One of the most complex issues in tax policy today is the treatment of the institutions, products, and services that make up the financial sector. It can be harder to ascertain income, expenses, and profits for financial firms than for firms selling goods and services, and it is easier for individuals and firms to manipulate financial transactions so as to exploit tax loopholes. This volume explores the challenges faced by tax policymakers and identifies modern best practices in several areas: banks, insurance companies, securities companies, investment funds, pension funds, and derivatives.

© 2004 International Monetary Fund

Production: IMF Multimedia Services Division

Cover Design: Lai Oy Louie

Cataloging-in-Publication Data

Taxing the financial sector: concepts, issues, and practices/editor, Howell H. Zee—Washington, D.C.: International Monetary Fund, © 2004

p. cm.

In memory of John King (1944-2003)

ISBN 1-58906-316-3

1. Fiscal policy. 2. Insurance—Taxation. 3. Securities—Taxation. 4. Financial instruments—Taxation. 5. Value-added tax. I. Zee, Howell H. (Howell Hang)

HJ192.5.T28 2004

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In memory of

John King



The papers in this volume address a set of issues that is probably among the most complex in the area of tax policy: the tax treatment of the primary institutions, products, and services that make up the financial sector—banks, insurance companies, securities companies, investment funds, pension funds, and derivatives. Getting this treatment right usually poses a significant challenge to policymakers, because the form of a financial transaction can be manipulated—without altering its economic substance—much more easily than that of a nonfinancial transaction (such as the sale of ordinary goods and services), thus rendering it easier to exploit tax loopholes. The consequent economic distortion could be costly. When it comes to taxing the financial sector, policy neutrality across different financial activities is key (unless, of course, non-neutrality is a policy objective), but ensuring it is a tall order.

Five of the six papers in this volume were originally prepared as background materials for a technical assistance mission of the IMF’s Fiscal Affairs Department to China in September 2002 to discuss, at the authorities’ request, various issues regarding the taxation of China’s financial sector. The immediate impetus for the request was China’s wide-ranging commitment to liberalizing its financial sector in connection with its accession to the World Trade Organization in 2001. The authorities were keen to assess the various policy implications of this commitment, one of the most important being the ability of China’s tax system to cope with a sector on the verge of fundamental transformation.

It soon became clear, however, that the background papers commissioned on that occasion had a much broader appeal beyond the China context. Indeed, the papers do not address China-specific issues; they instead provide a concise overview of important concepts, issues, and country practices in financial sector taxation, covering both direct and indirect taxes, in a nontechnical and highly accessible manner. It is hoped that the publication of this volume will not only inform the interested reader of the relevant issues involved but also guide policymakers on the design of tax policy as applied to the financial sector.

I note with profound sadness the passing of my colleague and friend John King, who died in the summer of 2003 in a rock-climbing accident in his beloved country, Scotland. John will be dearly missed. This volume is being published in his memory.

Howell H. Zee

December 2003