United Kingdom: Stamp Duty in 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 then 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 was facing at the time (and is currently facing as Prime Minister).

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 that 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 GBP5,000 transaction would cost the investor GBP25) is the highest in Europe.

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 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.

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 GBP1tn.

He was quickly proved right, when in May 2004 Inland Revenue figures showed that revenues from the tax on share trading fell from GBP4.5bn in the 2000/2001 tax year to GBP2.6bn in 2003/2004.

The UK government had thus -- in that period alone -- foregone GBP2.5 billion in revenues from stamp duty on shares as fund managers and investors turned towards derivatives to escape the tax.

Figures published in January, 2005, confirmed the picture, showing that revenues from the United Kingdom's stamp duty tax on share trades were likely to remain flat in 2005 at GBP2.6bn, despite a sharp increase in the volume of shares traded on the London Stock Exchange.

It seemed that the major reason for this was that investors were increasingly shunning traditional share purchases in favour of derivatives such 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.

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 a 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 seemingly chose to ignore during his time in the role. 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.

In May 2007, London Stock Exchange Executives suggested that it was only a matter of time before the UK government bowed to pressure from the financial services industry and scrapped stamp duty on stocks and shares.

Clare Furse, chief executive, told a news conference, convened to announce the exchange's full-year results, that: "the question is not if but when" the 0.5% tax on the trading of shares of companies listed in the UK will end.

Furse claimed that there has been a "significant shift" in the government's thinking since the publication of a report by Oxera, an independent economics consultancy, that concluded stamp duty repeal would bring about multiple benefits for the UK economy without denting the Treasury's long-term tax take.

The study, commissioned by the LSE, the Association of British Insurers (ABI), the City of London Corporation, and the Investment Management Association (IMA) suggested that ordinary savers and pensioners are bearing the brunt of the tax, which is reducing their ability to save and invest for the future.

The report revealed that stamp duty reduces a typical occupational pension scheme fund at retirement by between 1.52% and 2.38%, or between GBP6,441 and GBP11,538 in today's money. Government schemes such as Stakeholder Pensions are also said to be impacted significantly, by GBP7,540 to GBP10,389.

Although stamp duty yields GBP3 billion annually for the UK Treasury, the research calculated that if the tax were to be abolished, these receipts would be replaced over the longer term through a sustained rise in the UK's GDP of between 0.24% and 0.78%.

However, as of December 2008, there had been no further movement in this area.

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 (!)