Europe: Is the Fiscal and Treasury ‘crisis’ a Short Term Issue or a Symptom of Long Term European Federalisation or ‘Conciliation’?

The European Treaty structure, using the term in a lay sense, can either be seen as an incoherent set of treaties involving different organisations, or a pragmatic case by case resolution of specific diplomatic issues in a treaty context devoted to the diplomatic position in the defined sector addressed. Here I am placing the European Union institutions and the various treaty extensions within the European wide context of the other treaty networks and structures such as the Council of Europe and NATO, insofar as its functions extend to Europe.

The following outline is best read in the light of the formation and the ensuing work of the EU Code of Conduct Group, a non-institutional extension of ECOFIN[1]. This Group was in fact working outside the strict borders of treaty and EU institutional competence, as the last paragraph of the preamble to the Resolution of 1 December 1997 makes perfectly clear. This is confirmed by a more detailed study of the various ‘informal’ extra-institutional meetings leading up to it, enumerated in the ECOFIN “Conclusion” 98/C 2/01 to which it is annexed. None of these documents have ‘legal’ or enforceable status, under the treaties. However, the actions of the institutions acting under its political influence, rather than under legal structural obligation, are subject to certain general procedural constraints.

I would like to explore here the development of that body of diplomatic function, known loosely as the Congress of Vienna of 1815, through its development and partial attachment to what has now become the Consilium[2], as the diplomatic behaviour patterns in relation to smaller foreign jurisdictions such as international finance centres remain largely unchanged from that historical perspective. What is significant about the Vienna Congress was that it rarely met in plenary session and the main diplomatic strategy was to ensure that you were in the right session at the right time in order not to be left out of the developing process and its implementation. From that strategic perspective, little has changed. The ECOFIN fiscal Code of Business Conduct[3] in effect was an entirely and admittedly ‘unlawful’ or ‘extra-legal’ statement, which was given political mass and weight by the Member States and the Consilium, as it now is. That initial statement of policy has since gained political, but not legal mass. However, the European Commission and the Consilium have adopted methodology, which reverts back to the ‘procedures’ of the Congress of Vienna rather than to the core legal treaty concepts upon which they rely for their existence, competence and jurisdiction, ie, their raison d’être.

The development of the various Common Market, European Community, and now European Union treaties towards the idealised goal of a Union or Federalisation has led to a change in the balance of rights and powers as between economic actors and the various States concerned.

This is exacerbated by the political use of the macro-economic notion of fiscal ‘discipline’, and the inevitable distortion and incursion into the legal aspects of the definition of the taxpayer’s tax liability, its declaration, collection and enforcement, which remain within the microcosmic sector of analysis. There is an overreaching tendency of economists to assume that their science takes precedence over the law giving effect to it.

A deliberately non contentious example: In the negotiations of the 2004 Tax Treaty between France and the United Kingdom, the previous article 164C[4] ‘strong’ exemption was excluded from the renegotiated Treaty on the basis of a French assertion that the tax in question could not be recovered from an EU citizen. The French stated that it was understood that income tax was an issue which was indirectly covered by the EU Treaty in the context of the freedoms involved. In fact, the French tax administration was preparing to defend the contrary thesis before the CJEU and succeeded in front of that court in stating there that income tax was not covered by the EU Treaties, and that it could therefore discriminate. In other words the Member States, as between them, are not loyal, if scarcely honest, as to their assertions in bilateral treaty negotiation. The result was that HMRC gave up the treaty exemption, which now enables the French administration to assert taxing rights on deemed income arising on properties owned by United Kingdom residents and citizens. Spain retained the strong exemption in its treaty, and its citizens are not taxed. What is curious here is that HMRC made no attempt to defend its treasury ‘outflow’ as it was more concerned with defending the taxation of partnerships that it was proposing. What is serious is that, as between themselves and their taxpayers, Member States are being less than loyal in relation to prior established and legally superior European principles.

