Lowtax International Tax Planning/IOFC Analysis - Balancing the Books Offshore
By Lowtax Editorial
29 November, 2012
We hear a lot about how international offshore financial centres (IOFCs) are continuing to thrive despite the uncertain economic outlook, which is stymieing investment in many parts of the world. However, while new incorporations and corporate renewals in the major offshore jurisdictions are generally holding up well after some wobbles from 2008 to 2010, these figures do not tell the whole story; governments in a number of offshore territories are finding it just as difficult to balance the books as are the administrations of onshore governments, and some are having to make tough choices in terms of tax.
In the last few weeks alone, several key jurisdictions have revealed that, under much pressure to eradicate budget deficits, they are overhauling the way that they plan for the future in fiscal terms. Others, however, have said that they have little choice but to raise taxes or fees, and we round up some of the most notable recent developments in this area.
Guernsey Expands Scope of Corporate Tax, Proposes Company Fee Hikes
Guernsey plans to expand the scope of its 10% corporate income tax rate, and phase out mortgage interest relief under Finance Minister Gavin St Pier's maiden Budget for 2013.
Under the plans, the 10% corporate income tax rate will be extended to cover the activities of licensed fiduciary businesses, licensed insurers in respect of their domestic business, and licensed insurance intermediaries and managers, effective from January 1, 2013. Presently the 10% rate is levied only on banking institutions and loan companies.
The mortgage interest relief cap will be reduced by GBP50,000 (USD79,800) each year until the concession is phased out entirely by 2021. After a one-year grace period, the current threshold of GBP400,000 will be reduced to GBP350,000 on January 1, 2014.
Tax on property, fuel and alcohol will be hiked in line with inflation, by 3%. Duties on tobacco will be hiked above the inflation rate, by 6%.
According to St Pier, the proposals come ahead of a comprehensive review of the tax regime to commence in 2013. As part of this review, the government will consider amalgamating the personal income tax with social security contributions, examine the property tax system, and may rein in tax allowances for the island's highest paid.
The Guernsey Financial Services Commission (GFSC) has also proposed that company fees should rise from 2013 to meet the rising costs of regulating the financial sector.
In a consultation paper published in October 2012, which outlines the proposals, the GFSC said that presently its operations are costing around GBP12m (USD19m) a year although measures are afoot to significantly cut operational costs, based on the recommendations of a report by Ernst and Young in 2012. It is the Commission's policy to retain reserves equal to at least six months' operational costs, but these are presently lacking and need rebuilding, the Commission said.
Under changes currently being consulted on by the GFSC, application and annual fees will generally rise by 2%. However, fees for insurance cells will rise by GBP580 (41%) for applications and GBP350 (21%) for annual renewal.
The proposal follows the Commission's decision last year to freeze fee levels. Indeed, the creation of a further intermediate fee band in the fiduciaries sector had the effect of reducing fees for some licensees during 2012, the GFSC says.
By hiking fees by 2%, effective from January 1, 2013, the Commission will post a surplus of GBP84,000 during 2013, against a projected deficit of GBP306,000 if fees were to be retained at 2012 levels.
In order to deflect possible criticism that the fee hike may render Guernsey uncompetitive in relation to the other Crown Dependencies, Jersey and the Isle of Man, the consultation paper states that it is not straightforward to compare fee structures, given their different structures, funding commitments and expenses. For example, while fees in Guernsey's banking sector are typically higher than in Jersey and the Isle of Man, funds are considerably cheaper to set up and maintain in Guernsey than in Jersey.
The Commission projects that the number of licensed banking institutions in Guernsey will have fallen by three on January 1, 2013, down from 35 on January 1, 2012. The Commission said, however, that during the course of the year it had continued to receive enquiries by prospective new licensees, but that it could not be certain these would translate into new business for Guernsey. Outside the banking sector, the Commission has forecast modest growth in all other subsectors.
