Nothing doing

The Isle of Man’s decision to introduce a zero-rate income tax is intended to take the economy onto a whole new level in international finance. Andrew Corlett reports

The Isle of Man has been moving towards a zero rate of income tax on companies since October 2000. The 2005 budget, announced on 15 February, confirmed that the island is on course to deliver this by April 2006.

The genesis for this strategy was twofold: first, it was generated internally to enable Manx-owned companies to take advantage of the tax neutrality enjoyed by non-Manx-owned companies; second, it was to satisfy the Organisation for Economic Co-operation and Development’s (OECD) harmful tax competition initiative and the EU’s ‘Primarolo Report’, both of which criticised the “ringfencing” inherent in a regime that distinguishes between resident and non-resident ownership. It is now apparent, from an international initiative perspective, that a zero rate of tax is not harmful as long as it is applied fairly within an economy and does not discriminate between resident and non-resident participators. The approach taken by the island was recently described by The Daily Telegraph as “a neat piece of footwork”.

The Isle of Man is fortunate to be able to afford a zero rate. Surprisingly, it collects some 40 per cent of its GDP in tax. This percentage means the Isle of Man is very much within OECD member state norms of tax take. The tax is spent on delivering first-class public services. It has also been spent on renewing the public infrastructure, with some £750m being invested in capital projects such as power supplies, a hospital, sewage improvements and an incinerator. Government finances are managed prudently, notwithstanding an apparent difficulty between the local state-owned electricity supplier and the Isle of Man Treasury. By statute, the Isle of Man has to budget for a revenue surplus each year. The budget surplus for 2004-05 was some £9m, with £12m projected for 2005-06. Both Standard & Poor’s and Moody’s rate the Isle of Man’s debt as AAA. The economy is growing at a healthy 6 per cent rate and unemployment is virtually non-existent.

The island is able to afford a zero rate because most government revenue is taken from indirect sources, particularly VAT, which accounts for 56 per cent of government finances. The Isle of Man is in union with the UK’s customs regime, which in effect means it is within the EU’s VAT umbrella. By contrast, company income tax receipts amount to only 7 per cent of revenue.

The majority of company tax receipts emanate from the 50 or so banks on the island. By far the majority of the banks domiciled in the Isle of Man have UK or Irish parentage. The current total of assets within these banks is probably approaching £35bn. The local banking scene is dominated by the UK clearers. It is in this banking sector where the devil of zero tax is in the detail. The zero tax will apply to all businesses, whether local or international, regulated or unregulated, with one important exception – banks. Banking business will be taxed at a 10 per cent rate. There are currently no plans to include banking business within the zero rate. Of course, material parts of any bank’s operation are not strictly ‘banking business’ and it remains to be seen how the Isle of Man treasury will treat those non-banking elements, which often contribute substantially to a bank’s operating profit. A positioning paper is expected shortly. Experience indicates that the Treasury will try to be as facilitative as possible to enable banks to develop their non-banking activities on the island.

With banks continuing to pay income tax, the loss to the government of a move to a zero rate is estimated at £23m per annum against a 2005-06 government revenue of around £500m. It is hoped that this amount, and more, will be made up by a small annual registration fee levied on every company, possibly by some form of Isle of Man land speculation-style tax (still to be thought through), and most importantly by an increase in economic activity occasioned by the zero rate.

It is this expected increase in business that in large part explains why the banks seem reasonably content to continue to pay tax. There is a recognition in the banking sector, as there is throughout the financial services economy, that the Isle of Man will have to progress up the value chain in order to continue to prosper. This is for a number of reasons, but two in particular: first, the rising cost of doing business is due to compliance and the fact that the Isle of Man is no longer a cheap place in which to operate; and second is the implementation by the Isle of Man, in tandem with the Channel Isles, of the equivalent measures to the European Savings Directive.

Although it is relatively easy to circumvent legitimately the effects of the directive, it is envisaged that the implementation of the Isle of Man equivalent measures will result in an outflow of funds from the banking sector, especially from the building societies and lower-end retail side of the sector.

The 2005 budget was welcomed by the banking sector because the Isle of Man Treasury announced more measures to assist the movement towards quality international business. Ahead of 2006, the zero rate was introduced for six additional sectors: agriculture, e-gaming, film, fishing, manufacturing and tourism. They join fund management, insurance, shipping and space and satellite technology, which are already zero-rated. In addition, and of great interest to the local banks, is a proposal to cap personal income tax, perhaps at a level between £100,000 and £200,000 tax paid. The top rate of personal tax is currently 18 per cent. Some time ago, the island identified the vital importance of attracting not only good companies to the island, but also the entrepreneurs who own them. Income tax capping has been discussed for some time and is strongly advocated by sectors such as shipping. Bankers are seeing more family office-type activity on the island and a cap should help stimulate this growing area.

The Isle of Man’s economy is in transition and wants to shed its outmoded tax haven image in favour of being seen to be an international business centre. Despite this transition, the economy seems in robust health, in the process confounding its critics. As Isle of Man Treasury Minister Allan Bell said: “We want business to blossom on the island. An outsider looking at us today could only conclude that the Isle of Man remains a wonderful environment in which to live and work.”

As the economy diversifies into new and exciting areas, so the banks here are having to adapt to service the needs of the new industries. This inevitably means improving skills locally, or at least having streamlined lines of communication to centres of excellence outside the island. Customer profiles are also likely to change from the mass affluent to the ultra-high-net-worth and corporate accounts. These areas are already very competitive internationally, as most offshore jurisdictions have determined on similar evolutionary strategies. It is vitally important for the banks that the island attracts the super-wealthy to reside and dynamic companies to set up. By doing this, the banks will have a customer base on their doorstep. Zero tax and income tax capping is designed to help make this happen.

Andrew Corlett is managing director at Cains Advocates