SDRT in clearance systems: HSBC plc and Vidasco Nominess Limited (569/07)

Summary

The Advocate General has delivered his opinion in a case concerned with whether the UK SDRT rules that levy a Stamp Duty Reserve Tax ("SDRT") charge of 1.5% on the issue or transfer of shares into a clearance service complies with EU law. The Advocate General has opined that the UK legislation is contrary to Article 11 of Directive 69/335 (concerning capital duty) and that, if he is wrong on that point, the UK legislation nevertheless constitutes a restriction on the free movement of capital under Article 56 EC Treaty. If the ECJ follows the Advocate General’s opinion this will provide clear authority that the UK’s SDRT clearance service regime is not compatible with EU law. Those that have paid significant amounts of SDRT under the clearance service regime should review their position.

Background

SDRT and CREST

Historically, transfers of shares in UK companies have been made by registration of a stock transfer form. On the introduction of the CREST system for electronic share transfers (in 1996) the general rule that a transfer must be made by a paper document was relaxed and the registration of paperless transfers of shares is now permitted, provided it is made through an electronic system approved by the Treasury. CREST is the only system approved by the Treasury for this purpose. Since the introduction of CREST, SDRT (a tax on transactions, not documents) has overshadowed stamp duty as the main tax collected from share transfers (stamp duty still applies to paper transfers).

SDRT arises on any agreement to transfer "chargeable securities". Broadly, chargeable securities are shares issued by UK companies or shares in foreign companies that are registered in a UK register (or "paired" with shares issued by UK companies). On the issue of shares in certificated form or in un-certificated form in CREST, no duty arises on the issue of the shares. SDRT at the rate of 0.5% is charged only on subsequent transfers.

CREST calculates, collects and accounts for SDRT on the basis of the inputs made by its participants. There are a variety of different transaction stamp status flags that may be input by participants in CREST to indicate the nature of the transaction for SDRT purposes.

Clearance Services

Essentially, a clearance service is a system for holding securities and settling transactions in them by book entry. The securities may be held indefinitely within the system and despite changes in beneficial ownership are held either by the company operating the clearance system or by its nominee. Therefore, the securities are traded without the use of transfer documents. Clearance services are widespread in continental Europe but not in the UK.

UK legislation contains a special regime for certain transactions effected through clearance services. On the transfer or issue of un-certificated shares to the operator of a clearance service, duty at the rate of 1.5% of the issue price or the transfer consideration is charged but no SDRT is charged on subsequent transfers within the clearance service. It was because of the scope for avoidance by trading through an offshore clearance system that the rate of duty was increased to 1.5% for transfers or issues of chargeable securities to operators of clearance services (as the price for paying no duty on subsequent transfers within the clearance service). Although the charge was technically payable by the clearance service or its UK nominee it is market practice for the issuer or transferor to pay the charge.

However, the operator of a clearance service may, if it obtains HMRC approval, elect for no duty to be charged on the transfer or issue of the shares to its clearance service. Instead, duty at the rate of 0.5% is charged on each sale of the shares within the clearance service. As a condition of HMRC approval, HMRC requires an operator of a clearance service to comply with specified arrangements so as to ensure SDRT compliance. Broadly, HMRC will grant approval where the operator puts in place a system that enables it to comply with the recording, reporting, collection and accounting of SDRT on future transfers within its system, and provides appropriate undertakings as to the operation of those systems. Where the operator has no UK tax presence, HMRC may require, as a condition of its approval the appointment of a tax representative (with a UK business establishment and HMRC approval). The tax representative (who will be jointly and severally liable) should be entitled to act on the operator's behalf and is obliged to secure the operator's compliance with its SDRT obligations and liabilities.

The SICOVAM clearance service

The Société Interprofessionnelle pour la Compensation des Valeurs Mobilières (SICOVAM) was, in July 2000, the French settlement system for shares listed on the Paris Stock Exchange, and operated to provide market participants with an effective means of settling trades. Transactions through SICOVAM did not result in any change in the register of members (because SICOVAM or its nominee, Vidacos Limited, remained the registered owner). SIVACOM was renamed Euroclear France in January 2001.

The case

In June 2000, HSBC made an offer to acquire all of the issued shares of CCF conditional on obtaining 50% acceptances. The cash offer included a share alternative, under which 13 ordinary shares in HSBC were offered in exchange for each CCF share. HSBC arranged for its own ordinary shares to become listed on the Paris Stock Exchange with a view to making the shares and the share alternative more attractive to CCF shareholders. CCF shareholders accepting the exchange offer were able to elect to receive HSBC shares in one of three ways: (1) via SICOVAM; (2) via CREST; or (3) by registration on HSBC's share register in certificated form. In order not to detract from the attractiveness of the offer via SICOVAM, HSBC agreed to pay any SDRT arising on issue. The acquisition of the majority of the CCF shares was completed in July 2000.

