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Friday, 17 February 2017

Beyond the Rubicon: Capital Market Intaxication

Capital Market Intaxication

The taxman is knocking on the door yet again, so whether you like it or not, you best be ready for a Tobin Tax.

For the uninitiated, a Tobin tax, a phrase first coined by Nobel Laureate economist James Tobin in the 1970s, is a tax levied on transactions in connection with different types of financial securities.

One of the Egypt IMF loan conditions, as part of the overarching economic reform program, is the (re)introduction of a capital gains tax or stamp duty tax on the trading of financial securities. As I am sure you recall, the introduction of a capital gains tax on listed securities back in 2014 caused so much uproar by some capital markets players that the government had to back-peddle and suspend the tax for two years.

That period ends this May 2017, so it stands to reason that a short-term change on this front is inevitable. The campaign against the reintroduction of any tax on the capital markets (along with the customary doomsday predictions) have already started in earnest for the second round of this bout.

The way the taxman (this time, supported by the IMF) should be looking at this is pretty straightforward. Tax policy, in general, is designed with three primary objectives in mind: the first is to collect as much revenue as possible for the state without materially discouraging the underlying activity, the second is to redistribute wealth, and the third is to incentivize (or disincentivize) certain types of behavior based on wider policy considerations.
Turning to taxing capital market transactions specifically, this is a lucrative market and the taxman should definitely be seeking to take their “cut” of the action. Considering the additional tax burden so many have had to bear over the past period, not to mention the wider economic hardship over the past few months, any arguments against levying this tax will, for the most part, fall on unsympathetic ears.
Would the imposition of either a capital gains tax or stamp duty tax, deter market players from investing and trading on the capital markets? The camp against argue loudly that the capital markets will effectively crumble with any new taxes levied and point to days of steep decline and overall selling on the EGX whenever the topic of a capital markets tax comes up.

Looking at other vibrant capital markets, however, tells us a different story. In the UK, home to one of the elite capital markets of the world (for now at least), the taxman imposes both a stamp duty tax on the trading of shares and a capital gains tax that taxes the gains on financial securities. In the US, again home to elite capital markets, a capital gains tax is applied to gains from the investment and trading of financial securities.

Some might argue, rightly in my opinion, that looking at mature capital markets alone is not a fair comparison and that a more sensible approach would be to also look at realistic comparables in order to gauge whether introducing taxes on capital markets transactions would be competitive.
If we look at Turkey, for example, there exists a capital gains tax on marketable securities. However, this was very recently reformed to exempt any capital gains tax payable if the securities were held for two years or longer for unlisted securities and one year or longer for listed securities. What the Turkish taxman is trying to achieve is to use tax policy to incentivize long-term investors in securities as opposed to short term trading and speculation. The same policy is used in the UK and the US by using a range of mechanisms, including a lower applicable tax rate and higher capital gains allowances for long-term investors.

In Morocco, a capital gains tax is also levied on the capital appreciation of shares. In the UAE, however, no taxes are imposed on capital market transactions, but one does have to wonder for how long this will go on, considering the current trend in the GCC countries to move towards some basic levels of taxation to balance their books.

Clearly, in almost all of these markets, there is an appetite by the taxman to levy a tax on these lucrative markets, but at the same, some policies are introduced in order to incentivize long term investors as opposed to short term traders and speculators.
Under the current tax policy in Egypt, there are no taxes on capital gains of financial securities and no stamp duty tax on transactions, but there is a tax on dividends. This incentivizes the activities of short-term day traders and speculators over longer-term fundamental investors, which is contrary to what everybody else is doing and, in my humble opinion, doesn’t make any sense at all.

If we think of both equity and debt capital markets as efficient markets for sovereigns and corporates to raise capital in order to fund growth, then it stands to reason that the taxman should incentivize patient, long term institutional investors. In contrast, the policy should disincentivize speculators who, while admittedly add liquidity to the market, arguably do not contribute a whole lot of value to the economy.

Currently, we are incentivizing short-termism in our capital markets, when in fact we should be incentivizing long-term investors. Unless we plan to flout the Egypt IMF loan conditions and the agreed economic reform program, a tax on financial securities in the form of a capital gains tax or stamp duty will be levied, so there is really no point in resisting this. Instead, let’s focus on re-aligning policy to incentivize long term investors of capital. By observing mature markets as well as comparable emerging markets, there are plenty of different ways to achieve this, while remaining competitive.

The most recent statements by the government indicate that they are leaning towards a stamp duty tax regime, which is probably the simplest to understand and implement effectively. As my learned friend Dr. Ziad Bahaa El Din previously commented in connection with this issue almost two years ago, the real danger to a stable investment climate is a lack of clarity in the legal and taxation regime, as opposed to the tax itself. Whatever we do, let’s do it right and let’s stick to it.

Beyond the Rubicon is a column written exclusively for Enterprise every other weekend by Aly Shalakany, senior partner at Shalakany Law Office, which he joined from Linklaters in London. Aly is a noted specialist in finance, projects and mergers and acquisitions; his column appears exclusively in our Weekend Edition, offering an “inside baseball” look the intersection of business, economy and finance from the point of view of a practitioner at the top of his game.

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