Tax Policy Unit Report in Response to the Amendment to the 2011 Budget Regarding Non-Jersey Owned Companies

STATES OF JERSEY

TAX POLICY UNIT REPORT IN RESPONSE TO THE AMENDMENT TO THE 2011 BUDGET REGARDING NON-JERSEY OWNED COMPANIES

Presented to the States on 26th October 2012 by the Minister for Treasury and Resources

STATES GREFFE

2012   Price code: F  R.131

Report from the Minister for Treasury and Resources

Response to P157/2010, seventh amendment, relating to non-locally owned companies

Executive summary

1. This report is presented to the States in response to the Deputy of Grouville 's

amendment to proposition P.157/2010 which asked the Minister for Treasury and Resources to examine ways to raise additional revenues from non-Jersey owned

companies paying tax at 0%, provided that any changes should not jeopardise Jersey's business tax regime or its international competitiveness.

2. Since the amendment was approved in December 2010, there have been the following significant developments:

1. Jersey's corporate tax regime was confirmed as being compliant with the EU Code in December 2011.
2. The repeal of the deemed distribution rules has removed much of the (perceived) discrimination between Jersey and non-Jersey resident owners of Jersey companies.
3. Additional anti-avoidance rules are contained in the 2013 Budget proposals which will address the risk of abuse of the company tax regime. In addition, there are changes to the tax law that will prevent existing abuse of the law in relation to property ownership (group relief rules).

3. In summary the findings are:

1. A tax or charge linked to profits risks compromising the compliance of our regime with the Code of Conduct on Business Taxation.
2. A tax or charge which is specifically aimed at one sector or selectively affects non- locally owned companies will feed through to Jersey residents through higher prices, reduced wages or increased unemployment.
3. A measure aimed at non-locally owned businesses will deter inward investment and so be detrimental to economic growth.

4. The Minister proposes the following course of action:

1. Request the States support the anti-avoidance measures in the 2013 Budget.
2. Support the White Paper on data collection to ensure the States has up-to- date information to support the continuation of the current corporate tax regime and to develop future tax policy development.
3. Support the work on a substantial review of land and property taxation including some further anti-avoidance provisions relating to property ownership. Some changes may be proposed in the 2014 Budget, although their implementation may be phased in over a number of years due to the economic situation. An update will be provided on the progress of that work in advance of the 2014 Budget.

Introduction

5. The report sets out in summary:
   1. The background to the proposition
   2. The development of the current company tax regime
   3. Options considered to address the proposition
   4. Findings of the review including the issues arising
   5. Conclusions from the review
6. A detailed report prepared by the Tax Policy Unit has been published alongside this report.

Background

7. It is important to note that this review has not been carried out with the intention of dealing with a specific need for additional revenues. The purpose is to deal with one of the principal objections to the introduction in 2008 of the current company tax regime,

commonly known as zero/ten – that is its perceived unfairness.

8. In 2010 the Deputy of Grouville lodged an amendment to the 2011 Budget which called on the Minister for Treasury and Resources to introduce measures to increase revenues from non-Jersey owned companies paying tax at 0%. This amendment was approved by the States, as amended by the Treasury & Resources Minister to provide that any

changes could only be implemented provided they did not jeopardise Jersey's business tax regime or its international competitiveness.

9. The reference to non-locally owned companies reflected concerns that the shareholder taxation rules meant that there was no level playing field between companies owned by Jersey residents and companies owned by non-residents. Originally, Jersey and non- Jersey resident shareholders in Jersey companies were treated differently through the shareholder tax (deemed distribution and attribution) rules. Jersey resident shareholders were deemed to have received, and were taxed on, a dividend even if the company made no distribution. Non Jersey resident shareholders were not subject to such a charge. This lead to the view that there was not a level playing field between Jersey and non-Jersey owned businesses.
10. This issue has been dealt with through the removal of the deemed distribution and full attribution rules from 1 January 2012.
11. However, there remains the concern by some commentators that, as a result of introducing a general rate of tax of 0%, the majority of non-locally owned companies which do business in the Island do not pay Jersey income tax on their profits.

12. Some commentators are also, mistakenly, of the view that by subjecting all non-locally owned companies to tax as was the case prior to the change to a 0% rate, substantial amounts of revenues will be raised with no adverse consequences.
13. These companies make a large contribution to States revenues through social security and rates and some pay GST. They also contribute to the economy more broadly as employers, providing employment opportunities for Islanders outside the financial services industry, paying the wages that enable their employees to live in Jersey. The income tax and social security their employees pay also fund the provision of public services. By providing the goods and services that Islanders want to buy and widening the range of businesses here they also strengthen GST revenues, and make the Island a more attractive place in which to live.
14. Work has been ongoing to identify and evaluate the different options for raising revenues from companies currently paying tax at 0%. This has been informed by the comments of the EU Code Group on our current regime. In particular, the Code Group made it clear that tax measures aimed at company shareholders may be considered to form part of the overall company tax regime.
15. Since this work was begun as part of the Business Tax Review in late 2009the economic climate, both locally and globally, has continued to deteriorate. Although the numbers in employment are close to peak levels, at the same time more people are out of work. Business confidence, particularly in retail, continues to decline. The downscaling of the fulfilment industry has added to the level of unemployment, especially amongst those without specialist skills. The youngest and most vulnerable in our community have been most affected.
16. Careful consideration has been given to how the company tax regime can best support the States' economic growth and inward investment strategies. In particular, the likely impact on employment of any new measures must be taken into account.

Development of the current tax regime

17. During the early 2000's Jersey was under pressure to change its tax regime from two main sources.
18. Firstly, the European Union's work to enforce its Code of Conduct on Business Taxation

(" the Code" ), intended to stop territories from using discriminatory tax rules to attract business from non-residents. This meant that the Island could not longer offer preferential tax treatment to companies owned by non-residents.

19. Secondly, the competitiveness of Jersey's tax rates was being eroded as other

competitor offshore and onshore jurisdictions moved to reduce their own tax rates. The highest company tax rate in Jersey of 20% was no longer considered low in the face of this increasing competition from Ireland, Malta and other territories which were reducing their company tax rates to attract new business.

20. In addition, as an international finance centre Jersey had to be able to continue to offer a tax neutral regime for clients of the financial services entities.

21. The combination of these different pressures led the States to introduce the current system of company taxation with a general rate of tax of 0% and 10% for certain financial services companies in 2008.

Jersey's previous company tax system

22. Until 2008 Jersey's company tax system included the following features:

• Exempt company – available to any company owned by non-residents and which,

broadly, did not carry on a business activity in Jersey. Exempt companies were exempted from tax on all income earned outside Jersey and interest arising from

Jersey bank accounts. An annual fee of £600 was payable.

