This article provides a summary of the changes to how a Guernsey company’s profits are taxed with effect from 1 January 2013.
With effect from 1 January 2013:
- There will no longer be any “Triggering Events” or “Deemed Distributions” of
- Distributions will be treated as being made firstly from untaxed undistributed profits
- The “65% Election” will cease to have effect
- The “Loans to Participator Rules” will continue as before
- Fiduciary companies and certain Insurance companies regulated by the GFSC will pay
tax on their profits at 10%
Background - The “Zero-10” Tax Regime
On 1 January 2008, the standard rate of tax for Guernsey (i.e. Guernsey resident) companies was reduced to 0%. This rate applied to most Guernsey companies with the following exceptions:
- Rental income from Guernsey property which is taxed at 20%.
- Income from Guernsey property development which is taxed at 20%.
- Specific activities within the banking sector which are taxed at the intermediate rate of 10%.
- Activities regulated by the Guernsey Competition and Regulatory Authority which are taxed at 20%.
Until 31 December 2012, a Guernsey company’s untaxed post-2007 profits were only taxed when they were actually distributed or “deemed distributed” to Guernsey resident shareholders. Deemed distributions of a company’s profits occurred when a Guernsey resident shareholder was deemed to have received a distribution of a company’s profits (in proportion to his or her % shareholding) even when the shareholder may in fact have received nothing.
In general terms, until 31 December 2012 a Guernsey company was deemed to have distributed untaxed profits to its Guernsey resident shareholders if: 1) the company was in receipt of investment income; 2) one of a number of defined “triggering events” occurred; and 3) the company made loans to its Guernsey resident participators (broadly defined as being shareholders, proprietary directors and their family) from profits which had not all been subject to tax at 20%.
The triggering events referred to above included the following:
- The sale or transfer of a Guernsey resident’s shareholding.
- The death of a Guernsey resident shareholder.
- The emigration of a Guernsey resident shareholder from Guernsey.
- The migration of a Guernsey company to another jurisdiction.
- The winding-up of the company or a significant cessation of its trade.
The “Zero-Ten” tax regime therefore differentiated between Guernsey shareholders and non-Guernsey shareholders and was deemed to be “harmful” by the EU. In response, the States approved the removal of the deemed distribution provisions with changes to take effect from 1 January 2013.
What has changedwith effect from 1 January 2013?
- Income will no longer be deemed distributed to shareholders i.e. triggering events will cease to have any effect and investment income will no longer be deemed distributed. This means that locally-resident shareholders will be taxed only when they receive an actual distribution of untaxed profits from a company. Until untaxed profits are actually distributed, they will accumulate in the company free of tax.
- In an attempt to increase the tax revenue, actual distributions of profits will be deemed to be made firstly from untaxed undistributed income. The company’s “other income” and capital can only be distributed once all of the company’s untaxed undistributed income has been distributed and taxed. “Other income” includes pre-2008 income and post-2007 income which has been taxed at 20% or more.
A company can however choose for actual distributions to be made first out of undistributed income which has suffered tax at the 10% intermediate rate or overseas tax at less than 20%. In these cases the company will have to account for the deficit in tax between the actual tax suffered and 20%.
Any losses brought forward at 0% can be relieved against profits at the new 10% rate provided the company is carrying on the same business. However, group loss relief will be restricted to profits which are taxed at the same rate.
- Some Guernsey companies have made “the 65% election” where, in return for making an irrevocable election to distribute (or be deemed to distribute) and pay tax on at least 65% of the company’s untaxed profits each year, the company would be exempt from the triggering events. (The triggering events caused the deemed distribution of a company’s untaxed profits). Now that the triggering events have ended we understand that the 65% elections will also end with effect from 31 December 2012.
- Loans to Guernsey resident participators will continue to be taxed, with tax paid by the company on behalf of the participator. The “Loan to Participator” rules remain unchanged. Such loans include payments to directors, shareholders and their families over and above that declared via the ETI scheme as wages and above the balance of any shareholder/director loan accounts owed by the company. Such payments include personal expenses paid by the company on behalf of directors and shareholders.
- The intermediate tax rate of 10% has been extended to cover income from certain businesses regulated by the Guernsey Financial Services Commission (“GFSC”). These include licensed fiduciary activities (class 2(2)(ab) income), licensed domestic insurance (class 2(2)(aa) income), licensed insurance intermediaries (class 2(2)(ac) income) and licensed insurance managers (class 2(2)(ad) income) in respect of that type of business.
Implications, issues and anti-avoidance:
- For companies which now have different income streams which are taxed at the standard 0% rate and the new 10% intermediate rate, care must be taken to apportion the profits appropriately between each activity. The tax office has indicated that the gross profit from each activity would be a reasonable basis to allocate the overheads but it is likely that the tax office would also be willing to consider alternative bases if judged more suitable. The re-analysis of a company’s income between activities taxed at 10% and 0% will no doubt be much discussed, especially where a company has previously raised fee notes which group all of the activities together on the same invoice.