The HSBC ordinary shares were "chargeable securities" for SDRT purposes. Upon issue of the shares, SDRT at the rate of 1.5% arose (as SICOVAM had not made an election) which HSBC paid in accordance with its agreement with SICOVAM. HSBC submitted a claim to HMRC for repayment of the SDRT on the issue plus interest on the basis that: (1) the SDRT was incompatible with EC Directive 69/335/EEC and was in breach of the right of establishment, freedom to provide services and the free movement of capital.

Directive 69/335

The EU aspires to the abolition of capital duty, which may be levied on (amongst other things) the issue of shares. Broadly, under the Directive indirect tax may not be levied on (amongst other things) an issue of shares except capital duty where the Member State has since the introduction of the Directive, continued to charge it. The UK abolished capital duty in 1988 and the Directive does not allow a Member State to re-introduce it once it has abolished it. In fact, the majority of Member States no longer levy capital duty. However, the Directive specifically permits a duty to be charged on the transfer of securities.

HSBC’s position therefore was that the Directive prohibited the 1.5% SDRT charge because it was an indirect tax charge levied on the issue of shares. HMRC argued that 1.5% SDRT charge should be viewed as a tax on share transfers and was therefore permissible on the same basis as the 0.5% SDRT charge on transfers outside a clearance service. In effect, the 1.5% charge should be viewed as a share transfers “season ticket”; in other words as an upfront payment for future transfers of shares. The Advocate General rejected HMRC’s arguments on several grounds:

• The charge was payable by a single person (technically, the operator of the clearance service but in practice the issuer or transferor) whereas each successive transferee would normally be liable for the SDRT charge under the rules applying to transfers outside a clearance service.
• The SDRT charge was payable by reference to the value of the shares issued or the price on transfer at the time of entry into the clearance service whereas outside the clearance service the charge would be by reference to the price at the time of each transfer (which may be considerably higher or lower)
• The charge of 1.5% seemed arbitrary and indeed the evidence showed that more than 40% of the shares issued into the clearance service were withdrawn within two weeks before any transfer took place in the clearance service (with a further charge of 0.5% arising on exit from the clearance service).
• The Advocate General also made an oblique reference to the status of the UK’s tax jurisdiction in respect of subsequent transfers within the clearance service (outside the UK).

For these reasons the Advocate General rejected the notion that the 1.5% charge could be regarded as an advance payment of tax in respect of future transfers within the clearance service. In reality it was a tax on the issue of shares, which was clearly prohibited by the Directive.

Free Movement of Capital

The Advocate General also dealt with the compatibility of the UK legislation with the free movement of capital in Article 56 EC Treaty in case the ECJ should disagree with his conclusion under Directive 69/355. ECJ case law makes it clear that where the legislation of a Member State operates to discourage investment from other Member States it will be in breach of Article 56 unless there is some justification. This applies both to legislation that operates to discourage non-residents from making investments in a Member State and legislation that may discourage residents of a Member State from investing in another Member State.

The Advocate General concluded that the UK legislation did not comply with Article 56. The key to this seems to have been the fact that clearance services are widespread in continental Europe whereas they are virtually unknown in the UK. Therefore, it was no answer to say that the 1.5% charge applied not only to shares issued into a clearance service in another Member State but also to any based in the UK. The effect of the rules would be to discourage investment (in this case) by French residents in a UK company since the 1.5% upfront charge must be paid where the shares are issued through SICOVAM but not through CREST. It was accepted that the majority of shareholders in CCF would be less likely to take up the HSBC offer if the shares were issued through CREST thereby making it a commercial imperative that HSBC provide the option of accepting the offer through SICOVAM.

The Advocate General noted that for the restrictions imposed by the UK legislation to be justified it must not go beyond what was necessary to achieve the objective. The Advocate General noted that the parties addressed the issue of justification in a limited way with the focus on whether the availability of the election which the operator of the clearance service could have made justified the 1.5% charge that HMRC argued was necessary to ensure effective fiscal supervision. He rejected the notion that the availability of the election could be a justification; justification has to be found for the charge that has in fact been levied and no justification had been advanced as to why such an onerous measure was required by HMRC.

The availability of the election instead went to whether there had been a breach of Article 56 in the first place. However, the Advocate General concluded that the availability of an option to take positive action could not save UK law from being non-compliant with EU law. In any event the UK legislation gave the opportunity to make the election to the clearance service operator and not to either the issuer (HSBC) or the transferee.

He also concluded that the restriction on the free movement of capital could not be justified. He rejected the argument that the 1.5% charge was necessary to ensure effective fiscal supervision. Fundamentally, the 1.5% charge could not be regarded as an advance payment of tax in respect of future transfers (for the reasons mentioned above). However, even disregarding that, the Advocate General concluded that it ought to be possible to put in place a less onerous mechanism to secure effective payment of tax. Neither was he persuaded that the availability of an election to opt out of the 1.5% charge and apply 0.5% on transfers (subject to HMRC approval – see above) could provide any justification.