Exempt companies were typically used by clients of the finance industry to act as tax-neutral vehicles for the holding of investments outside of Jersey. As such,

they were an important part of Jersey's ability to attract private clients, funds,

insurance, securitisation, trust and financing business to Jersey. The trust and fund industries together employed just over a quarter of those employed in the financial services industry in 2011, and 6.4% of all Islanders in work[1].

• International Business Company (IBC) – also only available to companies owned

by non-residents. Tax was charged at 30% on Jersey-source income and at rates between 20% and 0.5% on international income. The average annual effective tax rate payable by IBCs was approximately 14%.

Typically, IBCs were banks, group service companies and other businesses which had a presence in Jersey but whose work was " international" in nature; i.e. derived from clients based outside of the Island. The banking industry is the single largest employer in Jersey, with 5,270 employees in 2011 representing nearly 10% of total employment[2].

• All other companies were liable to income tax at 20%.

The Code of Conduct –– review of Jersey's former tax regime

23. The European Union has no jurisdiction over direct taxation matters and therefore individual Member States retain the right to set their own tax rules, including their own tax rates. However, during the 1990s there was a concern that Member States were using their tax regimes to unfairly attract business away from other Member States. A set of principles was devised (the Code of Conduce on Business Taxation,  " the Code" ) which all Member States agreed to implement. The Code applies to laws, regulations and administrative practices.
24. When determining whether a tax measure is harmful, the Code asks:

• Whether advantages are accorded only to non-residents or in respect of transactions carried out with non-residents.

• Whether advantages are ring-fenced from the domestic market, so they do not affect the national tax base.
• Whether advantages are granted even without any real economic activity and substantial economic presence within the Member States offering such tax advantages.
• Whether the rules for profit determination in respect of activities within a multinational group of companies depart from internationally accepted principles, notably the rules agreed upon within the OECD.
• Whether tax measures lack transparency, including where legal provisions are relaxed at the administrative level in a non-transparent way.

25. A review in the early 2000s conducted by the Code Group found that the parts of Jersey's tax regime which allowed companies owned by non-residents to avail of low

rates of tax on  " international" income, or in some cases to be exempt from tax altogether, were harmful. Although Jersey is not a member of the EU, it voluntarily agreed to comply with the Code and with the findings of the Code Group. As a result, in 2003 Jersey agreed to abolish the harmful elements of its tax regime including the exempt company and IBC regimes.

International competition

26. The early 2000s saw a general reduction in company tax rates across the EU and further afield. Former Eastern Block countries like Estonia and Hungary introduced low rates in an effort to make themselves more attractive to foreign investment. Ireland dropped its company tax rate to 12.5% and Cyprus to 10%.
27. Faced with these pressures, it was clear that Jersey's top rate of company tax of 20%

was no longer attractive in an increasingly competitive international environment. After much consideration and public consultation, the decision was taken that Jersey should reduce its rate of tax for financial services to 10%.

The current company tax regime

28. The current regime of a general rate of tax of 0% was designed to meet the following key objectives:

• To ensure compliance with the Code of Conduct on Business Taxation by removing discrimination between companies based on the place of residence of their shareholders.
• To maintain the ability of Jersey to offer a tax-neutral holding company vehicle to clients of the finance industry.
• To ensure that Jersey could offer a competitive rate of company income tax to the Island's financial services sector, recognising that this industry is the largest employer in Jersey.
• To protect States' revenues as much as possible, recognising that the finance sector was the single largest contributor to States' revenues.

29. Under the new tax regime, the previous company tax system was abolished and replaced with a general rate of company income tax of 0%. A very limited class of companies are taxed at a higher rate of 10%: banks, trust companies, investment companies and fund administrators and custodians. Collectively these are referred to as " financial services companies" although not all companies considered to be in the financial services industry are taxed at the 10% rate, in particular fund managers and insurance companies. Utility companies are taxed at 20% on their profits, as are any profits derived from land or buildings in Jersey or from the importation of hydrocarbons.
30. Under the previous tax regime, the general rate of tax was 20% and special treatment was given to some companies allowing them to be taxed at lower rates, or to pay no tax at all. Under the new regime, the majority of companies pay at the 0% rate and a minority of companies are in effect  " discriminated against" , which is permissible within the letter of the Code.
31. The financial sector was chosen for the higher rate of tax on the basis that it was the single industry with the highest profits and therefore the greatest scope to generate tax

contributions. Also, charging this industry some tax would not affect Jersey's competitive position provided the rate charged was not too high.

32. Although Guernsey and the Isle of Man have also adopted a similar tax regime, the scope of the 10% rate, and therefore the tax collected, is much wider in Jersey than in either of the other islands. The scope for widening the 10% band further may therefore

be limited for a number of reasons including the risk to Jersey's compliance with the Code and the potentially detrimental effect on inward investment and economic growth.

The Code of Conduct –– review of Jersey's current tax regime

33. A formal review of the new company tax regime was conducted by the European Union's Code of Conduct Group in 2010 and 2011. Jersey defended its position and

succeeded in securing the acceptance that the company tax system in itself was not harmful according to the Code criteria. This provided much-needed stability and certainty for businesses in the Island and those thinking of investing here. This is particularly important in the current environment, with the effects of the global economic climate still being felt.

Options reviewed and work undertaken

34. The Tax Policy Unit has reviewed the main options available for raising revenues from non-financial services companies. The following methods of increasing revenues have been considered in detail:

• Extending the scope of the 10% or 20% band. Focus has been put on the retail

sector, as the most visible example of non-Jersey owned companies trading in Jersey, and therefore the focus of most of the concerns to date but this could apply to any sector which is currently taxed at 0%.

• Introducing a charge on all companies, for example based on headcount or property occupied. The effect of any non-profit based charge has broadly the same economic effect.
• Restricting input GST recovery for all companies.

35. External economic advice has been sought from Oxera.

Key objectives of the review

36. Each method has been reviewed in light of the key objectives, namely: Supporting the inward investment/economic growth strategy
37. While Jersey continues to experience the effects of the global downturn, and with unemployment rising by the month, in particular in the non-finance sector, any changes to the tax regime must promote conditions for economic growth by encouraging existing businesses to grow and attracting new business to Jersey.
38. Given the difficulties posed by the current economic climate and the high level of unemployment it is important to limit economic distortions as far as possible and understand the economic impact locally of any changes.
39. Stability of and certainty in the tax regime is important in building and maintaining business confidence.

