There has been some talk recently that we should not reform our corporate tax system, for fear of unsettling the finance industry. As a former international tax specialist, this seems to me mostly uninformed, and I feel I should set out the facts.
Guernsey taxes companies and individuals on a world-wide income basis. In broad terms, this means that residents are liable to Guernsey tax on all of their income, wherever it arises. In some cases, relief by way of credit is granted for any foreign taxes paid on that income. Guernsey’s regime was modelled on the UK tax system of the early 20th century, when Guernsey introduced Income Tax in 1920.
At the time, the world-wide income basis was the international norm for the taxation of corporate income, but gradually over the years, most countries have switched to a territorial basis for the taxation of corporate income. Broadly, this means that companies are taxed in the country concerned on their income arising within that state, but that country does not tax them on income arising elsewhere. In some cases, the territorial basis applies only to ‘active’ (ie trading) income, and in others it applies more widely to other parts of the income of the company. Within the EU, dividends from subsidiary companies are generally excluded from tax.
Today, there are only 7 OECD member states that retain the world-wide income basis for all of a company’s income. They are Chile, Greece, Ireland, Israel, Korea, Mexico and the USA. The UK switched to a territorial basis in 2009, and proudly advertises this fact to attract foreign investment. Apart from Greece and Ireland, all of the member states of the EU have adopted territorial tax regimes, in part or entirely. Our major competitors in Europe, eg Gibraltar, Luxembourg, the Netherlands and Switzerland, all use territorial tax regimes, as do our powerful competitors to the east, Dubai, Hong Kong and Singapore.
Imposing Guernsey income tax on the foreign income of Guernsey companies would have made Guernsey companies unattractive to clients of our finance industry, so for years up to and including 1988, companies which were incorporated but not resident in Guernsey were allowed to pay an annual flat fee called Corporation Tax, to avoid being liable to Guernsey Income Tax. However, to maintain their non-resident status, many of these companies took to holding board meetings in Sark. This obviously artificial arrangement became known as the ‘Sark Lark’, and it threatened to bring the island into disrepute.
After 1988, companies which formerly paid Corporation Tax were allowed to apply for Exempt Company status, which meant that they could hold their board meetings in Guernsey, but still benefit from a flat fee in place of liability to Income Tax. Additionally, some tax payers were allowed to benefit from special deductions against their income subject to Guernsey Income Tax, so that, for example, banks paid tax at only 2% on income arising from international loan business booked through Guernsey.
These arrangements, and others like them in various countries around the world, offended tax policy-makers in the OECD and the EU, who began work in the 1990s on shutting such ‘loopholes’ down. At the time, the OECD process did not get very far, but, under the EU Code of Conduct on Business Taxation (1998), the EU threatened to take action against countries which engaged in what it considered to be ‘harmful tax competition’.
In response, Guernsey decided, in 2006, to adopt the ‘Zero-10’ tax regime, by which the large majority of Guernsey companies are subject to tax at 0%, while minorities are subject to tax at 10% or 20%. The new regime came into effect in 2008. This of course had the effect of ensuring that most client companies of the finance industry continued to pay no Guernsey Income Tax, but at the cost of exempting all of the companies in our domestic economy, which had previously paid Income Tax at 20%.
The result was a loss of income to the Guernsey exchequer of about £100 million per annum. Part of this loss was caused by the overall reduction in the rate of tax paid by the Guernsey finance industry itself (eg the banks and trust companies operating here) which now pay 10% instead of the 20% or 2% that they paid previously. But the rest was caused by the loss of tax from companies operating in our domestic economy, which now pay 0% instead of 20%.
The consequence of this loss of tax from the corporate sector has been a substantial shift in the fiscal burden of the States from companies to individuals resident in Guernsey. For lower and middle income earners, our personal tax system is no longer competitive with that of the UK, and many of these people would be better off after tax and social insurance contributions, if they moved to take up similarly paid employment in the UK. As a result of this, and the lack of affordable housing on the island, coupled with our high cost of living, there is now a steady exodus from the island. If this is left unchecked, it will put us in the mire that today threatens Alderney and Sark.
Guernsey has a demographic problem, owing to the fact that we have the lowest fertility rate in the British Isles, and we are exacerbating the problem by driving away young families. In the Zero-10 strategy, this was not seen as a problem, because one of the objects of the plan was to replace lower ‘value-added’ people and activities with more productive contributors, thus enabling the economy to grow without substantially increasing the population. But in the event, the economy has not grown as much as predicted, and the structural deficit caused by Zero-10 remains with us today.