The point of this example is that the treaty concepts such as the freedom of movement of capital and payments are being rewritten by reference to the tax exception to that principle[5], and by reference to newer structural concepts such as subsidiarity. In other words the Consilium is being incoherent in its defence of the written treaty, but coherent in relation to other, opaque diplomatic issues beyond the EU treaty structure.

This is important to bear in mind, as the degree of resistance to non-EU corporation tax regimes, such as the ‘Zero-Ten’ debate was conducted on entirely non-EU legal principles, with the result that most of the eastern Europe Union has managed to base its tax revenues on flat rate taxation, at a lower level that that, for example of France, the United Kingdom and, incidentally, Jersey, Guernsey or the Isle of Man[6].

Provided that the European Union is not seen as the sole decider but rather as a consensus of the political inhabitants of the diplomatic space, which has for the moment attached itself to the Consilium in this area, the policies to be adopted by the EU in relation to, for example, alternative investment funds become more understandable. These decisions are in fact no longer taken by the Commission in Brussels as a principal instigator and ‘policeman’, but rather as an agent for the Consilium and for those influencing that remodelled institution’s decision making process.

So what for the future?

The long term build up to the creation of a European central bank structure as an effective economic fore has been stimulated by the crises, or rather the bumps in the process of financial globalisation from 2004 through to 2008 and until now. That globalisation encouraged by the USA is now reverting back to a set of regulatory barriers to freedom of movement at a participating state level. In short, it is only by the creation of a fully functional European Central Bank, in the eyes of the Federalists, that the momentum towards a unified market can be achieved.

Those studying the development of the treaty jurisdiction of the European Central Bank[7] and its adjunct, the ESCB[8] will have seen that, next to article 103 TFEU, the conceptual structure of these institutions has been taking the direction of a federalisation and that it will, in fact take very little more in the way of remodelling the Treaty to render the actual federalisation of the assets backing Euro a legal and constitutional fact. That has been one underlying current in the diplomatic space to which I have referred. That renders the issue of the fiscal ‘let out’ for Member States from the requirement that there be no obstacles to freedom of capital and payments, whether within the EU or to or from the outside world a legal strategic issue.

It is that area of semi-licensed discrimination that should concern the IFCs at this present moment.

The Court of Justice of the European Union may be the next port of call, were the license to tax under Article 65 (1) (a) TFEU be abused, as it is at present. It is going to be difficult for a Member State levying taxes as against other Union or third States’ corporate or citizens on the basis of its own legislation, to apply the information exchange requirements for taxes otherwise outside the formal Treaty scope, without admitting that these same taxes can constitute an infringement of Article 65 (1)(a). The subsidiarity ‘let out’ does not stretch that far.

What is also clear is that the Member States have asserted their claims to subsidiarity, and have strengthened their taxation of assets outside their inherent jurisdiction, on the basis that these are considered to be their citizenry’s or resident’s, whether corporate or individual, and if not, part of their national asset base when situated within their jurisdiction. They use what was no more than a mere fiscal exception to the principle of freedom of movement to enable such an arrogation to strengthen this miss-appropriation, which is not particularly ‘European’ in the true sense of the term.

The current change in ethos from the now rare exemption principle to avoid double taxation, to double taxation with credit, is being thwarted by double taxation without exemption and credit merely by asserting different legal bases of taxation on the same issue. A comparison of the HMRC taxation of a French usufruit dismemberment on the false basis that is a ‘settlement’ or a trust is but one example; as is confirmed by the recently introduction by France of a ‘tit for tat’ treatment of trusts as remaining within the foreign settlor’s estate for wealth tax, gift and estate duty purposes[9].

The original European ethos was severely compromised in the Lisbon Treaty, and the Revenue authorities of Member States have used their treasury crises as an excuse to arrogate assets and income to their own budgets which in the absolute legal sense were not theirs.

The financial centres outside the EU where to a greater or lesser extent alternative investment funds are administered, need to be prepared for more European institutional issues. The European Parliament should not be seen as operating as a parliament in the sense that it will defend business or its electorate, but rather as a staging post allowing for amendments negotiated elsewhere, involving the Consilium and the Commission, and being influenced by what are now described as ‘stakeholders’ throughout the decision making process. What is worse is that the European Parliament is seeking powers to initiate legislation, rather than debate matters proposed to it.

