The European Commission’s battle to limit Gibraltar’s economic advantages appeared to be hindering the state’s mission to gain an edge on corporate tax. However, its rulings have opened new doors. By Chris White and Clotilde Briquet

Gibraltar’s chief minister went to some lengths to explain the success story that is Gibraltar’s economy during his budget speech to Gibraltar’s Parliament on 23 June. A theme of that speech was the strides made in the development of the finance sector of the economy.

Indeed, as far as the finance centre is concerned, Gibraltar is a success story. Bank deposits and other liabilities have increased by more than £1bn (18.7 per cent) following an 18.6 per cent increase the previous year. Cash, loans and other assets have also increased in aggregate by the same amount. 2005 saw one new banking licence issued. Insurance-related licences grew by 10 to 83 in 2005 and by a further five to 88 in 2006 so far. This sector has now grown from 29 licences in 1996 to the current 88.

A continuing challenge, in respect of which the mist seems to be clearing somewhat, is the ongoing tussle between Gibraltar and the European Commission for the reform of Gibraltar’s corporate tax regime.

Most will be aware of the phasing out of Gibraltar’s tax-exempt regime following pressure from Brussels. In an attempt at steamrolling any attempt by Gibraltar to introduce an alternative corporate tax regime with an edge over others, Brussels went on to insist that whatever replaced the tax-exempt company had to be no different to existing UK corporate tax laws.

The success of Gibraltar’s finance centre rests in its ability to create supple, tax-efficient structures. The upshot being that this attempt by Brussels to stifle tax competition has been stiffly resisted by both the UK and Gibraltar, with the matter now resting with the European Court of Justice (ECJ) for a ruling.

Corporate tax review

On 6 September the Gibraltar finance centre indirectly received a very welcome boost from the judgment in ECJ Portugal v Commission (the Azores case), which served to consolidate Gibraltar’s position as a centre offering expertise in tax-efficient solutions to international clients and which may indicate the way the wind is blowing.

Indeed, with the unconditional support of the UK Government, the Gibraltar government has proposed reforms of the Gibraltar tax system, leading to the replacement of the Tax Exempt Company Legislation with a non-discriminatory, nil-corporate-tax regime.

The Commission has challenged these proposals on the grounds of regional or material selectivity. The constant public view of the Gibraltar government is that the position of the Commission on regional selectivity is unsustainable and that this will be challenged successfully before the European courts. It is clear that Gibraltar is not part of the UK and that it will soon have its proper constitution.

Although the Gibraltar government’s challenge should be heard next year by the ECJ, it is fair to say that the Azores case paves the way for the introduction in Gibraltar of a new corporate tax code to replace the exempt company regime.

Onshore developments

An extremely welcome – and very unexpected – intervention from the ECJ concerns Gibraltar’s attempt to reposition itself as an onshore finance centre.

A central element of any EU practitioner’s tax planning strategy has to be the incorporation of the EU’s parent and subsidiary directive in any tax-efficient structure put in place for the benefit of clients. The parent and subsidiary directive is a landmark piece of legislation designed to eliminate tax obstacles in the area of profit distributions between groups of companies in the EU by: abolishing withholding taxes on payments of dividends between associated companies of different member states; and preventing double taxation of parent companies on the profits of their subsidiaries.

The fact that member states of the EU have not yet agreed to harmonised tax rates means that the tax planning potential of this directive is not lost on the revenue authorities of those member states, many of which are busy trying to clamp down on perceived abuses.

In the case of the UK, the practice of the tax authorities to impose a charge on companies exploiting this directive for tax planning purposes came under the microscope.

In a recent judgment, the ECJ (Cadbury Schweppes, Cadbury Schweppes Overseas v Commissioners of Inland Revenue) addressed problems associated with high tax jurisdictions imposing penalties on companies making full use of the parent and subsidiary directive to reduce their tax bills. Typically, this is achieved by relocating sections of their business to a low tax jurisdiction. The case is significant because is casts light on the circumstances in which international clients can shop for jurisdictions offering favourable tax regimes without being penalised for it by the home jurisdiction.

The significance of this judgment for Gibraltar is clear enough. Clients wishing to benefit from, for example, the Parent and Subsidiary Directive by using Gibraltar’s favourable tax regime can now safely do so without fearing penalties from home jurisdictions, provided their presence in Gibraltar is not “artificial” and “genuine economic activities” are carried on.

The Cadbury Schweppes case

The facts of this case represent a typical use of the parent and subsidiary directive for tax planning. In essence, Cadbury Schweppes, through its subsidiary Cadbury Schweppes Overseas, held 100 per cent of the shares in Cadbury Schweppes Treasury Services and Cadbury Schweppes Treasury International, both incorporated in Ireland and subject to the Irish Financial Services Centre’s 10 per cent corporation tax rate.

In a question to the court, the UK tax authorities wished to know whether EU law prevented the UK from imposing a charge upon Cadbury Schweppes in respect of the profits of its subsidiaries Cadbury Schweppes Treasury Services and Cadbury Schweppes Treasury International, both resident in Ireland and subject to a lower level of taxation there.

In its landmark judgment, the court held that a community national cannot be deprived of their rights under the treaty simply because they seeks to profit from certain tax advantages. A company can therefore not be deprived of its rights of establishment under the treaty just because it seeks to benefit from a favourable tax regime. Such behaviour would not of itself constitute abuse of that freedom.

This echoes the Duke of Westminster rule (Inland Revenue Commissioners v Duke of continued #+ continued Westminster (1936)), which can be expressed as a rule that any taxpayer may organise their affairs in any way they wish (provided it is legal) so as to minimise tax, as opposed to the conflicting principle expressed in WT Ramsay v Inland Revenue Commissioners (1982), where a taxpayer will be taxed on the effect of their transactions, not upon the way they have chosen to organise them for tax purposes.

The ECJ went on to say that any advantage resulting from low tax to which a subsidiary company established in a member state, other than that to which the parent company’s was incorporated, cannot of itself authorise the parent company’s member state to offset that advantage by less favourable tax treatment of the parent company.

The court qualified its views by stating that such less favourable tax treatment could nevertheless be justified when the company’s tax arrangements are “artificial” and aimed at avoiding the effects of national legislation. Even then the less favourable treatment must be proportionate and not go beyond what is strictly needed to achieve the overriding policy purpose of avoiding tax forum shopping.

The court did not go on to elucidate on what sort of arrangements it would consider ‘artificial’. It simply points to the extent to which the company in question has a physical presence in the favourable tax jurisdiction and carries on genuine economic activities there.

Chris White is head of taxation and Clotilde Briquet is an associate, both at Hassans