Protection of the current company tax regime

40. The Business Tax Review found that the general rate of tax of 0% and a 10% rate for financial services is still overwhelmingly favoured by the majority of Island businesses. Any changes to the tax system must therefore protect the current regime.
41. Key to this is the ability to demonstrate that the general company tax rate in Jersey is 0%, i.e. this is the rate of tax paid by the majority of companies in Jersey, on the majority of profits earned in Jersey, by the majority of employers in Jersey and by the

majority of businesses actively carried on in Jersey.   This last point has recently emerged, based on the European Commission's review of 0/10 as part of the recent

Code Group review. This will significantly limit Jersey's ability to extend the scope of the 10% band, or any other tax-like charge, while maintaining its Code compliance.

Any changes must be sustainable in the medium term

42. Stability of and certainty in the tax system is important in building business confidence

and hence supporting growth. Jersey has been through significant changes in its tax regime in recent years and a period of stability would be beneficial.

43. Undertaking a fundamental change in the tax regime so shortly after introducing the new regime would be destabilising and create uncertainty. Even making small changes could adversely affect confidence.

44. Any changes made must be sustainable in the medium to long term. Therefore it is important that any changes are compliant with international standards to avoid the risk

of challenge.

Findings from the review

45. The abolition of the deemed distribution and full attribution rules at the end of 2011 has removed much of the perceived "unfairness" of 0/10, in that neither Jersey resident nor non-resident shareholders of Jersey companies are taxed unless and until profits are distributed.
46. Companies, whether Jersey or non-locally owned, paying tax at 0% make a large contribution to Jersey, beyond tax revenues. They employ 65% of all individuals employed in the Island and pay social security on their staff costs and some companies pay GST. The wages they pay their staff are subject to income tax, and a large part of those wages is spent on-Island, generating further revenue and economic activity.
47. The tax system must support the States Strategic Priorities and Economic Growth Strategy. Key to both of these policies is the support of economic growth and the protection and creation of employment for Islanders.
48. It is necessary to weigh the competing desires to protect Jersey's economy with the desire to increase revenues from non-locally owned companies.
49. Many non-financial services sectors have suffered a decline in profitability. As a result, the potential revenue increase from introducing a tax on profits will not be significant.
50. There are two key factors to consider in respect of any measure taken. Firstly, it is important to protect the current tax regime which is critical to support the finance industry and to maximise the opportunity for inward investment.
51. Introducing a profits tax to all non-locally owned businesses will result in the current regime being considered harmful by the Code Group as it would be impossible to defend the position that zero is the general rate of tax, particularly in light of the EU

Commission's comments in their review of Jersey's tax regime in 2010/11.

52. Introducing a charge which is linked to profitability would fall foul of the Code as it will likely be considered a tax rather than a charge and hence challenge the concept that 0% is the general rate of tax.
53. Even if the charge is not directly linked to profitability, there is a risk that the Code Group would consider it to be so closely related to the on-island business activity and hence fall within the scope. In that case, as with extending the 10% band, it is likely that they would challenge the general rate of tax being 0% resulting in the regime being non- compliant.
54. There is insufficient data available to allow a robust understanding of the nature of Jersey's potential taxpayer base both in terms of sector and profitability. This lack of data makes it is difficult to say with any certainty whether any changes would ensure that the general rate of 0% can be protected. It also makes it difficult to estimate the potential revenue any such measure might raise.

55. The second key factor is whether any change can be made without adversely affecting the economy through increased prices, reduced wages and jobs or loss of economic activity through business migration or deterring inward investment.
56. Oxera advises that of all the options for increasing revenues from non-financial services companies, extending the scope of the 10% or 20% tax band very slightly is likely to be least economically damaging, compared with the other options.
57. However, they also advise that if the States seeks to raise additional revenues from a specifically targeted sector of the business community, that additional revenue will be paid for by Jersey residents. This would be through a combination of increased prices (inflation), reduced wages or employment. Jersey residents could also suffer from loss of choice in the market as businesses close down. Imports would also become cheaper that locally produced items, due to the increased cost which would have a detrimental effect on on-island businesses.
58. Specifically in relation to tax, the effect of increasing the tax cost to increased prices is likely to be greater if targeted at non-locally owned businesses or at sectors which are dominated by non-locally owned companies.
59. Extending the scope of the 10% or 20% bands of tax to specified sectors would put Jersey at a competitive disadvantage to Guernsey and the Isle of Man and so potentially

restrict Jersey's ability to attract more high value low footprint activity. While the current difference between the islands tax regimes has not had a significant affect on Jersey's

ability to succeed in the financial services sector, the same may not apply to other sectors. This too may be counter to the inward investment/economic growth strategy.

60. In recent years, as tax rates have generally fallen, focus has moved away from taxing income in favour of taxing consumption. In that environment, renewed consideration has been given to the options for raising revenues through the taxation of land and property.
61. If additional revenues are needed in future and if this could only be achieved through an additional charge on business, a charge based on property would be the least damaging

economically. It should not however be considered to be the holy grail' as there are

some downsides to property tax, despite it being a relatively efficient tax. This will need very careful review and consideration.

62. Jersey taxes property lightly, particularly in relation to commercial rates. Jersey should consider ways in which its property tax regime may be reformed with a view to raising additional revenues.
63. It is evident from the work undertaken during this review that there is scope to tighten the rules on interest relief relating to property ownership, so that landlords of property in Jersey cannot claim excessive relief thereby avoiding a tax liability. This is particularly relevant to non-resident landlords.

Conclusions

64. The advice received from the Tax Policy Unit, supported by external economic advice, is that introducing a tax or charge for companies paying tax at 0% would damage the already fragile economy and potentially result in another costly EU Code of Conduct Group review of our tax regime, leading to further uncertainty.
65. While the least economically damaging option is to tax profits, through extending the 10% or 20% bands, it is not certain that in doing so Jersey's corporate tax regime, and

in particular tax neutrality, can be protected from challenge by the EU Code of Conduct Group. This is the case even if the change is restricted to non-locally owned companies.

66. A significant factor in this is the lack of current data on company profitability for those companies subject to tax at 0%.
67. Unless that data is available, making changes to the company tax regime may not be sustainable. For these reasons, a White Paper has been issued with a proposal to ensure this necessary information is routinely collected in the future.
68. A charge of whatever form will likely feed through to prices, wages, jobs and potentially business activity. In the current climate, this would be particularly damaging to economic growth.
69. Given these constraints, consideration should be given to ensuring that the taxes due under the current regime are collected.
70. Work is being carried out to review the tax legislation in relation to interest relief with a view to ensuring a full return on Jersey property is achieved, particularly from non- resident landlords.
71. In the future, should the economic climate improve sufficiently, consideration may be given to extending the property tax regime. Property in Jersey is taxed lightly, in particular through commercial rates. A review will be undertaken to review the scope to change the way property is taxed more generally. A commitment has already been given to undertake a review of this type and that review is underway.