Jersey Tweaks Anti-Avoidance Legislation, Plans For Long-Term
On November 20, Jersey's Treasury Minister, Philip Ozouf, lodged an amendment to this years budget, adjusting the 'distribution rules' which were published with the budget documents on October 17.
The island's deemed distribution arrangements are being revoked by the end of the year following a decision by the European Union's Code of Conduct Group on Business Taxation that the provisions are "harmful."
The new anti-avoidance rules seek to ensure that when taxpayers extract profits from a company, by whatever means, that income will be subject to income tax. However, if a company reinvests its profits to grow its business, neither the company nor the shareholders will be taxed. The new rules partly work by broadening the definition of a distribution. The calculations use the taxable profits reported by the company, and hence anything which is not taxable in the company, such as capital gains, is not taken into account.
Under the outgoing deemed distribution regime, tax is paid on individuals' holdings in profit-making companies as their respective holdings appreciate. A 'deemed distribution' is presumed by the government and individual income tax is due on the amount irrespective of whether a distribution is disbursed to the company shareholder.
According to Ozouf, the proposed changes to the anti-avoidance rules, to go before the island's legislative assembly on December 4, 2012, are intended to:
- Ensure the new distribution rules do not discourage shareholders from making commercial loans to trading companies;
- Provide the option of a simplified basis of taxation for those taxpayers who do not want to complete the calculations required under the distribution rules; and,
- Make a number of minor amendments to ensure that the distribution rules operate as anticipated.
Announcing the amendments, Ozouf explained:
"While we are determined to protect revenues, the Treasury has listened to feedback and we are proposing a number of additional measures to address the concerns raised."
"While we must ensure our tax revenue is protected from efforts to avoid or excessively defer tax, we would not want to prevent trading companies from obtaining commercial loans from their owners in order to expand or sustain their businesses."
"These changes will make it more straightforward for small trading companies to apply the distribution rules, without damaging the robustness of the rules as a whole."
Importantly for Jersey's future fiscal health, the islands legislative assembly, the States, has also approved the territory's first Medium-Term Financial Plan, ushering in budgetary planning in the island on a three-year cycle.
In what is effectively a three-year Budget without tax proposals, the States agreed revenue, spending, and capital expenditure targets and allocations, until 2015.
The government explained that the adoption of three-year budgeting is intended to enhance the prudent management of the island's finances, to ensure that the government operates efficiently while maintaining an attractive, and predictable low-tax regime.
Namely, the States agreed:
- Plans to invest a further GBP26m (USD41.2m) annual funding in Health and Social Services;
- Delivery of the next phase of Comprehensive Spending Review (CSR) savings;
- GBP56m for capital projects in 2013;
- An additional GBP14m for Social Security by 2015; and
- GBP5m for the Innovation Fund to boost business and create jobs through the 'Back to Work' programme.
In his speech on November 6 when he presented the proposed Medium-Term Financial Plan, Ozouf said:
This is a significant change in the way we do things. We are not simply making an administrative change to how we plan our finances, we are taking an important step towards securing our islands future. This plan delivers growth in essential services, balanced revenue budgets in all three years and support for the economy, while maintaining the current system of taxation."
It does so by making careful use of existing resources, by seeing through the final stages of the CSR and by setting out a flexible capital programme that can provide both improved services and fiscal stimulus."
We are in a unique position to be able to achieve this level of economic stimulus without drawing on strategic reserves or incurring debt. It means we will be able to spend our time doing what matters - serving the community efficiently and providing better value for money.
Isle of Man Facing Critical Challenge To Public Finances
The Isle of Man government is to ask more than 1,000 households to submit details of their spending to help assess whether the island receives a fair share of revenues under the long-standing value-added tax (VAT) and customs revenue-sharing agreement with the United Kingdom.
Under arrangements dating back centuries but formalized in 1979, the Isle of Man and the United Kingdom share revenues from hydrocarbon oil duty, lottery duty, VAT, pool betting duty, agricultural duty, and tobacco, alcohol and customs duties.
