Changes to Guernsey's corporate tax regime
You may have seen in the local press recently that the States have voted to change elements of Guernsey’s corporate tax regime to make it acceptable to the EU rule makers. The specific aspects that caused offence surrounded the deemed distribution measures for Guernsey investment holding and trading companies. This article provides some context around the issue, summarises the changes and offers some areas where directors and shareholders may need to be mindful of in the future.
The “Zero-10” Tax Regime
On 1 January 2008, the standard rate of tax for Guernsey companies was reduced to 0%. Jersey and the Isle of Man introduced similar regimes, from 1 January 2009 and 5 April 2006 respectively.
The changes meant that all companies were treated similarly in each jurisdiction, while allowing the Islands to remain competitive and attractive to the international business community.
However, each jurisdiction contained a number of exceptions to the standard rate. In Guernsey, these included:
- Income from the ownership and development of Guernsey land and buildings which is taxed at 20%;
- Some activities within the banking sector which are taxed at 10%;
- Investment income which is treated as though it has been distributed; and
- Trading profits which, triggered by the occurrence of certain events, are treated as though they have been distributed to Guernsey-resident shareholders, and subject to 20% tax.
This last exception is known as the “deemed distribution” regime, and meant that Guernsey resident individual shareholders continued to be treated differently to non-Guernsey resident shareholders.
What Happened Next?
It has been well publicised that the EU considered the island’s tax regime to be harmful. Concerns were expressed over both the 0% rate, and the different treatment of local/non-local shareholders, both of which were considered, potentially, to be contrary to the spirit of the EU Code of Conduct on Business Taxation (“The Code”).
In order to avoid a confrontation with the EU, Guernsey announced a formal review of its tax system, initially based on the assumption that there would be a general corporate tax rate of 10%.
Jersey and the Isle of Man took a different approach, and decided to defend both the 0% rate and (their local equivalents of) deemed distributions. The other Islands’ defence was partially successful, as the Code of Conduct Group accepted that the 0% rate was within the spirit of the Code. However, deemed distributions and the different treatment of locally resident/non-locally resident shareholders were considered harmful.
Both Jersey and the Isle of Man acted to remove deemed distributions from their respective tax codes, while retaining the 0% standard rate of tax, with effect from 1 January 2012. Guernsey indicated that it felt its existing tax regime was sufficiently different to the other Islands that it was compliant with The Code. The EU carried out a review and announced an initial finding that the deemed distribution element was harmful in April, which was confirmed on 22 June 2012.
In response, the States approved the removal of the deemed distribution provisions, with effect from 1 January 2013, at their meeting on 27 June 2012.
What Does This Mean?
With effect from 1 January 2013, all elements of the deemed distribution regime will cease to apply. This means that locally-resident shareholders will be taxed only when they receive an actual distribution from a company. Until profits are actually paid out, they will accumulate in the company, free of tax.
The more significant consequences of this change include:
- Investment income such as dividend and interest, which are currently deemed to be distributed to local shareholders on a twice yearly basis, will be accumulated free of tax unless actually distributed
- The various “trigger events”, which include sale of shares, death of a locally-resident shareholder, cessation of the company’s business, migration of either a locally-resident shareholder or of the company, will all cease to apply. No income tax will arise as a result of any of these events occurring on or after 1 January 2013.
It is therefore important to carefully consider the impact of these changes before undertaking any significant transactions or changes to ownership in the next 6 months, prior to the commencement of the new tax regime. In particular, we would recommend that tax advice is sought prior to actual distributions or transactions which would be deemed to be a trigger event for the deemed distribution of trading profits. The tax position of the company and the timing of any transfer of ownership may have significant implications for share valuations before major transactions.
The changes above will take effect only from 1 January 2013. The deemed distribution regime will continue to operate throughout 2012 meaning that income arising, or trigger events occurring, on or prior to 31 December 2012 may give rise to an income tax liability for locally resident shareholders.
It is also worth noting that the “Managed Service Company” rules, which are intended to ensure that individuals cannot defer payment of tax by providing their services as a director, consultant or other employee-type relationship, and “Qualifying Loans” rules, which cause loans made by companies to shareholders to be deemed to be taxable distributions, are not affected by this decision and will continue to operate.
Can We Expect Further Changes?
In order for the EU to consider Guernsey’s revised tax regime to be Code Compliant, the Treasury and Resources Department has had to make a commitment that “there is no intention to replace these [deemed distribution] provisions with another regime that replicates their effect”. Any changes will, therefore, need to treat local and non-local shareholders equally.
The Department estimates that the annual cost to the Island of repealing the deemed distribution provisions will be in the region of £4 million per annum based on tax raised since 2008. We believe the tax loss may be much higher after taxpayers commence tax mitigation activity.
Attempts to recoup this lost revenue are inevitable, and it currently appears that the most likely approach will be to extend the scope of the 10% and 20% tax rates to a wider range of financial service companies.
We will be keeping this area under close review, and will update our website with further details as they are announced.
Gareth Nicolle CA
19 July 2012
This article has been prepared as a general guide. It is not a substitute for professional advice. Neither Collenette Jones Limited nor its directors or employees accept any responsibility for loss or damage incurred as a result of acting or refraining to act upon anything contained in or omitted from this document.