Beneficial Ownership and American Exceptionalism

"Russia, Canada and the US despite the encouraging language were not up for public registries and full disclosure of beneficial ownership. Competition, costs, and privacy concerns, not to speak of the UKs own position, arguably along with the US (Delaware), the weakest of the G8, must have been a handicap." (Geoff Cook, Jersey Finance)
 
The first move towards transparency must be beneficial owner registers kept by a regulatory authority, even if those are not public. It is interesting to note that David Cameron acknowledges that the UK business community would be opposed to a public registry unless other countries also conformed to that standard, but in the meantime, a registry supervised by a regulator, would be a good step in the right direction..
 
While Deputy Tadier continues to criticise Jersey, it should be noted that at present, Jersey, the Isle of Man and Guernsey each have a register of beneficial ownerships regulated by their respective Financial Services Commissions, and with firm requirements to check the authenticity of the ultimate beneficial owners of companies - customer due diligence, CDD, and apply a risk rating to them, as well as reporting any suspicious transactions.
 
For all David Cameron's rhetoric, the UK does not have this. It has no regulated central registry of beneficial ownerships. Cameron has pledged that this will be forthcoming, although since then, he has been hedging about whether it is initially made public or not. So in terms of requirements, the UK has a certain amount of catching up to do.
 
At the moment, Company A in the Jersey could be owned by an onshore parent, say Company B, where the identity of that company's parent may well be a complete mystery. There is no central registry of beneficial owners in the UK, and no requirements for due diligence.
 
The situation is even worse in the USA. There is no central registry of beneficial ownerships under State regulatory authorities. As the Financial Times notes "Companies registered in Delaware do not pay income tax there unless they have operations in the state. The disclosure rules when setting up a corporation or partnership - which costs anywhere from $180,000 to $75 per year - are simple, with the main constraint being the provision of a "natural person" to be the contact for that entity in case law enforcement officials come knocking on the door."
 
Recently, 19 former prosecutors and activists sent President Obama a letter urging greater transparency. They wanted disclosure of beneficial ownerships of these corporations which the prosecutors say are ways for "corrupt politicians, tax evaders and organized criminals to hide and launder stolen money."
 
But this is a long term problem. Back around 2000, Senator Carl Levin of Michigan first proposed legislation for Congress which would require states to disclose beneficial owners of corporations set up in their state. It has come back, and has failed three times since 2000.
 
Unlike Jersey, where suspicious transactions have to be reported to the authorities, and a central register of beneficial owners is kept, an Immigration and Customs Enforcement investigation in the USA was hampered in tracking some 800 dummy corporations - incorporated in the USA - and for which it suspected there were hundreds of millions of dollars of suspect money. The reason? The states where the corporations were registered had no requirement for owners to be identified. As a report notes:
 
"Reports were offered showing $14 billion to $18 billion of suspicious transactions going through U.S. shell corporations. The U.S. Department of Justice has fielded thousands of requests from our international partners for information on who owns corporations suspected in money laundering and other fraud. We cannot help them because we don't know who owns thousands of these corporations set up in the U.S."
 
Automatic exchange of information sounds like a good idea, and is being heavily promoted by David Cameron, but it falls down when confronted with shell companies formed in states like Delaware or Nevada.
 
Banks in the United States cannot at present even provide the kind of data the United States asks of Swiss Banks, because there is no legislative requirement to collect that information. And there is no way you can exchange information on a Delaware holding company if you cannot say who the beneficial owners are.
 
Unless the bigger players like the US can come on board with the drive towards a beneficial owner registry, all the dodgy money will migrate there, as indeed much already has. To date, the US government has struggled to pass any measures through Congress, and the omens are not good for the future.
 
There's a wonderful exchange in Yes Prime Minister
 
Hacker: We must fight for the weak against the strong.
 
Sir Humphrey: Then send troops to Afghanistan to fight the Russians.
 
Hacker: The Russians are too strong.
 
Sir Humphrey: What was that about law and justice?
 