The system was introduced to enable the two countries to share a customs union, allowing the Isle of Man duty free entry into the European Union, and preventing UK import duties from being levied on goods bound for the Isle of Man but transiting through the UK.
However, in October 2009, the UK government announced that it would revise the Isle of Man's share of revenues. The change equated to a fall in revenue for the Isle of Man worth GBP50m in 2010; GBP100m in 2011; and GBP140m each year thereafter - representing of a quarter of total revenues received by the Isle of Man from the agreement in 2009. Presently revenues from the agreement account for more than half of the Manx government's annual income.
Explaining the purpose of the survey, Stephen Carse, Government Economic Adviser and Head of the Economic Affairs Division, stated: "When the Customs and Excise Agreement was revised it was announced that updated information about the island's spending patterns would be required to underpin the calculation of our share of VAT and customs revenues. The importance of this household survey cannot be overstated. With 57% of government's revenue coming via the Customs and Excise Agreement, the outcome will potentially be critical for the public finances. It is by necessity a huge survey, and we will be relying on the voluntary participation of residents. [This is] a historic exercise to make sure our island gets its fair share of revenues for the future funding of important public services."
Back in August, Treasury Minister Eddie Teare warned that tough political decisions will need to be made in order to put the Manx governments finances back onto an even keel.
Teare said that difficult changes were necessary to complete the rebalancing of governments budget by 2016 as scheduled. He disclosed that: "The budget rebalancing process is on target and so far it has had a relatively limited impact on services and staffing, which may have led to a degree of complacency. But we are not out of the woods yet, and there are still some big issues to be resolved before we can finally say we have put the Island back on course for the future."
"It is fair to say that, as expected, a gap exists between the total spending projections of Government and the reality of what is available", he added. "There is no easy way of bridging that gap, but we have to do it."
The Minister added that in addressing the fiscal challenge the Government had to make the necessary changes while avoiding a slash and burn approach that could destabilise the Islands economy, which was still showing positive growth.
He concluded by noting that at present he was content that the £55 million required from Reserves in 2012-13 would not be exceeded, and that as such the rebalancing of Governments finances remained on plan.
"Income is holding up in line with projections and even after the rebalancing Governments reserves will still be substantial," said Mr Teare.
The suggestion that taxes will rise on the Isle of Man has not yet been made, at least not publicly by the islands government. Consolidation efforts at the moment are focussing on cutting departmental expenditure, and the delivery of social care. However, the issue of changes to the VAT sharing arrangement with the UK is clearly a vital one, and this is a situation to be monitored closely in the months ahead.
Cayman Islands Put On the Budget Straight and Narrow
The prospects for fiscal stability in the Cayman Islands improved in November after the islands legislative assembly finally passed amendments to the Cayman Islands Public Management and Finance Law (PMFL) that incorporate a United Kingdom-drafted fiscal framework.
The approved version was the third to go before the assembly and incorporates the agreed Framework for Fiscal Responsibility (FFR) into the Cayman finance law.
The FFR commits the Cayman government to "restoring prudent fiscal management," in order to help "create an environment in which people and businesses can plan for the future with confidence."
The FFR states that the Cayman Islands governments fiscal strategy consists of the following five components: controlling government expenditure; limiting new borrowings; re-aligning the revenue base; improving the performance of Statutory Authorities and Government Companies; and reducing costs by working in partnership with the private sector.
In August, the United Kingdom government endorsed the revised Cayman budget for 2012/13 but restricted the size of a second overdraft facility to limit Cayman borrowing.
The budget was the result of a second revision of budget proposals from the Cayman government, which was instructed to rewrite its initial budget plans earlier this year after the UK government blocked the territory from increasing borrowing to service the islands' recurring budget deficits. A second draft of the budget was drawn up in July, but this draft was promptly abandoned after an outcry from the local financial industry regarding a proposal to introduce a direct tax on expatriate workers' income.
