenge the relevant directive when the time comes.

If the UK’s challenge had succeeded, it would have ended any prospect of a European FTT for the time being. Its failure keeps the prospect alive. But because the courts rightly did not rule on the merits of the UK’s case against the Commission proposal – simply because that proposal has not yet been adopted – the UK has only lost a minor skirmish, not the war.

The mere fact the tax was challenged at all has made it clear to the participating states that the UK will vigorously defend its legal position, and may therefore have contributed to their difficulties in agreeing to the Commission proposal. The government’s legal action, although unsuccessful, may yet play some role in ensuring that a transaction tax, if one is finally agreed, does not hurt British banks.

An FTT limited to transactions within participating countries would of course not raise as much money. Then again, the UK could also reduce its budget deficit if it could (for instance) collect a toll from drivers on German motorways, or tax all the cheese bought in France. The absurdity of these scenarios shows why a future British legal challenge to the final FTT, if such a challenge is necessary, would have a much greater chance of success.