I'm reminded of this when I hear David Cameron "summoning" the Crown Dependencies, and in part asking for something they already have, and the UK does not - a registry of beneficial ownerships. Of course it is terribly easy to summon small Islands to the Conference table and sound off about transparency, but what about America? I can imagine a fly on the wall might hear this:
 
Cameron: We must demand transparency and a register of beneficial ownership, and force it through. We must have fair taxation.
 
Cabinet Secretary: Then tell President Obama.
 
Cameron: The Americans won't take any notice of me.
 
Cabinet Secretary: What was that about fair taxation?
 
As the Guardian noted:
 
"Cameron wanted a couple of other G8 leaders to join him in pressing for public registries, but in the end none did so. All the G8 would agree to was that "some basic company information should be publicly accessible".
 
"Who, therefore is to blame for the summit's lack of real progress? Clearly, the G8 countries that put up strong resistance to change need to be named and shamed. This list includes the United States, where the tiny state of Delaware is the tax haven of choice for shell companies."
 
And Gavin Hayman noted:
 
"The credibility of this depends on the ability of the White House to advance legislation," said Hayman said. "The U.S. has promised this kind of thing before ... and not a lot happened."

Tax Questions in the States: A Gloomy Prognosis

Do you remember that Senator Philip Ozouf promised he would try and find a solution to the problem whereby locally owned companies, such as Voisins, effectively still pay income tax here, and yet the next door company De Gruchy does not? Ransom's Garden centre does pay local tax, but St Peter's Garden Centre - owned by non-Jersey shareholders does not. And the list could go on.

Deputy Geoff Southern has recently been criticised for asking too many questions at the start of States sittings, and one pundit in the JEP suggested he would be better off contacting the Ministers directly outside of the States. Perhaps, but when a question is asked in the States, then it nails a Minister down to a particular commitment. In this case, he asked:

Will the Minister assure members that he will keep his promise to bring forward in his fiscal policy for 2013, and beyond in the Medium Term Financial Plan, measures that will deal with the absence of a contribution to Jersey's tax revenues from zero-rated companies?

What lessons, if any, has he learned from the experience of Gibraltar in attempting to raise revenue from such companies without breaching European Union regulations?

We have the usual answer which really is just a restatement of Senator Ozouf's position:

The Minister remains committed to bringing forward measures to deal with the issue of nonfinance, non-locally owned businesses. However, the Deputy's question is fundamentally flawed when it states that there is an "absence of a contribution to Jersey's tax revenues from zero-rated companies". As has been stated many times, those companies which are subject to tax at 0% contribute significantly to tax revenues either through taxes and Social Security paid by individuals they employ, GST or contributing to the taxable profits of the finance industry.

Well - let's take an example. Robert's Garage is a town garage around Springfield with quite probably a fairly substantial income - it's in a good location, and cars are always going in and out. Recently it was taken over by a UK company. The result: a company which was contributing to local income tax on its profits is now contributing zero.

The reason is that local shareholders are taxed on those profits - they are "attributed to the shareholders" as local income, but overseas shareholders do not - they only get taxed in the country in which they receive any dividends.

Yes, Roberts Garage pays GST, and they employ staff - but they did that before. The loss of the profits coming into the Jersey tax net should not be underestimated - the fact that they pay GST suggests their turnover was pretty substantial.

The substantial contribution from their profits is now gone. If you look at the slice of the pie that they contributed, that's reduced substantially. So "much diminished contribution" would be a better way of describing the situation, but to read Senator Ozouf's reply, the suggestion is that is "significant", and nothing to worry about. But a good many companies have moved from local to UK ownership since zero / ten was introduced, and the black hole is growing.

Senator Ozouf's reply is lazy, and doesn't address the real concerns. Perhaps he should speak to the retailers and traders that I've spoken to - they all think the anomalous situation is grossly unfair to them. But finally something is coming to the table to address the issue:

A significant amount of work has been done on this and the fact that is has taken so long to deal with illustrates that this is not a simple issue and there is no perfect solution. Members will be fully briefed on this issue before the Budget debate. A report will be issued in the summer and proposals will be brought forward in the Budget Statement.