The overdraft facilities, with a combined value of USD81m, are being provided in recognition of the cyclical nature of Cayman revenues from the financial services industry. At the request of the UK's Foreign and Commonwealth Office, the Cayman Islands will be required to establish a 'Budget Delivery Board' to ensure that it achieves a budgetary surplus, as well as the repayment of the two credit facilities to the UK government by January 31, 2013, and June 30, 2013.
The fact that the Cayman Islands considered introducing a tax that was previously unthinkable, especially in more prosperous times, shows how badly the crisis has impacted the public finances of some offshore jurisdictions, many of which are highly exposed to the health of the wider global economy.
The so-called 'Community Enhancement Levy' which would have been the first direct tax in the Cayman Islands - was to involve a 10% levy on expatriate workers' income above a prescribed threshold, but the measure was dumped following an outcry from the islands' financial services professionals, who underscored that the tax-free environment the Cayman Islands have historically offered is critical to the territory maintaining its position as a world-leading international financial centre.
The measure, announced on July 25, 2012, along with a further levy of 5%, payable by employers, in respect of non-resident employees engaged in certain categories of work, was aimed at rapidly consolidating the nation's deficit following confirmation from the United Kingdom's Foreign and Commonwealth Office (FCO) in July 2012 that the territory would no longer be permitted to increase borrowing to service recurring budgetary deficits.
In announcing the July measures, Premier McKeeva Bush admitted that the package would allow the government to protect 500-700 civil servants from redundancy. The combination of measures would have achieved a fiscal surplus of USD84m in the fiscal year 2012/13, making available USD29m to service the territory's debt, and allowing the government to make payments towards outstanding pension contribution liability - consistent with the legal obligations agreed with the FCO.
The expatriate tax was touted by Bush in July as a less draconian tax than other potential revenue sources such as income tax, a sales tax, or a property tax.
However, in a statement arguing for the repeal of the levy, the Cayman Islands Council of Associations - comprising ten of the Cayman's main industry bodies, warned of the impact a direct tax could have on the competitiveness of the jurisdiction.
"The Associations regard the Community Enhancement Fee in its current form to be discriminatory, divisive to society and inequitable. This type of fee has been regarded as unlawful in other jurisdictions such as the Isle of Man and Gibraltar."
"We believe more can be done to reduce government spending and to generate cost savings as recommended in the Miller-Shaw report. We believe that increasing the cost of doing business at this time may cause a loss of business to our competitors."
"The introduction of direct taxation will mean giving up our single most important value proposition that we have to offer our investors: no direct taxation in a world where taxation is on the increase. The Council of Associations believes that if we implement the proposed new tax we will have lost the primary advantage that distinguishes Cayman from the rest of the world. We believe that by creating a system of collecting taxes, investors will be unable to trust that the proposed 10% fee will not change to 20% and that taxing payroll will not evolve into taxing income on residents and eventually investors."
In a sobering warning to the government, the Council concluded that:
"The real estate industry has already witnessed an outward flight of investors. Apart from the certainty that this will reduce government income in the short term, it could very well lead to an outward exodus of tax sensitive investors to other jurisdictions.
It is difficult to predict whether the Community Enhancement Fee would have led to an exodus of financial services firms from the Cayman Islands, or merely a trickle. However, it is probably safe to say that the impact on the financial services sector would have been negative.
Now the government has no choice but to tackle a public sector which is said to have become bloated.
Liechtenstein Tax Rises Unavoidable
During a recent sitting, the Liechtenstein government adopted a report and application pertaining to changes to the Principality's tax law, and introducing measures aimed at increasing tax revenues, including notably a new marginal tax rate for the country's top earners.
The decision was made following a series of talks between Prime Minister Klaus Tschütscher and representatives from industry to discuss a way forward. According to the Liechtenstein government, although the associations concerned underlined the need for further savings measures to be examined before significant tax rises are introduced, all were united in their agreement that tax rises are unavoidable.