Where does this leave Financial Services?

The financial service sector in the wide sense is not the most popular congregation within the economic religions or economic castes represented in Europe. However, the main emotional complaint being directed against lending institutions in general is that the ‘money’ put back into the system by differing means to replace the writing down involved in recovering the stock exchanges fluidity after the 2008 crisis is not reappearing in the money supply but is reinforcing capital, and therefore not consumption. This may in part be caused by the slowness of the American legal system in correlating collateral to the defaulting paper, botched by its reliance on interest from defaulting sub-prime loans. As part of its quantitative easing process the US Fed is currently proposing to buy back mortgage backed paper, a percentage of which were comprised in part of the additional interest kickers from sub-prime or Ninja loans consolidated with less risky security to render their revenue apparently more attractive.

It is here that the financial centres have to rise to the occasion with an objective clarification of their role in the supply of money at all stages of its creation and circulation. There will be less difficulty within the financial markets within which they presently play a role, as their presence is regulated and process understood.

The difficulty will be faced where there are the following four factors, at work:

1. Where there are business opportunities within an EU jurisdiction within the Eurozone, the currency defences being built up by Eurozone central banks and the fiscal authorities to protect their own markets, and ability to raise finance, both against other central banks and against private capital influence;
2. The political / legal implications of fiscal discrimination implicit both in 1. and generally, and attempts at capturing foreign liquid capital within the capital markets of the home state: cf FATCA;
3. The intentional use of differing economic definitions in the domestic establishment of financial transactions taxation between Member States, and third jurisdictions;
4. The ramifications of the false proposal that money ‘offshore’ is ‘dead’, when in fact it is reinvested onshore: it has to be, as otherwise, it has no value.

This also needs to be seen in the context of private capital being in a sense ‘nationalised’ in order to provide part of the host central bank’s money issuing process, in a disturbingly similar manner to the warring Italian City States in Renaissance Italy. Against what does a Central Bank effectively borrow and re-lend? The future prospect of tax revenue and capital within its own purview: the efforts and capital of its residents, in the case of the United States, its citizens and residents. However, the disturbing change in the flow is that the United States have effectively realised that their economy had functioned as a form of Ponzi scheme in that foreign liquid capital had to be poured into their stock markets in order to maintain some semblance of balance sheet and asset value, when in fact there was then none which could be adequately defined. FATCA is no more and no less than a fiscal trap for that foreign capital, posing as an attempt to isolate and tax non-compliant American citizens abroad.

The main issue now is that certain of the EU Member States have aligned their fiscal policy along FATCA principles, and are negotiating FATCA relaxations with the US in exchange for information, in both directions.

The main issue is therefore the need for a clear intervention in the legislative process, both in, and within, the European Union and outside, to prevent the meaning of ‘money’ and risk investment becoming distorted into a state monopoly.

However, there is a need for ‘regulation’ in the wide sense, in that the American sub-prime issue turned into a systemic crisis as a result of the over commercialisation of ‘ninja’ type investments as an ‘add on’ to render more conservative loans look attractive on the higher paper at several levels removed.

It is therefore essential that the financial centres act to provide liquid capital to sponsor investment, which will lead to future capital creation and investment, rather than being perceived, wrongly, even at the level of such institutions as the OECD, as being the main source of systemic ‘risk’. That was simply the American economic sub-prime model becoming extended beyond its rational scope, for domestic political expediency, enabling Americans to ‘own’ their own home whilst in effect leasing it from the capital markets. The legal system in the US has still not yet managed to match collateral to the loans written down, nor thereby to release the rescue liquidity poured in from abroad: a significant failure of a so called ‘regulated’ economy. Hence FATCA capital imprisonment and the tax ‘exception’ justification currently being deployed by certain European States.

