Madeira - VAT Capital of the World?
By Lowtax Editorial
08 March, 2011
The Madeira International Business Centre
Madeira is part of Portugal, and thus has full membership of the EU; but under the Regional Aid Programme of the EU the Portuguese government has been able to legislate for a low-tax regime in Madeira which compares very favourably with anything else available within the EU, and is better than many outside it.
Like Ireland, the Portuguese government has followed a policy of constructive engagement with the EU, and has gained great benefit from it on behalf of Madeira, and many Portuguese companies and individuals who have made investments in or through Madeira.
Madeira's offshore sector is known as the Madeira International Business Centre (MIBC) and consists of four sections:
- The Free Trade Zone, which came first, and was intended for use by manufacturing companies;
- The International Services Centre, which has no exact location, but allows service companies associated with the Free Trade Zone to establish themselves anywhere in Madeira and take advantage of the Free Trade Zone's exemptions;
- The Offshore Financial Centre, which provides an equivalent regime for banks, trust management and other financial sector companies; and
- The Madeira Shipping Register, which provides for ships and shipping companies. Under the original legislation, companies in the MIBC are exempt from corporation tax until 2011.
Madeira's Experience In The Offshore Clamp-Down
How then has Madeira fared in the international clamp-down on low-tax jurisdictions? Presumably because it's not an independent country or territory, it was left off the FATF and OECD blacklists, although its regime is certainly no 'better' (or should it be, 'worse'?) than many that were included. But the MIBC Free Trade Zone was included on Dawn Primarolo's 'Code of Conduct' list of 66 'harmful tax practices'.
The Primarolo report seems to have been quietly buried along with other contentious parts of the EU's 1996 Tax Directive, when (ironically for Madeira) the Fiera summit at the end of the Portuguese presidency pretended to reach agreement on an information-sharing directive which has little chance of implementation. However, the EU State Aid Directorate has been pressurising the Portuguese government to do something about what it takes to be abuses of corporation tax exemptions in the MIBC, particularly by Portuguese tax-payers. The EU estimates that tax exemptions gained through the MIBC amounted to a billion euros just in 1997, through 4,000 companies that employ a mere 1,000 people. On that calculation, each job (the main object of EU regional policy is to create employment) cost a million euros, which is quite high even by Brussels' bloated standards. The arithmetic is bogus, however, because you have to ask the question, where would that job be if not in MIBC, and the answer (the OECD can tell you!) is in Barbados or Vanuatu. You can't 'lose' tax you were never going to have - Finance Ministers' speeches are always full of 'lost' tax that never existed except in their officials' imaginations.
Anyway, the Portuguese tax authorities shared the EU's concerns, and the government responded in 2000 by putting through legislation which moderates the MIBC's tax exemptions and weakens the island's tight banking secrecy regime.
New Legislation Effective In 2001
The new legislation has not altered the zero tax rates applying to companies in the Industrial Free Zone itself and to ships; but companies in the International Services Centre are affected.
All companies licensed before 31st December, 2000 continued to be tax exempt until 2011. Companies licensed during 2001 and 2002 paid corporation tax at 1% until 2011; companies licensed in 2003 and 2004 paid 2%, and those licensed in 2005 and 2006 paid 3%.
Financial institutions must be approved by the Bank of Portugal and licensed to operate within the Free Zone. Institutions licensed in 2001 and 2002 paid tax at 7.5% of profits; the tax was 10% for licenses granted in 2003 and 2004, and 12.5% for licences granted in 2005 and 2006.
In January 2008, the Portuguese government issued a decree that allows new companies licensed from January 2007 to December of 2013 to enjoy reduced corporate tax rates of 3% between 2007 and 2009, 4% between 2010 and 2012 and 5% between 2013 and 2020. Companies licensed to operate within Madeira's International Business Centre before the year 2001 continued to benefit from a full exemption from corporate tax until the end of 2011, as well as from withholding taxes on dividends, royalty payments and capital duty. As of 2012, such companies fall under the new regime which is valid until the year 2020.
The regime for holding companies has also been adjusted in various respects, including the abolition of roll-over relief on proceeds from the sale of subsidiary shareholdings - tax is now payable over a 5-year period subsequent to a disposal, at the ruling Portuguese rate.