Defending the planned tax measures, the Liechtenstein government alluded to the budget plan, which revealed an expected revenue shortfall in 2013 and in subsequent years, and noted that although the government has already adopted two fiscal packages to redress the state budget, the measures included have proven insufficient.
The government explained that it had therefore submitted a bill for consultation, providing for a series of new tax rises. However, as a number of the proposed measures were highly contested in the consultation process.
During the consultation process, plans to decouple the notional interest deduction and the own capital interest deduction were rejected, as were plans to increase the minimum income tax and therefore also the minimum capital levy to CHF1,800 (USD1,950).
According to the Liechtenstein government, the Prime Minister and industry representatives agreed that as a first step the revenue measures agreed within the framework of the consultation process should be implemented.
Therefore, the government's adopted report provides for these "undisputed" measures, and provides crucially for the introduction of a new marginal tax rate applicable to top earners in the Principality. The government has not, however, furnished further details of the new tax rate.
The report also provides for an increase in wealth and individual income tax by adjusting the lower and middle tariffs in such a way as to ensure that the tax burden is the same as under the country's old tax law. In addition, the introduction of an additional 8% tax rate has been agreed, together with plans to increase the endowment tax rate.
Finally, the report provides for the loss carry-forward allocation to be limited and provides that no loss carry-forwards are to be generated by own-capital interest.
Given that these new measures will still be insufficient in themselves, the government aims to take further measures to redress the state budget. Consequently, a joint project group, comprising representatives of the associations and the government, has been set up. The group is due to draft a report by mid-February 2013, advocating additional fiscal initiatives which should be taken to consolidate the budget by the required CHF52m.
Given the sustained attacks on banking secrecy in the past two to three years from foreign governments, notably Germany, the countrys financial services and asset management industry seems to be holding up remarkably well. It remains to be seen however, how the industry reacts to the prospect of higher taxes in the future.
Antigua and Barbuda on the Slow Road To Recovery
An International Monetary Fund (IMF) mission monitoring the structural and financial reform program it approved for Antigua and Barbuda under a Stand By Arrangement (SBA) in 2010, has reported that although the fiscal balance target for September may have been missed, the authorities continue to demonstrate strong commitment to the policies and objectives of their Fiscal Consolidation Program.
The report notes that revenue performance in the first three quarters of 2012 was below target but well above the same period last year. Corrective measures to ensure that December targets are met were discussed with the authorities, and an agreement on 2013s fiscal program was reached.
Expenditure in the first three quarters of the year was within program targets, and the 2013 fiscal program is expected to result in a central government primary surplus of 3% of gross domestic product (GDP) and a central government overall surplus of 0.3% of GDP. Inland Revenue and Customs reforms are also said to be progressing.
Several structural benchmarks, including a valuation/compliance audit on petroleum imports and increased compliance of state-owned enterprises with their tax obligations, have been completed.
The following are expected to follow by January 2013: enactment of the new Tax Administration Procedures Act (TAPA); activation of legislation authorizing the garnishment of overdue ABST (Antigua and Barbuda Sales Tax) and personal income taxes (as part of TAPA); tax compliance of 20 out of 23 statutory bodies; the presentation and passage of a New Customs Act; and the implementation of the harmonized customs code.
The mission met with several state-owned entities to assess their financial situation and discuss possible reforms in preparation for a technical assistance mission in January 2013.
The IMF, which stressed that "carrying out the plan remains essential to achieving long-term economic growth and job creation," intends to return to Antigua and Barbuda in mid-February 2013.
Antigua and Barbuda sought IMF support following a 20% decline in tax revenue in 2009. The deficit widened from 6% of GDP in 2008 to about 19% in 2009. The government took action to consolidate the nation's finances, including by increasing petroleum product prices, and introducing significant public sector spending cuts and tax measures in the 2010 Budget, worth 4.5% of GDP. These tax measures included an expansion in the value-added tax base, and increases in import duties and excise taxes on alcohol and tobacco.