Or is it? The rest of the Senator's statement does not actually give us much grounds for hope:

The Deputy rightly mentions the recent Gibraltar case. This highlights two issues. Firstly that the international world is constantly changing and Jersey needs to act accordingly. Secondly, assuming the Code of Conduct Group takes a similar position as that taken by the European Court of Justice, it will not be possible to tax the majority of companies in Jersey and maintain a compliant regime.

Jersey chose to implement zero/ten as that was in its best interests to protect its economy. It more recently chose to maintain zero/ten for the same reason. No action will be taken to jeopardise that position. Similarly no action will be taken which jeopardises employment when the economy is so fragile.

What is the Gibraltar case? Gibraltar had proposed to implement a new tax system setting a zero rate of corporation tax for all companies, much like Jersey. But in order to claw back taxation from local companies, the proposal not only removed effectively corporation tax, it also involved replaced replacing it with new taxes targeted at company personnel and property occupation - which would have been capped at 15% of profits.

The European Court of Justice ruled in November 2011 that while property taxes and payroll taxes would normally not be subject to corporate tax regime scrutiny, that in these circumstances - because it was specifically set up to claw back tax revenue from local companies, and not the offshore ones (who had been paying an exempt company tax instead), it was discriminatory.

In the judgement, it states that "due to the absence of other bases of assessment, combining those two bases of assessment excludes from the outset any taxation of offshore companies, since they have no employees and also do not occupy business premises".

"By combining those tax bases, even though they are founded on criteria that are in themselves of a general nature, the Court of Justice finds that in practice the regime would discriminate between companies which are in comparable situations. Combining those bases does not only result in taxation according to the number of employees and the size of the business premises occupied, but also, due to the absence of other bases of assessment, excluded from the outset any taxation of offshore companies, since they have no employees and do not occupy business property."

"Furthermore, the fact that offshore companies are not taxed is not a random consequence of the regime at issue, but the inevitable consequence of the fact that the bases of assessment are specifically designed so that those companies, which by their nature have no employees or occupy premises, have no tax base under the bases of assessment adopted in the proposed tax reform. This gives reasons for the Court of Justice to conclude that offshore companies enjoy selective advantages."

Hence, "those criteria discriminate between companies which are in a comparable situation with regard to the objective of the proposed tax reform, namely to introduce a general system of taxation for all companies established in Gibraltar."

The general guiding principle in the ruling seems to be that a tax system designed in such a way that offshore companies avoid taxation constitutes a State aid scheme that is incompatible with the internal market. This is where those words by Senator Ozouf are important - "it will not be possible to tax the majority of companies in Jersey and maintain a compliant regime".

It may well be the case that no scheme is possible without falling foul of judgments on taxation, and the case of Gibraltar rules out some of the options already being mooted for Jersey. That's probably not the message Senator Ozouf wants to deliver, and it's not what Jersey people want to hear, but the Gibraltar ruling may have boxed us into a zero / ten regime that is very difficult to escape.

Part of the problem was that the Isle of Man acted unilaterally, boosted by their own VAT system for providing extra tax revenue, which was already established. Once they decided on a zero / ten regime, it was hard for Jersey and Guernsey to compete with, for example, an low but not zero corporation tax rate. In effect, it was a race to the bottom, and we are still paying the price for that kind of fiscal strategy.

A Taxing Dilemma

BBC Radio 4's documentary programme looked this week at tax matters, and in particular, how large corporations manage to re-arrange their corporate structure to avoid paying tax.