It is clear that the perception of the Tobin Tax in Europe is that it in some manner discourages the excesses in the derivative markets, despite the OECD not giving it a clean bill of health in 2003. The EU version of FTT[10] currently under consideration is, for some reason being raised to the level of an EU own resource. That will mean that the Commission will be able to treat the FTT as an institutional matter in the same manner as it has VAT in the past.

This will lead to increased legal pressures on financial centres to concentrate on areas within which their investments are not at risk, as the European Parliament has indicated that it wishes to render FTT “unstamped” transactions “unenforceable”. The systemic risk involved in such a step is to all extents and purposes infinite in a global economy, but less so in an insularized one. The FTT definition of the ‘taxpayer’ has also been modified so as to render it possible for a European situated bank not to honour its quasi-derivative contracts, thereby offering a further systemic risk in the world-wide currency markets. All this on the basis that ‘index betting’ does not represent a category of derivative of a positive nature, which unwind themselves at the end of their investment cycle, generally agricultural or industrial. It is therefore not by offering vehicles apparently promoting perceived ‘greed’, rather than protection models, that the former will be acceptable entrance ‘gifts’ to gain access into the EU market.

However, European risk appetite is generally limited, as the European models generally insist on lower loan against collateral ratios. It is at that point that the financial centres can continue to provide private capital to fund investment, which is after all what the European and British markets are crying out for.

This has to be seen in an overall context where the internal weaknesses and inadequacies of the Euro work to the benefit of certain, not least the unified Germany, but act as a increment to the strong’s creditworthiness, reducing certain otherwise sustainable economies to the status of sub-prime. Were capital to have been available to Greece and Spain at lower interest rates, rather than flowing through to Germany and other strong economies, would there now be as large a problem? The ERM would have served as a vehicle to export German recession following unification, which happened anyway, and that issue appears to have been forgotten.

London and Dublin will doubtless need to decide to what extent they are prepared to remain a conduit for live capital from the Crown Dependencies and from Associated Territories; rendering these attractive legal platforms for ‘non-domiciled’ investment from the BRICS or elsewhere. Otherwise, the Tax Justice Forum’s fallacy as to ‘dead’ offshore capital may become reality, for the wrong reasons, and serve only to further republicanise the concept of ‘money’ and its creeping fiscalisation onshore, towards the left.

The question is whether there is a sufficient perceived need to reduce withholding and tax discrimination relating to these international flows and investments. Most Member States have a ‘back-door’ funds arrangement to assist capital risk investment, and it is a question of whether these particular advantages can be tolerated in the current political and emotional context.

The Court of Justice of the European Union has recently required France to remove its 15 per cent withholding taxes on certain fund distributions paid both to foreign EU funds and also to those in tax compliant third countries. This is on the basis of the wording of the freedom of movement of capital provisions, which are designed to avoid deflection of capital coming into and out of Europe. Here there are both potential entrances and exits for foreign fund capital.

In short, there is much to be done if financial services from abroad into Europe are not going to be taxed on their full monetary value, rather than the income or capital gains that the capital produces. In other words to prevent the FATCA developments in the USA being indirectly implemented within Europe between Member States. Hence the prior reference to the Italian Renaissance City States that stood or fell on the basis of their citizen’s ability to continue to guarantee their own bonds and therefore currencies, and their reliance upon hiring foreign mercenaries – at that time from Essex [11]-, amongst others - to appropriate other City States capital. That is still happening at the Member State level and the conceptualisation of ‘subsidiarity’ within the Union framework is but one tool employed.

However, there is no doubt that the diplomatic corpus appearing regularly in one shape or form throughout recent European history, certainly since the Napoleonic wars, was in a sense the vehicle for Europe’s stability, barring the odd war or three. It is therefore necessary to treat the Consilium as an emanation of a political and diplomatic continuum, and not necessarily as a final arbiter. It is towards that amorphous body that the finance centres should be directing their influence and energy, a little like the German printers at the Vienna Conference , to ensure the survival of their intellectual property. Certainly as such batons of ‘unlearned’ political influence such as the TJF as wielded by their NGO and union sponsors have penetrated the institutional framework, it may need a different approach from IFCs which are after all quasi-sovereign micro-states.