Senator P.F.C. Ozouf

Minister for Treasury and Resources October 2012

Tax Policy Unit report in response to the amendment to the 2011 Budget regarding non- Jersey owned companies

CONTENTS

1. EXECUTIVE SUMMARY

1. Background to review
2. Options considered and researched
3. Economic advice
4. Findings
5. Key dates in the development of the current company tax regime

2. SCOPE OF THIS REPORT
3. BACKGROUND
   1. Introduction
   2. What the sectors subject to 0% tax contribute
   3. Principles of Jersey's long-term tax policy

5. OBJECTIVES OF THE REVIEW

1. Supporting the inward investment and growth strategy
2. Protecting the company tax regime
3. Creating a sustainable tax regime

5. THE INTERNATIONAL FINANCIAL SERVICES INDUSTRY IN JERSEY
   1. The role of Jersey in international finance
   2. What aspects of Jersey's tax regime make it attractive to the international financial services industry?
   3. What is tax neutrality?
   4. What the finance industry contributes to Jersey
   5. What losing the financial services industry would mean to Jersey

7. DEVELOPMENT OF ZERO/TEN
   1. Jersey's previous company tax regime
   2. The Code of Conduct on Business Taxation
   3. International competition
   4. Designing the current tax regime
   5. Code Group review of the company tax system
   6. Business tax review

8. WHERE JERSEY IS NOW

1. Clarity on the company tax system
2. A more level playing field
3. Clarification of aspects of the Code – the Gibraltar State aid case

8. ANALYSIS OF OPTIONS

1. Scope of work
2. Changes tothe UK tax treatment of overseas income
3. Interaction w ith S tates eco nomic growth pl an and C ouncil o f M inisters' Strategic Plan
4. Extending the scope of the 10% or 20% tax band
5. Introducing a charge on all companies
6. Restricting input GST recovery
7. Other measures previously advanced and reconsidered

1. Tax on deemed rental income
2. Community charge

9. PROPERTY TAXES

1. The principles
2. The Mirlees Review
3. Property usage in Jersey
4. The proposed review

10. KEY FINDINGS

1. Improved fairness of the Jersey tax system for shareholders
2. The importance of the financial services industry to Jersey
3. Data availability
4. Summary of the tax and economic impact of introducing a tax or charge, or limiting recovery of GST for non-financial services companies
5. Property taxes
6. International developments

APPENDICES – SUPPORTING RESEARCH

1. Medium Term Financial Plan, Long Term Tax Policy – July 2012
2. Facing Up to the Future – 2004
3. Code Group assessment findings – 1999
4. Comparative analysis of the Crown Dependencies company tax regimes
5. Oxera report: The economic impact of specific potential changes to the taxation of, or application of charges to, specific activities in Jersey – October 2012
6. Bibliography

1. EXECUTIVE SUMMARY

1. Background to review

1. In 2010, the States agreed that "a new mechanismshould be put inplacetoensure that addi tional r evenue i s raised f rom ce rtain non -locally owned n on-finance companies trading in Jersey as is raised from locally owned companies trading in the Island", and requested the Minister forTreasury and Resources to"bringforwardfor approval t he nece ssary legislation t o g ive effect t o t his decision so that t he new system can be fully implemented by 1st January 2012 providedthatto do so would not jeopardise the i ntegrity o f Je rsey's business tax r egime or i ts international competitive position."
2. The reference t o non -locally o wned co mpanies reflected co ncerns that the shareholder taxation rules (deemed distribution and full attribution)which were then in placemeantthat there was not a level playing field between companies owned by Jersey residents and companies owned by non-residents.
3. The shareholder taxation rules meant that a Jersey resident individual who owned an interest in a Jersey company was taxed as though they had earned the company's profits themselves. These rules did not apply to non-resident shareholders of Jersey companies. The effect of the shareholder taxation rules was that companies carrying on similartrades could have very differentcash flow models, with companies owned by Je rsey r esidents potentially under m ore pr essure f rom t heir shareholders to distribute their profits rather than retain or reinvest them.
4. This different treatment was removed in 2011, when the shareholder taxation rules were repealed. All companies in Jersey, regardless of where shareholders are resident, are not taxed on the company's profits until thoseprofits are distributed. In this way a level-playing field has been created.
5. Following theremoval of thedeemeddistributionrules, the EUCodeofConduct Group found Je rsey's company t ax r egime to be co mpliant i n D ecember 2011. Following the formal recognition ofthis compliance, work continued on reviewing the options forincreasingrevenues from non-locally owned companies that pay tax at 0%. T his involved researching new options not previously considered, as well as reviewing and r e-evaluating opt ions that had pr eviously been co nsidered for addressing this issue.
6. This report represents the outcomeof that review. Itidentifies the main options for increasing revenues and the key findings.
7. Consideration has also been given totheCouncil of Ministers'Strategic Plan, which was approved in May 2012 and prioritises the protection of jobs and the promotion of diversification within Jersey's economy.

2. Options considered and researched

1. The main options available for raising revenues from non-financial services companies include:

• Extending the scope of the 10% or 20% band - the focus of public comment on the company tax regime has been mainly in the retail sector, as it contains the most visible examples of non-Jersey owned companies trading in Jersey, but this could apply to any sector which is currently taxed at 0%.

• Introducing a charge on all companies - for example based on headcount or property occupied. The effect of any non-profit based charge has broadly the same economic effect.

• A deemed rental charge - whereby co mpanies that ow n t he pr operty t hey occupy are taxed on the notional rental value of the property.

• Restricting input GST recovery for all companies.

• Introducing a form of community charge - this was suggested by a member of the public during the Business Tax Review.

2. It is worth notingthat the Business Tax Reviewcarried out in 2010 a nd 2011 i n response totheEUCode of Conduct review, considereddifferenttypes of corporate tax regimes, including for example, introducing a low rate of tax in place of the 0% rate. Thesehave not been reconsidered given the conclusion of thatreviewthatthe current company tax regime was the preferred option to protect Jersey's economy.
   3. Economic advice

1. Tohelpassess these options,independent economic advice has been sought from Oxera. Intheirreport,they assess the economic impact of potential changes tothe taxation or charging o f Je rsey co mpanies owned by non -residents. They hav e concluded that any measure to increase revenues directly from non-financial services companies would be l ikely to r esult i n Je rsey residents indirectly payi ng for t he change, particularlyinsectors,such as retail, wheremany of thelargestcompanies are owned from the UK. This would be due to increased prices (inflation), reduced wages and increased unemployment. The reports states:

" if the objective is to somehow target companies that currently do not pay corporate profits tax, but supply goods and services into the domestic market, in most cases, it will be Jersey residents who actually pay the tax or charge." (Oxera)

2. Oxera advises that i f the i ntention o f any r eform i s purely t o i ncrease S tates revenues, and was not specifically related to non-financial services companies, there are more economically efficient ways of doing so.