While the government axes public spending to try to cut the deficit, Michael Robinson investigates loopholes which let big businesses slash their UK tax bills. This month George Osborne said he plans to make Britain the most attractive corporate tax regime in the G20. But some companies have already moved abroad for tax reasons. And for others able to operate on a global scale, there are many ways for them to reduce their tax liability. So how does the Government square the tax circle?

http://www.bbc.co.uk/iplayer/episode/b00vhgpl/File_on_4_A_Taxing_Dilemma/

Surprisingly, there was little about offshore jurisdictions. The main problems came from variable tax regimes within the European Union, and the fact that European law trumps British tax law.

In the Republic of Ireland, for example, there are offices where the name plates bear reference to subsidiaries of UK companies but where the companies themselves are simply wealth holding companies. All they hold is money - they have no fixed assets, no employees, and while they have to have directors, the directors receive no remuneration. In essence, they are empty shells, a channel for profits, and yet any tax they would pay is levied at Irish corporation tax rates, and not British ones, which are higher.

The UK had sought to stop this loophole, by means of the CFC (Control of Foreign Company Rules) which declared that companies who structured their corporation to avoid paying UK tax would still be caught in the net - it declared that profits would be applicable at UK corporation tax rates where there were "wholly artificial arrangements intended to escape the [UK] tax normally payable".

The UK therefore decided to pursue this in the case of Cadbury Schweppes:

The position of Cadbury Schweppes Cadbury Schweppes had set up two subsidiaries in Ireland to raise finance and provide that finance to other subsidiaries in the Cadbury Schweppes group. The Irish profits were subject to tax at 10 per cent under the rules then applicable to companies established in the International Financial Services Centre in Dublin. It was agreed by the parties that the set up in Ireland was to enable the profit from the intra-group financing transactions to benefit from the low tax regime in Ireland.(1)

The arguments centred around the "motive" of the company, which is a notoriously difficult area for anything to be proven. The UK argued that the company was subject to CFC rules and should pay UK tax, Cadbury Schweppes maintained it was just part of a general corporate strategy with no particular intent to avoid paying UK tax:

In its written statement to the ECJ before the case was heard the UK Government put forward the proposition that the Irish subsidiaries were solely incorporated to avoid UK taxation and the activities were superfluous to the group's commercial business. Cadbury Schweppes maintained that it had incorporated the Irish subsidiaries to conduct a commercial business of raising and lending money. (1)

The EU courts decision was that any tax avoidance structure had to be shown to be one set up with "wholly artificial arrangements" and the CFC rules would not apply if it could be shown "that controlled company is actually established in the host Member State and carries on genuine economic activities there". Otherwise this would be contradictory to EU law, and a restriction on intra-EU free movement. Clearly, despite to all intents and purposes, there being no operations in the Cadbury Schweppes arrangements in Ireland, the Court accepted that it was set up to "conduct a commercial business of raising and lending money", and therefore the ruling was that the CFC rules could not apply.

The same situation arise with Vodaphone and Luxembourg in 1999:

There are always a number of twists and turns to these UK/ECJ cases and Vodafone is no exception. The case centres around the takeover of Mannesmann in Germany by Vodafone in 1999 and, in particular, the establishment of a subsidiary in Luxembourg which owned the European sub-subsidiary companies in Europe and lent money to those sub-subsidiaries and, in return, earned interest on the loans. The UK Revenue argued that the interest income of the Luxembourg subsidiary should be treated as if it had been received by the UK parent company under the then CFC legislation (2)

But once more this was challenged in the Courts, on the basis of the previous ruling, effectively saying that member states could not interfere in the tax regimes of other member states, and that a company had its own freedoms:

The objective of freedom of establishment is to allow a Community national (including a company) to participate on a stable and continuing basis, in the economic life of another Member State. (2)

The Court of Justice in its judgement yet again provided a reminder to national courts that they are obliged to interpret domestic legislation in a manner consistent with Community law. The treaty is directly effective and supreme over domestic law. (2)

The Court reminded us that it is settled case law that the fact that a taxpayer sought to benefit from a tax advantage provided by another Member State does not deprive them of the right to have their freedoms protected.(2)

What this means, essentially, is that while low corporation tax regimes outside the EU may be subject to challenge, tax competition within the EU could not be subject to the same kind of challenge. It is a major headache which is still present within the UK, as more companies seek to minimise UK corporation tax by restructuring their tax systems to take advantage of the ruling, and billions are lost in UK revenue.