Meanwhile, the rest of the world has moved on. More and more countries have adopted territorial tax regimes, and the OECD has joined the EU in a campaign against ‘tax haven’ activities. This has manifested itself this year in their project against Base Erosion and Profit Shifting (‘BEPS’), and the development of their Common Reporting Standard. The UK has jumped the gun on BEPS, and introduced its Diverted Profits Tax, which is more of a threat to us than has been publicly acknowledged. All of these developments will have impacts on some Guernsey companies, and will make some of the activities of our finance industry unviable. Together with changes in the regulatory environment, these developments are restricting our future business opportunities.
While Guernsey is not singled out as a target in these developments, and while we can argue that we are not a ‘tax haven’ within the OECD definition, there is no doubt in my mind that our zero percent corporate tax rate is inflammatory. If we can ‘normalise’ our tax system, and our relationships with other countries, without doing significant damage to our economy, we would be foolish not to do so.
In 2006, I considered the Zero-10 policy to be a mistake, but the developments since then make it now absurd. Guernsey is giving up valuable and legitimate revenue streams, and at the same time painting a target on its back, inviting further retaliatory action. If instead Guernsey adopted a territorial tax regime, we would not have to exempt companies trading in our domestic economy from local tax, and the vast majority of the client companies served by our finance industry would be unaffected by changes in our corporate income tax rate. And all we would be doing is adopting a version of the world’s normal corporate tax regime.
Under a Territorial 10 tax regime, the finance industry itself would remain liable to local tax at 10% (as it is now), and its clients would remain either Exempt (eg because they are investment funds), or non-taxable on their foreign-source income, rather than taxable at 0%. The only finance industry client companies that would be affected would be the few trading in Guernsey through a permanent establishment.
So what are the objections to reforming our corporate tax system in this way? Firstly it is argued that any change would “unsettle our finance industry”. I have worked in the industry for 34 years, and know a wide variety of the senior people in it. Far from being opposed to any change, most of them can see the benefits of stabilising Guernsey’s fiscal situation, and its international relationships, by normalising its tax system. Our credit rating would not be under such threat if we were running a budget surplus.
Of course, the development of a new system will involve fine-tuning around the edges, but the principle is really not that controversial. If it was, the industry would have panicked when former Chief Minister Lyndon Trott announced to the States, in 2009, that Guernsey was reviewing its corporate tax system based on a presumption that we would adopt a 10% rate of tax. In reality, there was little or no reaction.
Secondly, we are told that a Territorial 10 regime would not produce much additional tax. So we are asked to believe that the abolition of the 20% basic rate of tax for companies in 2008 caused a loss of £100 million, but the imposition of a general rate of 10% would not produce very much? In my view, it would produce enough to fill our current ‘black hole’. And the companies that would be paying the extra tax are not finance industry companies, they are retailers, building contractors, fuel suppliers, hotel companies, delivery companies etc operating in Guernsey. They are businesses which use our public services, and which ought to help pay for them. Moreover, in most cases, they are companies that are quite willing to contribute.
Thirdly, we are told that we should not have a corporate tax system different from those of Jersey or the Isle of Man. Apparently, it is OK for us not to have consumption taxes, as they do, but a different corporate tax system would be hard to market, even if it is the system used by most of our other major competitors. This is palpable nonsense. If the Zero-10 system gave us any competitive advantage, international business would be moving from Singapore to the Channel Islands, and not the other way round.
Guernsey often has to be different from the other Crown Dependencies. We are the smaller jurisdiction, and have had to be nimble to compete. None of the clearing banks are based here – the Guernsey operations of Barclays, HSBC, Lloyds and RBS are all subsidiaries or branches of banks based in Jersey or the Isle of Man. If we are not careful, in a world where offshore businesses are consolidating, mergers between and restructuring of offshore operations will put a squeeze on Guernsey. We have to be better.
We have to look for any competitive advantage we can find, and being the one Crown Dependency that operates a normal corporate tax regime could be the platform we need. For example, it could get us off black-lists, or unlock the possibility of full double tax treaties with major economies.
If I have any influence in the next States, I will propose that we should review our corporate tax system, based on a presumption that we will move to a territorially-based corporate income tax, with a general rate of tax of 10%. The review team should include international tax specialists with a global reputation and perspective, and the output of the review should be the subject of wide consultation in Guernsey, before any proposals are put before the States.
We have a persistent structural deficit, and the States has, rightly, ruled out a GST, so doing nothing is clearly not an option. I have heard a rumour that there is a plan to introduce GST by stealth, in 2019. Apparently the idea is that other taxes will be hiked to unpalatable levels (starting with the 20% tax on big retailers) so that eventually the public and business community will accept a GST, in return for a reversal of the hikes.
If this is true, the electorate will be offered, in 2016, a clear choice over our future direction: as indeed will be the voters of St Peter Port North on 2 December.