The fact that no significant European premier ego has been elected to the Consilium’s head is a sign of its stability as an emanation of that continuum. None of Mssrs. Giscard, Kohl or Blair have made it to that seat. The current geographical area covered by the Consilium renders it very similar to the Congress of Vienna, and its geographical scope is now sufficiently towards the East of Europe and Russia to render reference to its historical development pertinent. All the financial services sector lacks is a less crippled but more vociferous organisational Talleyrand, before it is reduced to a mere satellite such as the German printing industry represented at Vienna, in their attempt to counter Mettenech’s attempts to curtail their ‘business’. That ‘business’ was the flow of ‘republican’ ideals within the then nascent pseudo-monarchic order by the then sole means available to communicate ideas without travel.

It is essential therefore that the finance centres do not allow their worth to be miss-defined and thereby effectively sidelined, otherwise their business, the flow of money, will also be curtailed within a new order, which will become politically hostile to their contribution, unless informed and, in a sense, placated.

Talleyrand’s main expertise at the Council of Vienna was reformulating the notion of ‘statehood’ behind a form of constitutional monarchy, which could be dismissed, of a non-republican nature, whilst permitting the increasingly potent democratic forces some freedom. At that stage Europe had had enough violent ‘republicanism’, and even Napoleon had started to formulate a notion of constitutional leadership. The same ideas are required now in the field of international money flows, as the European Central Banks in the ECSB start erecting barriers within an increasingly ‘federal’ Europe to maintain their ‘ideal’, the Euro. With that will surely come fiscal pressure on non-resident non-voters, with each Member State asserting its own sovereignty in its time-hallowed traditions, with the added injustice of double taxation at penal rates on non-residents who use legitimate methods other than those tolerated by the tax administration.

It is therefore of the essence to encourage the use of such historic institutions of influence as the Foreign and Commonwealth Secretariat to further the interests of the Commonwealth in general and the Crown Dependencies and the Associated Territories in particular, in conjunction with the larger Commonwealth states; to the extent that their interests are not contradictory. However, the main issue is to avoid being relegated to the status of a mere ‘stakeholder’, but retaining their influence as jurisdictions within the current post-Westphalian context[12].

N.B I stress that this is no more than a conceptual argument from an international tax lawyer’s perspective. It is certainly not intended to be an absolute or a scientific analysis of any merit.

[1] ECOFIN: The Economic and Financial Affairs Council is, together with the Agriculture Council and the General Affairs Council, one of the oldest configurations of the Council of the European Union. It is commonly known as the ECOFIN Council, or simply "ECOFIN" and is composed of the Economics and Finance Ministers of the Member States, as well as Budget Ministers when budgetary issues are discussed. It meets once a month

[2] By Consilium, I am referring to the institution also styled the Council of the European Union

[3] See Resolution 98/C/2/01, above.

[4] Article 164C code general des impôts taxes non-resident individuals on a deemed income arising from their ownership of property in France equivalent to three times the annual rental value of the property, irrespective of whether it is let out or not. The French assume that an individual owning property in France has to have that level of income to be able to upkeep it. That is double taxation of a deemed income, taxed elsewhere, without credit and the previous exemption.

[5] Article 65(1)(A) TFEU

[6] Generally the rate of income tax in these Crown Dependencies is 20%.

[7] European Central Bank

[8] European System of Central Banks

[9] Articles 792 -0 bis, 885G and 990J Code général des impôts

[10] Financial Transactions Tax

[11] or what were the Iceni, in a previous inversion of roles

[12] The Treaty of Westphalia commenced the notion of a nation state, subsequently taken up more or less in the Congress of Vienna: that concept of nationhood has been eroded since the Second World War. That now provides an opportunity for smaller micro-jurisdictions to assert their position, as they are doing at several international levels such as the OECD Global Forums.