As a result - and this will be familiar to Jersey readers - the UK is facing increasing pressure to increase taxes on that part of its tax intake that cannot be restructured abroad - namely domestic taxes - duties on drink, tobacco and petrol - widening the social security payments (essentially starting to function as a payroll tax) - and increasing VAT, as well as cutting back on benefits expenditure.

This targets the home population, who cannot so easily avoid the tax, and it is almost a mirror image of Jersey's solutions to its zero / ten regime.

But the Cadbury Schweppes ruling has other implications for Jersey. Jersey's Comptroller of Taxes has a very similar clause against tax avoidance schemes in Jersey tax law, but if a corporation structured its system to hold profits elsewhere without direct Jersey shareholdings - ostensibly to "conduct a commercial business of raising and lending money", but at an effective tax rate less than the 20% on local shareholders, Jersey could face a real challenge in proving that its rules applied. Whether it is commercially viable yet is debatable, but in principle the opportunity may yet arise. Of course any dividends or funds that eventually ended up back with Jersey residents from the corporate group would be taxed at 20%, but in the meantime, potentially taxable revenue would be outside the Jersey tax system.

Clearly the move to seek tax harmonisation within the EU would go some way to correcting these anomalies, as the situation as it stands is leading to a "race to the bottom", with the money moving to areas within the EU where it is least taxed. But this is unlikely to happen while EU countries such as Ireland are struggling to cope with the world economic downturn:

Dublin's favourable tax regime for big corporations - currently only 12.5 percent - will remain "a cornerstone of Irish industrial policy," a spokesman for the ministry of finance told Dow Jones news wire. His comments came after the American Chamber of Commerce in Ireland urged Prime Minister Brian Cowen to "categorically rule-out" EU pressure on corporate tax. "We have to realise that we are still way out of line in terms of our cost competitiveness, and Ireland's competitive corporation tax rate is one of the few competitive advantages we have" (3)

EU officials have frequently raised the issue of greater tax harmonisation in Europe, with a recent report by ex-commissioner Mario Monti identifying tax divergences as a damaging factor to the internal market. (3)

It is ironic that it is not (for once) offshore "tax havens" that are causing most disruption, but the way in which tax regimes and competition operate with in the EU itself.

Links
(1) www.icaew.com/index.cfm/route/142022/icaew_ga/en/Technical_and_Business_Topics/Faculties/News/Cadbury_Schweppes_and_the_UK_CFC_rules__The_ECJ_Judgment
(2) http://www.accountancyireland.ie/Archive/2006/December-2006/Cadbury-Schweppes--Is-it-really-the-Tonic-Irish-Revenue-Ordered/
(3) http://euobserver.com/19/30950

Zero Ten - What is it all about?

Basic Structure

The mantra for GST was "let's keep it simple".

When it comes to Zero-Ten Taxation, however, there is something of a nightmare of complexity.

The background comes from the removal of exempt companies, who paid £600 a year, and did not trade in Jersey, and had non-resident ownership. Clearly these companies were not having to apply the same rules as locally owned companies, taxed at 20%. So a system was devised whereby all companies pay the same rate of tax, regardless of whether they are trading here or not. This is (roughly) how it works:

0% - This is the company rate for all trading companies. No tax. But it is not quite as simple, and the labyrinth below explains how.

10% - This is the rate levied on finance companies, basically those entities regulated and licensed by the Jersey Financial Services Commission.

12% - This is the current minimum "effective rate of tax". Bear with me, and you'll see where it comes in later.

20% - This is tax on schedule A - rental income, now to include property development gains on land in Jersey (i.e. if an outside Island company buys a property /land, develops it, and sells it, this profit will be taxed).

Now let us return to 0% company rate.