MIBC companies have previously been deemed to be non-resident in Portugal, but in order to guard against abuse by Portuguese residents, they now have to document transactions in order to prove that they are trading or dealing with non-Portuguese partners or customers. This is no more than a bureaucratic annoyance for companies with genuinely non-resident activities, but affects a number of companies who have been running Portuguese trading operations from the MIBC.
No doubt with an eye to the general tightening-up of global standards of protection against money-laundering, the Tax Reform Act has changed the rules so that the tax authorities are no longer required to obtain a Court Order requesting taxpayer's information from banking, credit and finance institutions. There is still a right of appeal for the taxpayer in most circumstances, and this is sometimes suspensive. There are a number of other safeguards, including compulsory notification to the tax-payer of any investigative process, and a requirement to disclose evidence to the taxpayer. The legislation also contains a much wider definition of reportable transactions than previously.
Madeira's Special VAT Status
The Portuguese Accession Treaty to the EU provided that Madeira and the Azores Islands could benefit from a lower rate of VAT than that applied on the Portuguese mainland; this provision was also added to the Sixth (VAT) Directive. In 1996 the Portuguese Government enacted a standard VAT rate of 12% for Madeira in its Value Added Tax Code as Law Nº 91/96. NB from June, 2002, this rate was 'temporarily' increased to 13%.
At their meeting on Friday, 19th January 2001, the EU's ECOFIN Council approved a Directive amending the Sixth Directive, providing that the Member States would make every effort not to widen the then current gap of 10% points between the lowest and highest VAT rates (then 15% and 25%). The Directive is attempting to prevent a growing tendency towards divergence, which could lead to structural imbalances and distortions of competition in the Community. That is, it is trying to prevent tax competition.
The amendment to the Sixth Directive did not affect Madeira's privileged position on VAT rates, and this was highly significant for Madeira's future because of the EU's attempts to apply VAT to incoming supplies of digital product from non-Union origins. There were several territories which were similar to Madeira in that they have Treaty exemptions covering VAT, particularly the Isle of Man, but it is not formally in the EU, simply in the Single Market. Gibraltar is in the EU, but does not apply VAT.
The EU's Digital VAT Proposals
It was in June, 2000 that the EU announced proposals to bring taxation of 'imports' of digital goods by consumers into line with the existing treatment for supplies within the EU. Frits Bolkestein, Internal Market Commissioner, said it would remove a major distortion of competition and give certainty to suppliers. If the proposal passes into law, any non-EU supplier with sales to EU consumers (ie non-VAT-registered buyers) exceeding EUR100,000 will have to register for VAT in one EU member state (any one) and channel its EU supplies through that member state in a fiscal sense, charging VAT at the rate obtaining in its chosen member state, and paying the VAT collected to that state.
Initially it didn't seem very likely that the proposals would be adopted by the Council of Ministers, or that if finally enacted, they would be effective. First they have to be agreed unanimously by all 15 member states, and countries charging close to 25% VAT were sure to see the rules as the thin end of a very damaging wedge which would tend to drive incoming e-commerce business into the arms of lower-tax competitors. Second, any foreign company falling under the rule cannot easily be obliged to comply unless foreign countries legislate accordingly, which seems an extremely remote possibility. The most important foreign country, the US, will be strongly opposed to the tax. Virginia Governor and Chairman of the Advisory Commission on E-Commerce (ACEC) Jim Gilmore said: "Europeans tax everything and they're good at it. The Internet should be allowed to grow without burdensome tax regulations."
First meetings went in the expected direction, with high-tax Member States demanding that registration should be mandatory in the country of supply, but a long process of persuasion and discussion on the part of officials has brought some sort of agreement into sight, with EU ministers now seeming to have backtracked on their opposition to permitting non-European sellers to register in only one EU country.
Erkki Liikanen, Member of the European Commission responsible for Enterprise and the Information Society, said that a compromise to share the tax revenue was being discussed. In March he said in an interview: 'You could still register in one country but then through modern software you share the revenue among the countries on the basis of the destination of sales.'
EU finance ministers hoped to come to a definitive agreement on the taxation of digital downloads by June. Liikanen said: 'It will not be administratively heavy and complicated. That has been the aim and why the Commission proposed that companies should register in one member country.'
In December 2007, European Council of Finance Ministers (Ecofin) reached a landmark political agreement on two draft directives and a draft regulation aimed at changing the rules on value-added taxation intended to ensure that VAT on services accrues to the country where consumption occurs, and to prevent distortions of competition between member states operating different VAT rates.