"If the objective is to raise additional government revenue then, compared to the options considered here, there are likely to be alternative approaches which are more economically efficient (ie create less deadweight loss in the economy) and for at least some of these it may also be possible to target them in a way that can meet distributional objectives (in terms of progressiveness or regressiveness) if appropriate." (Oxera)

3. The eco nomic climate has deteriorated a s this r eview has continued. Business confidence has suffered and is not recovering as quickly as had been hoped. Profits have decl ined, while un employment has risen. T he incomes of Jersey r esidents have been i ncreasingly s queezed i n r ecent y ears, as taxes and pr ices have increased faster than wages. This is unlikely to reverse in the immediate future.

4. Careful consideration should therefore be given to introducing a measure which would be likely to increase costs for Jersey residents.

4. Findings  

1. Removing the shareholder taxation rules has removed some of the concerns about the current company tax regime..
2. There is no "perfect" wayto increasing revenues from non-Jerseyownedcompanies currently paying tax at 0%. A chargewouldeitherjeopardisethecompliance of the tax regime or increase costs to Jersey residents, or both.
3. Discriminating between companies owned byJersey and non -Jersey shareholders may deter inward investment.
4. Charging all companies that carry on an act ive tradingactivity in Jersey income tax on theirprofits would likely not be compliant with theCode as the generalrateoftax would not be 0%.
5. However, moreinformationshould be co llected from companies in Jerseytoallow their profitsto be accu rately k nown. A White Paper on m ethods toimprovethe collection o f t his information i s being i ssued along w ith t his report, w hich i nvites comments on the best way to ensure the necessary information is collected. This will assist the development of future tax policy.
6. If charges were levied on companies, the additional cost would likely be passed on to Jersey residents in theformof increased prices (inflation) or through reduced wages or employment. Ifthosecharges were linkedto companies' profits,they would likely not be compliant with the Code as the general rate of tax would not be 0%.
7. Charges which arebased on a par ticular costofproductioncanaffectdemand for that particularelement most immediately. T herefore, a c harge based on property usage would be l ess likely toaffectemploymentintheIslandthanothertypes of charge, although there would still be an impact on the economy as a whole.
8. Inthe future, shouldthe economic climate improve sufficiently, consideration may be given toextendingthe property tax regime. P roperty inJersey is taxed lightly,in particular through commercial rates. A review will be undertaken to review the scope to ch ange t he w ay pr operty i s taxed m ore gener ally. As an initial st ep, it is considered that there is an opportunity to look at the relief that landlords, and in particular non-residentlandlords,claimin respect ofinterest,inordertoensure that the ow ners of p roperty i n Je rsey pay t he t ax pr operly due. A commitment has already been given to undertake a review of this type and that review is underway.
9. Jersey should continue to monitor developments in international standards in taxation as well as changes in its key co mpetitors in o rder t o ensu re t hat its tax sy stem remains competitive.

5. Key dates in the development of the current company tax regime

Key date  Event

1997:  EU agrees wording of Code of Conduct on Harmful Practices in Tax

Matters

1999:  EU Code of Conduct Group issues report on harmful tax practices in

EU Member States and dependent and associated territories. Four of Jersey's tax measures are found to be harmful

2003:  Jersey voluntarily agrees to comply with the terms of the Code June 2003:  ECOFIN confirms that the Code Group had found that none of the

measures proposed by the Crown Dependencies (i.e. 0/10) were considered to be harmful

2004:  Publication of "Facing up to the Future" by the Finance and

Economics Committee, proposing to replace the existing company tax regime with 0/10

November 2006:  The Code Group confirms that the 0/10 measures proposed by the

Crown Dependencies are in compliance with the Code

2007:  The Isle of Man introduces 0/10

Jersey's States debate and approve the legal framework for the introduction of 0/10

2008:   Guernsey introduces 0/10

June 2008:  Jersey introduces GST at 3%

2009:   Jersey introduces 0/10

September 2009:  Jersey, Guernsey and the Isle of Man are informed by the UK that it

does not consider that 0/10 complies with the "spirit" of the Code of Conduct on Business Taxation. Jersey and the Isle of Man announce plans to defend 0/10

The worsening global economic climate prompts a review of Jersey's finances, the Fiscal Strategy Review. At the same time, a Business Tax Review is also started, which looks at ways of making the Island's company tax system more compliant with the Code of Conduct and if possible, raising revenues

May 2010:  The Code Group announces its intention to formally review the 0/10

regimes in Jersey and the Isle of Man.

 The consultation exercise on Jersey's Business Tax Review begins

September 2010: Jersey representatives appear before the Code Group in Brussels,

and make representations regarding the 0/10 regime

December 2010: The States approves an amendment to the 2011 Budget which calls

on the Minister for Treasury and Resources to introduce measures to raise an equivalent amount of tax from non-finance, non-Jersey owned companies, provided that doing so does not damage Jersey's international competitiveness or the integrity of its tax system.

February 2011: The Code Group, on advice from the High Level Working Party on Tax

Matters, finds the interaction of the deemed distribution rules with 0/10 has harmful effects.

Jersey announces intention to remove the deemed distribution rules.

July 2011: The States of Jersey formally approve the removal of the shareholder

taxation rules (deemed distribution and full attribution), to take effect from 31 December 2011

September 2011: The Code Group finds that the 0/10 regime, without the shareholder

taxation rules, is compliant with the Code

December 2011: ECOFIN formally approves the 0/10 regime, without the shareholder

taxation rules, as compliant with the Code

2. SCOPE OF THIS REPORT

1. This report sets out the background to the review and revisits the rationale for developing Jersey's tax system in its current format.
2. It goes on todiscuss the recent pressures on the0/10regime from the EU and from domestic political forces.
3. Next, itsets out the positionthatJerseyis now in, with additionalclarity on so me aspects of the Codeof Conduct, a morelevelplaying field for investors in Jersey companies and clarification on aspects of the Code.
4. The options for increasing revenues from non-financial services companies are set out in Section 8, with each analysed forits potential economic impact on the Island's economy and its likely compliance with the Code of Conduct.
5. The appendices include additional background information.