For the simple case of an investment company (income from dividends on shares, interest and the like), there is a full deemed attribution of the profits of the company to the shareholders at 20%. That is, the shareholders are taxed as if they had taken out the profits as their income, so that it would appear on their tax return.

For your bog standard simple trading company (assume it has no "mixed bag" of rental and investment income as well), let us assume the directors take out a salary. That is subject to ITIS, and is taxed at the appropriate rate. At the end after that come the profits of the company, less any capital allowance.

Now the shareholders may made a distribution to themselves, which might amount to 40% of those profits. But regardless of that, they have attributed to themselves a "deemed distribution" of at least 60%. That is, the local shareholders (not the UK ones) are taxed proportionately as if they had taken out the 60% of these net profits (adjusted for capital allowances) as their income, so that it would appear on their tax return.

How they take these profits in accounting terms does not matter for tax (dividends, shareholder's bonus etc does not matter), they are treated alike for tax purposes.

They can decide to go for the full 100%, but they don't have to. But if they do go for 60%, the 40% profits is stored up, and will suffer tax on any "trigger event", which would include the disposal of shares, leaving the island, the dissolution of a company, or the death of a shareholder. On that basis the accumulated stored up profits are deemed to have been distributed to that shareholder, either in full (or in part with the disposal of some shares). This leaves the possible nightmare of a deferred tax liability growing year by year. Also small shareholders with shares greater than 5% may be stuck with the decisions made by the directors.

The rationale behind the 60% appears to be that cash flow problems might arise otherwise, but that is just a reasonable speculation; I don't know the exact reason. The 20% x 60% gives the 12% current minimum effective rate mentioned above on which is suffered.

With regard to shareholdings, there is a de minimis limit below which shareholdings are not subject to deemed distribution, which is currently 2%.

Complications

Of course, complications arise if the company is a "mixed bag" - i.e. a mix of investment company, rental company and trading company. There are obviously provisions for commencement of trading, and cessation of trade. There are special provisions for a group of companies, and equally if a company owns shares in another company, the deemed distribution is investment income in that company subject to those rules. There are also special treatments relating to profits on which tax has already been suffered (revenue reserve), and changes in the shareholders loan accounts are also scrutinised for taxable income.

Oddities

As trading companies are zero tax, there would appear to be no need to file accounts with the comptroller! However, company law still requires the preparation of accounts. Also the comptroller will almost certainly request accounts from trading companies who trade locally and/or have local shareholders. Moreover, the company secretary will be obliged to file a return regarding the actual distribution to shareholders, who and this will probably trigger the request from the comptroller regarding the accounts.

http://www.gov.je/TreasuryResources/IncomeTax/ZeroTen/

 

Tax Arrangements

A very good letter by Ed Le Quesne a few weeks ago. I've only just got round to commenting on it.

The only really strong point that could be mustered against it would be if there were actual legal contracts in place. If there were - like the contracts that existed with States Loans, which used to fix the upper rate of interest payable - contracts on income tax, signed by both parties, agreeing to a fix sum per annum, then it would be more difficult to break (although not impossible - just look at how covenants can be overturned by the States!).

But do such contracts exist? Or were the sums involved fixed by a "gentleman's agreement", over a handshake, and perhaps a glass of wine?

Perhaps John Christensen, who seemed to be privy to various haggling on the subject during the seventies and eighties, could let us know?


From Ed Le Quesne.

I DON'T accept Senator Le Sueur's statement that it is immoral to change the tax arrangements for wealthy residents.

It would be immoral to back-date any changes, but I am sure there would be strong support for him saying in his Budget speech in December something like: 'From 2009 the taxes paid by all wealthy 1(1)K residents will be assessed on the same basis, whatever may have happened in the past.'

It fits in with the 20% means 20% taxation of wealthy Jersey people which is being phased in, and may need a similar phasing-in period.

If Senator Le Sueur omits to say it, I hope another States Member will bring a Budget amendment to the same effect.