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International Tax Planning/IOFC Analysis - Certainty

By Lowtax Editorial
25 July, 2012

Tax certainty is as crucial a factor as tax rates for an investor or a business when deciding in which jurisdiction to locate a company - if not more so - and this is something that applies to offshore jurisdictions as well as the large 'rich' countries.

A company will be reluctant to invest in a country if it has a history of changing the tax goalposts on a frequent basis, as this makes the important business of long-term planning very fraught and complicates further already complex tax codes.

The United States is particularly guilty of this. Although the US is still considered the world's premier free market economy and is ranked highly in terms of business friendliness, in tax terms it is becoming increasingly uncompetitive.  Not only is America's corporate tax rate now the highest in the OECD, but the tax code is littered with special interest tax breaks and temporary tax provisions, making forward planning harder for businesses and individuals alike. There were approximately 4,430 changes to the US tax code from 2001 through 2010, an average of more than one a day, including an estimated 579 changes in 2010 alone, according to the National Taxpayer Advocate Nina E. Olson.

Businesses are not shy in pointing this out to Congress and the Government, although the simplification lobby has made little impression. In one of the most recent examples, the Business Roundtable (BRT), an association of chief executive officers of leading American companies with over USD6 trillion in annual revenues and more than 14m employees, wrote a letter to Congress and the White House in mid-July urging them to begin immediately to resolve fundamental fiscal and tax issues confronting the US. In the BRT's opinion the current political paralysis hindering a compromise on those issues has fueled needless economic uncertainty that impedes a more robust economic recovery. Without effective action soon, it believes that the uncertainty "will spawn a dangerous crisis, threatening (the US) economy, businesses and workers".

Businesses investing in the United Kingdom face a similar scenario. By 2007, the Tolley's Yellow Tax Handbook, which is often cited as an unofficial barometer of the size and complexity of UK tax legislation, had reached the 10,000 page milestone, up from 6,000 pages in 2001 and 4,500 in 1997. While the current coalition government is making strides towards cutting out unnecessary bloat from tax legislation with the creation of the Office of Tax Simplification, it has yet to make serious inroads, and each new Budget produces reams of new anti-avoidance provisions and additional tax regulations, effectively nullifying efforts to condense tax law. As the Confederation of British Industry's Chief Economic Advisor Ian McCafferty observed prior to the 2012 Budget in March:  "Companies that lack certainty on how they will be taxed in the future are reluctant to invest, so Government must deliver on its corporation tax roadmap without delay. We must make sure that we continue to attract and keep successful multi-national businesses in the UK."

Investors in India face an even more arduous task in complying with tax laws. India currently has one of the most complex tax systems in the world, and ongoing delays to important new proposals to improve the situation are not helping with simplification efforts. The Direct Taxes Code, which was scheduled for introduction this year, has been delayed by at least one year, while a major reform of indirect taxes has been postponed many times. The Indian government has also not helped its cause with 2012 Budget proposals which provide the government with the power to retroactively change tax laws and overturn a series of recent court judgments. Not surprisingly, this has got the investment and business community up in arms, with warnings that it could create an atmosphere of uncertainty, discouraging investors. Indeed, telecoms company Vodafone has challenged the legislation out of concern that it might allow the government to override a recent Supreme Court ruling in its long-running tax dispute.

These examples are being mirrored in many other countries, with tax legislation inevitably growing and rarely shrinking. This is especially the case where there is a need to raise vast sums of revenue at short notice, and businesses are suffering increasing uncertainty in countries like France, Italy, Spain, Ireland, Australia and South Africa, to name but a few. This, therefore, is another area, in addition to tax rates, where low-tax offshore business and financial centres have a competitive edge on the major 'high tax' countries. And while it is hard to quantify just how much business the likes of the US, the UK, France and similar economies lose as a result of their badly-planned tax laws, there is little doubt that IOFCs are benefiting.