3. BACKGROUND

1. Introduction

1. In 2010 t he S tates approved an am endment t o t he 2011 B udget calling on t he Minister for Treasury and Resources to introduce measures to increase revenues from non-Jerseyownedcompanies paying tax at 0%,providedthatanychanges should not jeopardise Jersey's business tax regime or its international competitiveness. This report se ts out t he w ork that has been done to i dentify potentially su itable r egimes, and considers the su itability of each i n t he cu rrent economic climate.
2. In line with the terms of the amendment agreed by the States, this review was not undertaken with a sp ecific figure ofrevenuetoberaisedinmind. T he strengthof Jersey's finances is such thatthereis no need toincreaserevenuestofill a specific funding gap. Where this reportrefersto "increasing revenues", this should be borne in mind.
3. One ofthe principal objections tothe introduction of thezero/ten (0/10) companytax regime i n 2008 w as its perceived unfairness. While most commentators acknowledged thereasons for its introduction andthe need t o support the finance sector, Jersey's key industry, there was also concern that the policy meant that many companies trading inJerseywould benef it at the expenseofindividualislanders. The matter was raised by Scrutiny panels over the years, but no workable solution could be identified.
4. The reference t o non -locally o wned co mpanies reflected co ncerns that the shareholder t axation r ules meant t hat t here w as no l evel pl aying field bet ween companies owned by Jersey residents and companies owned by non-residents.
5. Under theserules, a Je rsey residentindividual who owned an interestin a Je rsey company would be t axed as though he had ea rned the company's profits himself. These rules did not applytonon-residentshareholders of Jerseycompanies. T he effect of the shareholder taxation rules was that companies carrying on similar trades could have very different cash flow models, with Jersey-owned companies potentially under more pressure from their shareholders to distribute their profits rather than retain or reinvest them.
6. Following the finding of t he E U C ode G roup on B usiness Taxation t hat t he shareholder taxation rules represented unfair discrimination, they were abolished in 2011. A lthough theabolition of the rules means thatcompanies and shareholders are now t reated i dentically f or Je rsey t ax pur poses, the per ception o f un fairness persists, possiblyinpart due to a lackof understanding of the wayshareholders are taxed on themoneytheyreceivefromtheircompanies. This is explained infurther detail in Section 7.2.
7. Work has been on going to i dentify and ev aluate t he di fferent op tions for r aising revenues from companies currently paying tax at 0%. This has been informed by the comments of the EUCodeGroup on the0/10 regime. In particular, the Code Group made itclearthattaxmeasures aimed at company shareholders may be considered to form part of the overall company tax regime. Therefore, any measure which could be consideredto be part of thecompanytax system would be deemedto be a t ax, and may thereby jeopardise the 0% general rate of tax.

8. Since this work was begun as part of the Business Tax Review in late 2009 the economic climate has steadily worsened. C areful consideration has been givento how t he co mpany t ax regime ca n best su pport t he States'economic growth and inward investment strategies. In particular, the likely impact on employment of any new measures must be taken into account.
9. This paper sets out the backgroundtothe introduction of the currentcompany tax regime, theoptionsconsideredtoraise additional revenues from companies and an evaluation of each by referenceto a numberof key criteriaincluding the potential impact on Jersey's economy and inwardinvestmentstrategy. Itconcludes with key findings arising from the work done.
10. A key part of this work has involved understanding how Jersey's economy works and the key i ssues facing i t at this time. A lthough t here i s no i ntention to i ncrease revenues from financial services companies, as for themostparttheyalreadypay income t ax on t heir pr ofits1, an unde rstanding oftheissuesaffecting the finance industry is key as this sector is the mostimportantcontributortoJersey's economy. A discussionof the importance of protecting the financial services industry is set out in Section 5.

2. What the sectors subject to 0% tax contribute

1. Non-financial services companies, whether locally or non-locally owned, contribute to Jersey's economic well-being in a number of ways:

• Direct employment – 63% of employment is in the non-finance sector.

• Social security - Employers pay social security contributions on the salaries and wages they pay to their staff2, monies raised from employers to fund benefits for Jersey's residents.

• GST – By providing the goods and services that people in Jersey want to buy, and collecting the GST which has gone some way to making up some of the direct tax revenues lost through the introduction of 0/10. Some companies pay GST if they have not registered for the tax (typically, if their annual turnover is less than £300,000 per year).

• Providing diversity of opportunities for Jersey's residents, who may not wish to work in the finance industry.

• Tax and social security on the wages of employees.

• Producing and distributing the goods and services that Islanders use and enjoy on a daily basis.

2. Government is trying toencouragethediversificationofbusinesses in Jersey and this strategy has been reflectedintheCouncilofMinisters'Strategic Plan 2011 –

1 The majority of companies considered to trade within the finance sector are subject to income tax at 10%, but a minority are taxed at 0%. These businesses would include fund management companies, insurance companies, lawyers and accountants, although many legal and accountancy firms are structured as partnerships and as such their partners are taxed on the profits at personal tax rates.

2 From 1 January 2012, employers' social security contributions are payable at 6.5% on earnings of up to £3,778 per month, and at 2% on earnings of between £3,778 and £12,500.

2014 and t he r ecently publ ished Economic Growth and D iversification S trategy prepared by the Economic Development Department.

3. Any changes made to the way in which companies are taxedmustnotdeterinward investment iftheintentiontodiversifytheeconomyawayfromtraditionalfinancial services activities. Measures should pr otect the r evenues the S tates currently receives directly and indirectly from the non-finance sector. Any changes should also support the objectives of theCouncilof Minister toprotect and increase employment in the Island.

3. Principles of Jersey's long-term tax policy

1. The draft Medium Term Financial Plan for the period 2013 – 2015 is to be debated by the States in the autumn of 2012. Appendix Eleven to that document sets out a long term taxpolicyforthe Island. T his document (whichis reproduced in Appendix I) sets out a number of principles which should be used to inform decisions on Jersey's tax regime.
2. Jersey's tax policy should support theCouncilofMinisters'economic and political policy objectives.
3. In order to do this Jersey's tax regime should have the following features:

• Stability. Je rsey has a reputation for stability in its tax regime, which is a k ey feature of its global offering. Investors, whether financial services related or not, considering the use of Jersey need to know how they will be taxed for the foreseeable future.

• Certainty. This is linked t o t he point on st ability. Changes should be m ade infrequently, after careful consideration and consultation.

• Revenues. Jersey m ust r aise su fficient r evenues to m eet i ts spending requirements.

• Flexibility. Where a ne ed is identified, whether t o attract new busi ness or to defend existing business, Jersey must be able to move quickly.

• Competitiveness. In all things, Jersey must ensure that it does not damage the Island's ability to effectively compete for business. In this, the Island must keep aware of events in its key competitors and in the broader world which may affect it.

• Efficiency. Any tax changes should distort taxpayer behaviour as little as possible, unless that is one of the reasons for introducing the tax in the first place.