Companies which will now suffer the 10% intermediate rate and which have financial years ending on dates other than 31 December will need to time-apportion their profits accordingly. Again it is likely that the tax office would be willing to consider alternative bases if judged more suitable.
- There may be some companies which are now taxed at the intermediate rate of 10% and which pay a management charge to a non-resident company or to another Guernsey company which suffers tax at the standard 0%. There may also be companies which pay fees to non-resident directors without the deduction of any income tax. We expect that the Guernsey tax office will look more closely at the bases of these management charges and directors’ fees to ensure that they are charged on a reasonable commercial basis and that their purpose is not to avoid paying tax at the new 10% rate.
- When considering the sale or purchase of a Guernsey company it will no longer be necessary to clarify who will bear the cost of the tax payable by the company on the deemed distribution of its accumulated untaxed profits at the date of sale. However, given that a company’s assets will comprise partly untaxed accumulated profits, a Guernsey resident purchaser will need to bear in mind that a subsequent distribution of those untaxed profits will be taxed at 20% and consider adjusting the purchase price accordingly. By way of a simple example: if a Guernsey company has an issued share capital of £2 and accumulated untaxed profits of £999,998, represented by a bank balance of £1,000,000 then a Guernsey resident purchaser might be willing to pay only £800,000 for the company since this would be the net distribution he could take from the company after the deduction of tax at 20%. Previously, the company’s vendor would have been assessed on the company’s untaxed profits at the same time the company was sold and either would have paid the tax himself or the company would have paid the tax on his behalf.
In most cases the abolition of triggering events merely delays the point at which the tax on the company’s untaxed profits becomes payable.
- There was very little publicity for the general public or even the accounting and tax profession about the detailed changes to the deemed distribution regime. This was presumably to prevent Guernsey companies from taking pre-emptive action to minimise the additional tax to be paid under the new rules. Since any distributions from 2013 onwards are deemed to be made firstly out of untaxed income (or income taxed at less than 20%) many Guernsey companies (if they were indeed aware of the changes) might have considered declaring a dividend out of taxed profits before the new rules took effect.
When a company has insufficient cash to pay such a dividend, the unpaid dividend is left owing to the shareholder in a “shareholder’s loan account ”. The creation of such loan accounts has been common practice for many years because such a loan allows a Guernsey shareholder to withdraw previously taxed profits as and when he chooses without the payment of additional tax. A loan owed to a shareholder also avoids the commercial risks and tax implications associated with debit loan accounts (i.e. where a loan is owed by a shareholder to the company).
The tax office became aware of the possibility of a company declaring a dividend of all of its taxed profits before 2013 to create a loan account which would allow shareholders to draw-down funds from the company as loan repayments for many years to come, thereby delaying the distribution of untaxed profits on which tax would be payable. The tax office has therefore issued a general warning that if companies declared one-off dividends to create a shareholder’s loan account in order to delay paying tax on untaxed income from 1 January 2013, it would ignore such a dividend and treat any subsequent shareholder loan repayments as distributions of untaxed profits.
It is unclear how the tax office will treat the repayment of shareholders’ loan accounts which were created by the distribution of a company’s pre-2008 taxed profits shortly after the introduction of zero-ten but, given that the purpose of such a dividend was not to avoid the payment of tax, it would seem unfair if repayments of these loan accounts were also treated as distributions of untaxed income.
- Until 31 December 2012 the migration of a Guernsey resident shareholder from the island would have triggered the payment of tax on his or her share of the company’s untaxed profits at that date. This was a simple and effective anti-avoidance tool to prevent Guernsey shareholders migrating to a jurisdiction where they would suffer no (or minimal) tax on untaxed profits when they were distributed by the company. The end of the deemed distribution regime does therefore give increased scope for Guernsey owners of Guernsey companies to leave the island, distribute the company’s untaxed profits and avoid the Guernsey tax they would have suffered if they had distributed the profits in Guernsey. Whether the tax office considers issuing any ant-avoidance rules to close such a loophole remains to be seen.
- It is likely that those companies which made the 65% election and which have financial years ending on dates other than 31 December 2012 will need to time-apportion their 2013 profits accordingly. Again it is likely that the tax office would be willing to consider alternative bases if judged more suitable.
Presumably any profits which were taxed under the 65% election, but which have not yet been distributed, will not be able to be distributed until all untaxed profits have been distributed and taxed first. This legislation is currently being drafted so in this case there may be some exceptions to the general rule.
Can We Expect Further Changes?
The answer is almost certainly “yes”, but we hope that these changes will not be fundamental. Although the actual changes to the deemed distribution regime appear fairly simple (the change to the order of distribution of untaxed profits actually involved the insertion of just three words), we think the implications arising are yet to be fully understood. It may not be until accountants and tax advisors have had a chance to deal with a company’s 2013 accounts and tax affairs that more questions will arise and more Statements of Practice will be issued.
Mike Collenette FCA
27 February 2013
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.