A recent opinion by the EU Advocate-General may be of great assistance to Gibraltar in its efforts to maintain its position as a leading international finance centre following the agreement with the EU to phase out the tax-exempt company status that has been in existence since 1967.

The opinion in question was given on 20 October 2005 in connection with the Azores case, concerning regional selectivity, which considered whether the introduction by the Azores Regional Assembly of tax advantages for companies in the Azores was illegal state aid.

The EU (if the European Court adopts the EU Advocate-General’s opinion) will probably confirm that the Azores regime does constitute state aid and is therefore illegal. However, it is likely to adopt the Advocate-General’s principles concerning regional selectivity, which are set out in his opinion and which could be of great assistance to Gibraltar’s position.

Gibraltar is in competition with the other leading global international finance centres such as Jersey, the British Virgin Islands and Bermuda. Part of Gibraltar’s attraction has been its offering of tax- exempt company status. On payment of an annual fee, a tax-exempt company is not liable to further taxation in Gibraltar and is not required to file tax returns. Such a company is prohibited from carrying on business in Gibraltar or with residents of Gibraltar, but it may carry on business with other exempt companies.

Two-edged sword
Gibraltar is a part of the EU, having acceded at the same time as the UK. However, being part of the EU has been something of a two-edged sword in that it also entails a need to ensure compliance with EU legislation. This brought the use of tax-exempt company status under scrutiny by the European Commission as possible state aid.

The recommendations that have since been agreed by the UK and Gibraltar are that existing tax-exempt companies will retain the benefits of their exemption until 31 December 2010, provided that there is neither a change in ownership or activity. If there is such a change, then the status will cease on 31 December 2007. Existing exempt companies that change ownership and/or activity after 30 June 2006 will lose their tax-exempt status. Companies that obtain tax-exempt status after 18 February 2005 (and there is a limit on the number of new companies that can be given this status) will be able to retain the benefits of that status until 31 December 2007, whether or not there is any change in activity or control.

To replace the tax-exempt company status while maintaining its competitiveness, Gibraltar has proposed introducing a radically different taxation system. This involves abolishing income tax on company profits and replacing it with a payroll tax (£3,000 per employee in Gibraltar) and a business property occupation tax, in addition to property rates, at 100 per cent of the liability to property rates. The total tax liability would be subject to a cap of 15 per cent of profits, or £500,000, whichever is lower. There would be additional ‘top-up’ taxes for financial services companies and utility components, but with the same cap.

This proposal has been put forward to Brussels, but was rejected by the Commission and is now the subject of litigation. However, one of the principal planks of the rejection by Brussels was that the proposals involve regional selectivity in that the reforms only apply to Gibraltar and not to the UK as a whole. If some form of regional selectivity is involved, the Commission’s position is that there is likely to be state aid.

Autonomous or not?
The Advocate-General’s opinion in Azores sets out the circumstances that he believes would not give rise to selectivity, one of which being where “the lower tax rate results from a decision taken by a local authority that is truly autonomous from the central government of the member state”. By ‘truly autonomous’, he has opined that he means “institutionally, procedurally and economically autonomous”.

Gibraltar will be arguing strongly that its position is that it is not integrated with the UK and its special status means that it has a completely independent tax regime. Any taxes in Gibraltar are not derogations from, or changes to, the UK regime but are independent taxes. They have nothing to do with the UK tax system. It is therefore likely that the anticipated decision in Azores will be of great assistance to Gibraltar’s position. The European Court’s decision is expected in the early months of 2006.

Stephen Forster is a partner at Hassans