• Cost effective. The Fiscal Strategy Review, and resulting decisions by the States to increase GST and social se curity and r etain a m aximum i ncome tax r ate, suggest that in addition to the factors noted above, taxes should be cost effective for both the States and for taxpayers.

• Fairness and equity. These are extremely difficult to define and m ean different things to different people. R ecent decisions on introducing "20 means 20", the desire t o modernise an d si mplify t he t ax r egime and t he i ntroduction of G ST "protection measures" indicate that fairness and equity includes ensuring that the wealthiest pay a gr eater pr oportion o f t heir i ncome i n t ax while t hose on t he lowest incomes are protected. It has also been recognised in recent decisions that the introduction of a competitive tax regime to encourage wealthy individuals and their businesses to Jersey is beneficial to the economy. In the absence of the direct and i ndirect revenues raised and t he economic activity derived from this inward migration, the burden in taxpayers would be greater.

4. With the above in mind, the following principles were recommended:

• Taxation must be necessary, justifiable and sustainable.

• Taxes should be low, broad and simple. This follows the OECD's best practice guidelines regarding how countries should set their taxation regimes.

• Everyone sh ould m ake an appropriate contribution to the co st o f providing services, while those on the lowest incomes are protected.

• Taxes must be internationally competitive.

• Taxation sh ould su pport eco nomic development and, w here possi ble, so cial policy.

4. OBJECTIVES OF THE REVIEW

1. Supporting the inward investment and growth strategy

1. While Jerseycontinuestoexperiencetheeffects of the global downturn, and w ith unemployment still high (though stabilising in recent months), in particular in the non- finance sector, any changestothetaxregime must promote conditions for economic growth by encouraging existing businessesto grow and at tracting new business to Jersey.
2. Given thedifficulties posed by thecurrenteconomic climate and thehighlevelof unemployment it will be important to limit economic distortions as far as possible and understand the economic impact locally of any changes.
3. Stability of and ce rtainty inthetaxregimeis important inbuilding and  maintaining business confidence.

2. Protecting the company tax regime

1. The Business Tax Review f ound that 0/10 is  still overwhelmingly f avoured by the majority of Island businesses as the consequences of not beingableto provide tax neutrality in a transparent and simple waytotheclients of the finance sector would be significant, and make Jersey uncompetitive for the supply of a major part of the current m arket. Any changes to the tax system should protect the international acceptability of the 0/10 structure, which at presentis driven by compliance withthe Code. Key to this is the abilitytodemonstratethatthe general companytaxratein Jersey is 0%, i.e.this is the rateoftaxpaid by themajority of companies in Jersey, on the majority of profits earned in Jersey, by the majority of employers in Jersey and by t he m ajority o f busi nesses actively ca rried on i n Je rsey.   This last poi nt has recently emerged,based on t he EuropeanCommission's review of 0/10 as part of the Code Group review. This will significantly limit Jersey's scope to change the current regime while maintaining its Code compliance.
2. For 2009, themost recent year for whichcompleteinformationis available, thesplit between Jersey incorporated companies subject tothethreerates of tax is analysed as follows:

Category  Companies  Total profits  Employees 0%  29,960  96.5%  1,530m  68%  33,000  75% 10%  1,000  3%  670m  30%  9,000  20% 20%[1]  40  0.5%  40m  2%  2,000  5% Total  31,000  100%  £ 2,240m  (100%)  44,000  (100%)

3. These figures include someestimates particularly inrespectoftotalprofits as full detailed information is not available. They arehowever based on known data from earlier years.

4. Jersey taxes companies and individuals on a r esidence basis, so thatresidents of Jersey areliabletotaxinJersey on alltheirincome, wherever inthe world itarises. A non-residentis not generally liable toJerseytax, apart from on income earned in connection w ith r enting or dev eloping l and o r buildings in Je rsey, e mployment income earned in the Island, or from a trade carried on in Jersey.
5. A co mpany will be co nsidered t o be r esident i n Je rsey for tax pur poses if i t i s incorporated inthe Island, or ifitiscentrallymanaged and controlled from Jersey. The place of ownershipof a company does not determine whether that company is resident or not in Jersey. This is an approach which is common to most jurisdictions. There is an exceptionforcompanies which areincorporatedhere but managed and controlled in another territory, if the company is considered to be resident in that other jurisdiction and if a tax rate of at least 20% could apply.
6. "Central management and control"is a concept which refersto the highestdecision making function of a c ompany, t ypically t he pl ace w here t he di rectors m ake t he highest decisions relating to matters like mergers, acquisitions or the declaration of dividends. This would ordinarily be expectedto take placeatboardmeetings but is not confined to them.
7. A company that is resident in Jersey is therefore subject to Jersey tax, albeit that the rate of tax applied in most cases is 0%.
8. This table abov e does not include f oreign i ncorporated but Je rsey t ax r esident companies taxed at 0%. C ommonly companies are incorporatedoverseas but are tax residentinJersey. A lthough someinformationis provided annuallytothe tax authorities, su ch as the num bers, nam es and addr esses of su ch co mpanies, n o information i s currently routinely collected on t heir l evels of pr ofitability if t he companies are subject totax at the 0% rate, as such informationis not required for tax purposes. The Comptroller ofTaxes has the powertoobtainfurther information where itis relevant to a Jersey taxliability or to enable himto respond to a request for information from the taxauthorities of anotherjurisdictionwith which Jersey has signed a Tax InformationExchangeAgreement,forexample. C ompanies are also required to maintain this information.
9. One ofthe key findings of this review is that measures should be putinplaceto ensure thatsufficient information is routinely collected by theStates in orderforitto formulate future tax policy and to demonstrate that 0% continues to be the general rate of company tax.
10. A co nsultation has been l aunched w ith t his report to se ek v iews on t he m ost appropriate method of collecting this data.

3. Creating a sustainable tax regime

1. Stability of and certainty in the tax system is important in building business confidence and hen ce supporting growth. Jersey has been t hrough si gnificant changes in its tax regime in recent years and a period of stability would be beneficial.
2. Undertaking a fundamental changeinthetaxregime so shortlyafter introducing the current company tax regime would be destabilising and create uncertainty. Even making small changes could adversely affect confidence.

3. Any changes made must be sustainableinthemediumtolongterm. Thereforeitis important that any changes are compliantwithinternationalstandards to avoidthe risk of challenge.
4. If the b roader busi ness co mmunity co nsidered t hat Je rsey's tax r egime w as not sustainable in the medium to long term, it would adversely affect the Island's ability to attract new businesses or employment. Businesses will be r eluctant toinvestnew funds if they have doubts about thetax environment in which they will be operating.