By way of example, figures compiled by Hemscott confirm that Jersey continues to be the number one ranked jurisdiction for registering FTSE 100 companies outside of the UK. Of the eleven such companies as of June 29 this year, eight are listed in Jersey with a combined market capitalization of GBP69bn (USD108bn). Jersey has a further nine companies registered in the FTSE 250 Index, representing a total market capitalization value from both indexes of more than GBP78bn - at least six times higher than any of its closest competitors in the market. 

The volume of company registrations offshore also seem to be holding up well given the uncertain economic environment: according to the Cayman Islands' Economics and Statistics Office, just over 7,000 new companies were registered in the jurisdiction in the first nine months of 2011, a 14% increase compared with the same period in 2010; the Dubai International Financial Centre saw a 2% rise in the number of active companies registered in the free zone in the 12 month period to the end of March, 2012; and business incorporations and registrations in the British Virgin Islands, at 17,056 in the third quarter of 2011, showed improvement on the previous quarter's registrations and incorporations of 15,689. 

Hong Kong serves as a shining example of what can be achieved by maintaining a stable and low tax regime. According to the Hong Kong Companies Registry, almost 1 million companies were live on the register as of June 30, 2012, with new registrations in the first half of this year 3% higher compared with the second half of last year. Over 300 non-Hong Kong companies were also established in the first half of 2012, bringing the total number of non-Hong Kong companies registered in the SAR to just fewer than 7,000. Foreign direct investment (FDI) figures also reflect well on Hong Kong's tax laws: according to the United Nations Conference on Trade and Development's World Investment Report 2012 Hong Kong's FDI inflows hit a record high last year to exceed USD83bn - 17% higher than 2010's figure.

Nevertheless, this is not to say that administrations in offshore jurisdictions aren't concerning themselves about maintaining legal certainty. Having been subject to extensive reviews of their legislative frameworks from the likes of the OECD and the FATF over the past decade, some jurisdictions have responded to demands for more transparency with some fairly extensive reforms of their own.

In the BVI for example, new legislation took effect on January 1, 2005 to ensure the territory is fully compliant with the European Union (EU) Savings Tax Directive and EU Code of Conduct on Business Taxation, as required by the United Kingdom of all its Overseas Territories. This effectively abolished the ring fence around the 'offshore' sector of the economy, meaning that all companies regardless of status paid 0% tax.

Similar changes were made in the Crown Dependencies of Guernsey, Jersey and the Isle of Man.

In Guernsey,  from January 1, 2008, the standard rate of income tax for companies moved from 20% to 0% and exempt company and international business company regimes were abolished (other than for Exempt Collective Investment Schemes - CISs). As a consequence of this, most Guernsey registered companies are treated as resident for tax purposes. In addition, the GBP600 annual exempt fee ceased to be payable from January 1, 2008 (again, other than for exempt CISs).

In common with some other offshore jurisdictions, Jersey allowed its International Business Companies (which had to be owned by non-residents who have declared their beneficial ownership) to set their own rates of tax, with a minimum of 2%, in order to climb over the bar of any minimum tax rate specified in the owner's country of origin. However, in accordance with Jersey's commitment to the 'Rollback' provisions of the EU Code of Conduct for Business Taxation, the International Business Company vehicle was abolished to new entrants with effect from January 1, 2006. Benefits for existing beneficiaries of the International Business Company regime were progressively extinguished by no later than December 31, 2011. Like Guernsey, a 'zero/ten' tax system for companies now applies, achieved by introducing a standard rate of corporate income tax of 0%, and a special rate of 10% for specified financial services companies, into the Island's existing schedular tax system from 2009. Utility companies, rental income and property development profits continue to be charged at the standard income tax rate of 20%.

In 2006, the Isle of Man also moved towards a zero tax rate for all businesses, except companies holding banking licences and those receiving income from land and property in the Isle of Man (which includes rental income, extraction of minerals and property development). Prior to this change, companies in the insurance, fund management, space and satellite technology and shipping sectors enjoyed a zero rate of corporate tax (extended in 2005 to companies in the manufacturing, film, e-gaming, tourist accommodation, agriculture and fishing sectors).