By 2011, the government had brought the budget deficit down to a more sustainable 1% of GDP, but introduced a number of stimulus measures, including tax concessions, in the 2011 Budget to support the territory's economic recovery.
The Antiguan governments cause surely could not have been helped by the ruination of its e-gaming industry as a result of new legislation in the United States which effectively freezes its operators out of that market. In 1999, internet gambling employed 1,600 people in Antigua, and the jurisdiction had a 60% share of the global market. However, over 80% of the jurisdictions e-gaming and sportsbook firms had left by 2003. Given its vulnerabilities to external forces therefore, the Antiguan government seems to have done a good job in turning things around. However, these vulnerabilities very much remain a source of economic and fiscal weakness.
Dubai Clarifies Free Zone Rules
While no-tax Dubai hasnt yet felt the need to introduce new taxes, or reduce the generous tax incentives offered in its many free zones, the emirates Department of Economic Development has reiterated that businesses based in Free Zones across the UAE require a licence and registration in order to take advantage of a law passed in 2011 allowing Free Zone businesses to operate within Dubai.
Mohammed Shael Al Saadi, who is Chief Executive Officer of Business Registration and Licensing at the DED, said that: "Under no circumstances can a Free Zone company in Dubai operate outside its jurisdiction unless it has a branch licensed by DED. The same applies to companies in any Free Zone in the UAE. Alternatively, such companies may appoint an intermediary to sell their products or services in Dubai, but the intermediary should have a DED licence."
"Recently, we have been receiving complaints from various Free Zone companies, most of them operating outside Dubai, that their licensors had promised they can do business in Dubai under the Free Zone license. We have clarified to them that there is an established route to doing business in Dubai."
"Through Law No.13 of 2011, Dubai has acknowledged the role of Free Zone companies in economic activity in the UAE and the leadership wants to allow such companies to contribute further to overall development. DED's role is to enable businesses that choose Dubai as their base to benefit from a competitive environment and best practices."
Dubai licences are dependent on continuing Free Zone activity, and the involvement of a local service agent to sponsor employees.
Dubai's economy is fairly clearly divided between the 'onshore' sector, dominated by local business interests, with restrictions on foreign ownership, and the 'offshore' sector which consists of the Jebel Ali Free Zone, the Dubai Investment Park, Dubai Internet City, the Dubai International Finance Centre (DIFC), the Dubai Airport Free Zone, and Dubai Media City. There are no taxes to speak of in Dubai, on- or off-shore, but 100% foreign ownership and customs privileges make the Free Zone and its successors some of the most favourable locations in the Middle East for international operations.
However, the recent statement from the DED appears to suggest that the authorities in Dubai will have no truck with firms wishing to take liberties with what is already a very generous tax system!
While all this doesnt really amount to a full-blown fiscal crisis in the world of offshore, some IOFCs have been affected by the global financial meltdown much worse than others. The worst affected have tended to be those relying on a narrow income stream from a certain section of the financial services spectrum, and with little or no other economic activity to fall back on. This has been the case in the Caribbean, where the contraction of the tourism market has hit many jurisdictions with a double whammy, and Antigua and Barbuda is a prime example.
The IOFCs that have been able to tough things out and emerge in better shape are those which have worked hard to expand their offerings into other areas of the financial services and asset management. The UK Crown Dependencies have done this well, by targeting a growing sources of untapped wealth in the Middle and Far East, and in the emerging economies.There is clearly a trend emerging however, and it is no coincidence that several IOFCs have elected to consider tax increases at around the same time. This may be a temporary blip, to reverse itself when the fiscal problems have been fixed, and it can be assumed that most IOFCs will fight to keep taxes low. But for investors, these are developments that warrant closer attention in the months ahead.
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