A&L Goodbody LLP
  March 29, 2006 - Ireland

Stamp Duty and Contracts for Difference

On St Patrick’s Day the Irish Revenue Commissioners issued a communication, through CREST, in relation to CFDs. In the communication the Revenue said they believe the underlying hedging transaction behind a CFD, where the broker acquires Irish shares, may not fall within the relevant stamp duty exemptions that the brokers are claiming. If the Revenue are correct the broker has a 1% stamp duty liability on this hedging transaction. Consequently it is likely the brokers will seek to incorporate this additional cost into the pricing of the CFD. There has been considerable media comment on the reaction of the broker community to the communication. However, contrary to what some commentators have suggested, the Revenue have not introduced any new legislation or practice and they are not seeking to levy stamp duty on CFDs themselves. The Revenue are in essence questioning whether the exemptions are being validly claimed. Exemptions to the 1% Stamp Duty Liability There are two exemptions that may currently be claimed on the hedging purchase. Market Maker Exemption This exemption applies to a market maker acquiring securities in the ordinary course of business of acting as market maker in the securities concerned. A market maker is a person who holds himself out in compliance with the rules of the Irish or London Stock Exchange (and is recognised as such by the Exchanges) as willing to buy and sell securities at the price specified by him. The Revenue Commissioners have queried whether buying securities to hedge a position sold through a CFD is a transaction effected in the ordinary course of market making in the securities concerned. They seem to draw a distinction between being a market maker in the derivative instruments and being a market maker in the relevant shares. We believe that the question as to what activities are carried out in the ordinary course of the business of market making is best answered by the market makers themselves. It has been suggested that the Revenue’s communication displays a lack of knowledge of the activities of the market maker. We understand from a number of brokers that they would consider the purchasing of shares to hedge a CFD to be part of the ordinary market making activities in the relevant shares. In selling a CFD and hedging its position by acquiring the underlying shares a broker is creating a market in the shares. Whether those shares are being passively held by the broker or held for the purposes of hedging a CFD should be irrelevant. The market maker is buying and/or selling securities at a specified price. With the increased sophistication of the market, investors are increasingly obtaining exposure to the markets by acquiring derivative investments. This facilitates the market in the underlying shares because the brokers offering the derivative products hedge their exposure by acquiring the underlying shares. While investing through a CFD avoids the stamp duty liability that would arise on an acquisition of the underlying shares, this is not the primary reason for doing so. The main attractions are the inherent leverage in a CFD (because the full principal amount of the underlying shares does not have to be paid up), the convenience of being able to enter into all trades with a single counterparty, and the intra-day settlement procedures. Broker Dealer Exemption This exemption is available where a member firm of the Irish or London Stock Exchange acquires shares as principal. Provided those shares are sold on to a bona fide purchaser within a month of their acquisition, the original purchase is exempt from stamp duty. The Revenue Commissioners have indicated that they have come across arrangements where they do not believe the “bona fide purchaser” condition has been satisfied. We believe that if there are artificial arrangements put in place, there may be circumstances where this condition would not be satisfied. However, if there are genuine sales of the securities to purchasers within the one-month period and subsequently there is a further acquisition of the relevant securities in an unconnected transaction, this relief should be available. It is only if there is an artificial arrangement to satisfy the one-month requirement that there might be an exposure for a broker. Similarly, since a CFD often has a term of less than a month, the hedging in these transactions should be exempt if the hedged shares are sold on when the CFD is terminated. Obviously, regardless of the outcome of discussions with the Revenue, brokers should not be factoring stamp duty into the costs of such short-term CFDs. Retrospective Nature of the Change The Revenue Commissioners would argue that there is no retrospective element to their communication. If the relevant brokers have been interpreting the law incorrectly the Revenue may seek to collect back tax. Reaction to the Communication The Irish Stock Exchange, the London Investment Banking Association and other industry bodies are lobbying the Irish Revenue Commissioners on this issue. Given the potential impact of a fall-off in the uptake of CFDs on the liquidity of Irish equities it is in the interests of the Irish financial industry, and the economy generally, to reach a solution. While lobbying efforts may result in a satisfactory outcome brokers should in the meantime examine their potential exposure. As highlighted above the issue may not be as straightforward as suggested by the Revenue Commissioners. There are many instances in which we believe there may be no exposure to stamp duty on these transactions.