It is fair to say that the 'zero/ten' reforms in the Crown Dependencies were favourably received by their respective financial services industries. However, a major shadow of doubt was cast over the future legislative tax framework in all three jurisdictions after the Code Group suddenly expressed doubts as to whether zero/ten was within the 'spirit' of the Code, after initially giving these changes the green light.

Nobody was quite sure whether the Code Group reviews launched against '0/10' in Jersey and the Isle of Man would require a bit of legislative tinkering on the part of these governments, or whether wholesale reform would be required. Guernsey, which conducted its own review in response to a preliminary investigation by the Code Group, prepared for the worse by outlining a plan for five alternative corporate tax regimes. Clearly another round of major change to corporate tax, coming so soon after the initial reforms, would be the least-desired outcome for these jurisdictions.

In the event, the solution to the Code Group's concerns was more legislative tinkering for all three territories, rather than wholesale reform, with the deemed distribution laws chopped in Jersey and Guernsey, and the attribution regime for individuals repealed in the Isle of Man; and, while no permanent harm seems to have been done in terms of reputation, the episode served to underline the importance of tax certainty for offshore jurisdictions and their investors. Consequently these jurisdictions have been quick to transmit reassuring messages to the corporate world.

Gavin St Pier, Guernsey's Treasury Minister, said in late June, as he steered though the necessary bill  repealing deemed distribution provisions that: "The Code Group has already confirmed through precedent that a zero/10 regime without deemed distribution aspects is compliant through its previous assessment of Jersey and the Isle of Man. I am confident that repealing our deemed distribution regime swiftly and decisively is the right action to take and will result in our corporate tax regime being assessed as compliant with the EU Code of Conduct on Business Tax. The move will ensure that our corporate tax regime remains internationally acceptable and competitive and provide the necessary tax neutrality which is vital to safeguard the economic success of our finance industry."

The Isle of Man was also quick to release a new Practice Note clarifying the tax treatment of corporate distributions to individual taxpayers under '0/10' following the repeal of the island's attribution regime for individuals, which followed confirmation from Treasury Minister Eddie Teare, that the Manx government has no intention of introducing a capital gains tax to replace revenues lost through changes to '0/10', as had been speculated. Indeed, Teare was keen to stress that it is the government's collaboration with the financial services sector in all things legislative that has allowed it to grow into a major IOFC. "The close and reciprocal liaison between the private sector and government in the Isle of Man is one of our great strengths, and I believe that it contributes directly to our competitive offering as a financial services centre," he said. "I understand that this recent liaison work has highlighted some areas where more clarity is needed, and the key now is to move forward quickly and professionally to a point where current and potential future investors and their advisers have reassurance regarding how company distributions will be taxed in various situations."

Meanwhile, Jersey Treasury Minister Phillip Ozouf has stressed that, with the trials and tribulations with regards zero/ten at an end, and with a budget shortfall having been addressed, the jurisdiction's tax regime will remain unchanged, hopefully for a considerable period of time. "From a government perspective, we now have a more normalized mixture of funding sources from income tax, company tax, consumption tax and duties. This is much more sustainable for the future," he said. "Over the next three years we will be balancing our budgets and we will not be moving from our current system of taxation. Zero/ten will remain and Goods and Services Tax will stay at 5%. There will be no substantial changes. I am committed to low taxation, broadly-based and levied in a sustainable way. That is the Jersey system and will remain so. We have been through three very tough years and have made some difficult decisions on tax and spending. Jersey now has strong public finances and we are well placed to maximize the coming opportunities for growth."

In summary, perhaps a key difference between 'high tax' countries and IOFCs is that governments in the former, reacting to economic or political events, tend to make tax policy on the hoof, with little thought to the consequences. Although the public are usually consulted on major tax reform projects, there isn't the same degree of collaboration between government and stakeholders that seems to exist in the major offshore financial centres, where the outlook is often more long-term (as opposed to merely as far as the next election). However, in the light of the financial crisis and various tax scandals, offshore remains firmly under the world's microscope, and the pressure for change is unlikely to abate any time soon. 


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