The agreement ended a five-year deadlock on the sweeping changes to the community's VAT laws, but the reverse charging of VAT on the purchases of goods and services electronically will not begin until 2015, with a revenue sharing agreement phased in over the subsequent three years. This appeased Luxembourg, which had used its veto to block the proposed reforms. Like Madeira, Luxembourg has become a popular location for internationally known e-commerce businesses with its low 15% rate of VAT.
The new rules will require taxation for VAT on business-to-business supplies of services at the place where the customer is situated, and no longer at the location of the supplier, as is currently the case. For business-to-consumer supplies of services, the place of taxation will continue to be that where the supplier is established. However, in certain circumstances, the general rules for both businesses and consumers will not be applicable, and specified rules will apply to reflect the principle of taxation at the place of consumption. These exemptions concern in particular: restaurant services, the hiring of means of transport, cultural, sporting, scientific and educational services, and business to consumer supplies of telecommunications, broadcasting and electronic services.
To simplify VAT arrangements made necessary by the new rules for telecoms, broadcasting and electronic services, a "one-stop" system will be introduced, to enable service providers to fulfil in their home member state a single set of obligations for registrations, declarations and payments, including for services provided in other member states where they are not established. VAT revenue will then be transferred from the country in which the supplier is located to that where the customer is situated, whose VAT rates and controls will be applicable.
As a general rule, the measures entered into force on 1 January 2010.
The Council's political agreement was made possible by a compromise regarding the change of rule on the place of taxation for business-to-consumer supplies of telecoms, broadcasting and electronic services. For this sector: application of the new rules and the one-stop scheme will be deferred to January 1, 2015; the member state of establishment will, until January 1, 2019, retain a proportion of VAT receipts collected through the one-stop scheme. This proportion will amount to 30% from January 1, 2015 until December 31, 2016, 15% from January 1, 2017 until December 31, 2018, and 0% from January 1, 2019 onwards; the Commission will be asked to report on the feasibility of the new rules before their entry into force.
Madeira As A European VAT Hub
Supposing that the legislation does get approved on the basis of one-country registration and division of revenue, there still remains the question of whether companies selling into Europe will use it. That's impossible to answer in advance, although there are some types of company which would feel themselves obliged to conform, and it would be open to the EU to take legal action against a company which broke Union law. Small, offshore suppliers of digital product to the consumer market would quite possibly feel that they could escape detection by charging entirely through credit cards, but any firm which supplies the business market as well as the consumer market is rather easily traceable. Most larger companies would presumably comply.
For a company outside the EU which wishes to sell into it, and has a non-physical product (there is a very wide range of such companies) a low-tax base is very tempting. At first it seems that such a base could be anywhere with sufficient connectivity (eg Bermuda, Hong Kong, the Isle of Man). However, delivery of such types of product will require a broadband connection, and that will probably come to mean that servers should be placed reasonably close to the destination market.
Madeira benefits from a submarine cable station, hosted in the Madeira Datacenter, operating several international optical submarine cables, allowing interconnectivity with national and international SDH networks and providing, as such, significant advantages in terms of quality, cost, bandwidth and scalability. Another available infrastructure is the Internet Gateway provided by Marconi Internet Direct (MID) which offers international internet access.
The IP platform has its international connectivity distributed by: 3 PoPs (London, Amsterdam and Paris), peering connections with hundreds of major international ISPs and IP transits to Europe and the USA.
Madeira's telephone connectivity is reasonable, and is improving rapidly. In addition to modern state of the art sub sea and satellite communications through Portugal Telecom; there is also a San Diego company (Omnigon) who are lifting and taking a spur from the sub-sea trans-Atlantic cable which passes Madeira. Also, there is a dedicated Cable & Wireless cable from mainland Europe (Lisbon) to Madeira, although it is not currently operational. Also, now that Portugal Telecom's monopoly is being broken, prices will come down. It is understood that Madeira is on track to receive its own Top Level Domain designation.
Even if Madeira's connectivity will not be on a par with for instance the Isle of Man, that won't necessarily impede its development as an e-commerce hub. Location of server and location of headquarters are not the same thing: as a headquarters location Madeira is already very attractive and will become even more so if the VAT directive comes into force. Thus, a company could establish itself in the MIBC, carry out sales transactions there, but deliver product from servers with high bandwidth located in destination markets, or, if the OECD finally decides that this would constitute a permanent establishment, in a low-tax jurisdiction with good connectivity such as the Isle of Man.
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