Changes are coming: Preparing for the tax operations storm

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There has been a steady stream of transaction taxes introduced globally in the last 10 years that financial houses have yet to fully tackle, including dividend taxes in the U.S. — 871(m) and 305(c) — and capital gains taxes, and the recent announcement of potential financial transaction taxes (FTTs) in New York and New Jersey, alongside new regulations represent a growing operational challenge. The increase in these types of legislative moves indicates an evolving need for global market solutions to address these types of taxes and the nuances involved at a state-by-state level.

As countries and regions look at new ways of raising revenue, the transaction tax is increasingly seen as a viable option. As many local economies across the United States continue to grapple with the effects of COVID-19 and as the election progresses, there is growing uncertainty around potential changes to tax laws that may be implemented in the next couple of years to increase revenue. And with FTTs and capital gains tax rules emerging globally, the impact of rising taxes becomes more impactful on financial institutions.

Such uncertainty around fiscal policy, particularly about potential new taxes, typically causes a surge in the trading volume ahead of an election. However, most financial houses do not have the centralized technology to process and manage such large streams of relevant data across this range of taxes and will need to look into ways to deal with these new requirements. This opens the door to new machine learning, tech and AI solutions that can automatically ease the burden as these new rules are introduced.

Many of those unfamiliar with the process might assume that the only cost comes from the tax itself. They would be wrong. As with other regulations, the implementation of a new tax regime comes with a “soft cost” due to operational consequences requiring the implementation of new software. These extras can potentially dwarf the cost of the tax itself.

An example of this is 871(m), which derived negligible revenues from dividends paid to foreign investors in equity derivatives but also required enormous internal bank expenditures for operational and compliance purposes. Banks and asset managers need to process and manage all of the relevant data on the taxable security and then process this data against a range of rules to determine the appropriate tax or exoneration reasons. While this is already a complex issue, an increase in taxable securities falling into scope and a growing list of proposals coming into play should cause real concern.

Some states are already looking to implement new FTTs, and in at least one case, build on already existing taxes that haven’t been applied in decades. New Jersey recently announced it was mulling a potential bill on high-volume trades, which would cause significant headaches for trading firms to track and process every single trade for every single tax obligation.

This proposal would have imposed a 0.25 cent tax per trade and would include any trades made via North Jersey server farms, of which there are an abundance given the proximity to both the NYSE and Nasdaq. The NYSE quickly responded with a plan to leave the state if such a tax were imposed, and the Nasdaq has already begun implementing a plan to temporarily move some operations to Chicago.

Likewise, New York has been considering a bill that will enforce a 0.05 cent tax on stock trades over $20 per share, to avoid budget cuts to health care and education. Notably, this tax is already technically law but hasn’t been collected since 1981. This will merely be an enforcement of an existing law that many firms are not prepared to address.

Looking ahead, it seems clear that raising tax revenues remains a goal in the coming months, either nationally or state by state, which could affect global markets. The tactical solutions that may have been tolerated to date out of lack of oversight enforcement simply will not scale to meet the processing requirements of an ever-greater number of taxes in the world’s largest financial center.

This is especially important as a number of jurisdictions in Europe are considering the implementation of extraterritorial taxes that would affect the U.S. market too. A strategic overhaul is required to industrialize this process, and it cannot come soon enough. While other software projects for potential new regulations may be at the top of the agenda, it is time for tax to sit alongside them.

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Tax planning Tax prep software State taxes Capital gains taxes Automation State tax revenues