5 THE INTERNATIONAL FINANCIAL SERVICES INDUSTRY IN JERSEY

1. The role of Jersey in international finance

1. Jersey services the financial needs of manyUK nationals living abroad and provides a tax neutral pathway for funds into other financial centres, mainly the City of London.
2. Jersey, together with the other Crown Dependencies, therefore makes a significant contribution to the liquidity of theUKmarketthroughthe "up streaming" of funds, thereby substantially benefiting the UKbanks and theUKexchequer. Upstreaming enables deposits to be gathered by subsidiaries or branches in a number of different jurisdictions and then concentrated in one centre,such as the City of London, where the bank has the necessaryinfrastructureto manage and i nvest these funds. A recent independentreport for HMTreasury4 has demonstrated that the stock of net financing provided by the Crown Dependencies to UK banks was $332.5 billion in the second quarter of calendar year2009,largely accounted for by the up-streaming to the UK head office of deposits collected by UK banks in the Crown Dependencies.
3. Jersey's financial se rvices industry pr ovides services to t hese cl ients, who need administrators, bank accounts, legal advice, accountancy services and a range of other specialistservices. Much of this is carried on inJersey and all of this creates employment and eco nomic advantage for t he I sland, i ncluding but not l imited t o direct tax revenues.
4. Jersey's robust regulatory regime and reputation as a centre forexcellence gives clients the confidence to entrust their assets to service providers in the Island.
5. The profits of this industry funded the growth and development ofJersey's economy and taxpaid on thoseprofits funded thehighstandardofpublic services that Jersey residents came toexpect from the mid-1970sto the presentday. However, there is no room for complacency as new financial centres, particularly in the Middle East and Asia, are rapidly developing the range of specialist skills required in order to compete for international financial services business.

2. What aspects of Jersey's tax regime make it attractive to the international financial services industry?

1. Jersey's tax system has a number of features which make it an attractive location for the international financial services industry.
2. Simplicity. Jersey, in common with many other international finance centres, offers a simple tax regime which is easy for outside investors to understand and administer.
3. Certainty. Whendecidingwheretoinvestin or operate from, itisimportantthat the investor canhave a reasonabledegreeof certainty regarding thetax treatment likelyto apply for, if not the life of the operation, at least a number of years into the future.
4. Competitive rate. Jersey offers providers of financial services a competitivetaxrate of 10% or insomecases0%5. A lthough the scopeof financial services activities

4 "Final report of the independent review of British offshore financial centres", M. Foot, October 2009 http://webarchive.nationalarchives.gov.uk/+/http:/www.hm- treasury.gov.uk/indreview_brit_offshore_fin_centres.htm

5 The majority of companies considered to trade within the finance sector are subject to income tax at 10%, but a minority are taxed at 0%. These businesses would include fund management companies,

subject to tax at 10% in Jersey is slightly wider than in Guernsey or the Isle of Man, it compares well with other financial centres. It must be noted that the headline rates of t ax di splayed i n ons hore t erritories can mask the true tax co ntribution m ade; companies that are subject to tax at a seemingly high headline rate of tax may, after use of deductions and exemptions, in fact pay a much lower effective rate.

5. Supports development of crucial support services/infrastructure. Inordertoprovide high quality services, the Islandmustalsoeducate, house and provide an adequate health serviceinfrastructure for theworkforce. T here shouldbeadequateroads, housing, telecommunications infrastructure. Sufficient public revenues should exist to support this, and Jersey's current broad tax regime provides this.
6. Neutrality for clients. Most international finance centres offer their clients tax neutrality, in a v ariety of ways. Whilethis is not theonlyreason why a particular centre will be chosen,theabsence of theneutrality will limitthescope of services it can provide.
7. The trust and company administration sector,whichis fundamental to the restof the financial services activities undertaken in Jersey, relies in particular on the availability of t ax neut rality f or i ts clients. Without this, i t i s likely that t he m ajority o f t rust business would l eave t he I sland, w ith a co rresponding i mpact on j obs in ot her financial services sectors and the wider economy as a whole.
8. The m aintenance o f the abi lity t o o ffer t ax n eutrality t o i nternational i nvestment vehicles is a cornerstoneof Jersey's existence as an international financial services centre.
9. Tax neutrality can, and is, provided in a number of ways, for example through Double Tax Agreements between governmentstopreventincomeearnedin one territory by a residentof another being taxed in both jurisdictions. Other ways of achieving tax neutrality include EU directives on the treatment of intra-EU flows of income and capital, and some jurisdictions achieve neutralitythroughunpublishedpracticeand negotiation w ith t he r evenue aut horities. A 0% co mpany t ax r ate i s si mple and transparent. There is no international standard which determines tax rates.
10. Although arguably not critical to the continuing success of all non-financial services sectors, many othersectors benefit substantially from theexistenceof tax neutrality and a t ax neut ral pl atform i s a k ey feature i n at tracting new non-finance related industries, particularly in the absenceof a comprehensivedoubletaxtreatynetwork. The geographical limitations of manyinternationalfinancialcentres means that they compete t o at tract l ow-footprint but high v alue industries. Je rsey co mpetes with other low-taxjurisdictions in attracting more of this type of business in the future. Non-financial services sectors also benefit indirectly from the success of the financial services industry, which itself is reliant on tax neutrality.

3. What is tax neutrality?

1. Jersey competes globally with otherinternationalfinancecentres and taxneutrality, particularly for highly mobile capital such as investment funds, is an important feature of these jurisdictions. All international finance centres offer a form of tax neutrality – that is, a regimethatdoes not subjectcompaniesto additional taxation,recognising that underlying profits should be subjectto tax where the assets that give rise to

insurance companies, lawyers and accountants, although many legal and accountancy firms are structured as partnerships and as such their partners are taxed on the profits at personal tax rates.

those pr ofits are l ocated and i nvestors are t axed on t heir r eturns in t heir hom e jurisdictions.  Many other countries achieve tax neutrality with specific exemptions particularly  for hi ghly m obile ca pital and i n  ways  which ar e of ten  complex and opaque.

2. Tax neutrality is an important feature of Jersey's tax system which underpins much of the provision of international financial services from Jersey and to remain competitive access to tax neut ral s tructures should be maintained. A lthough ce rtain f inance companies pay tax at no less than 10% on the profits they generate,the majority of international clients rely on the availability of tax neutrality.  Tax neutrality is also important to non-financial services businesses and can influence developments in other parts of the economy.
3. Tax neutrality prevents unnecessary additional layers of taxation, provides certainty in taxtreatment and allows fiscally efficientcrossborderinvestment which facilitates global ca pital  flows.  Double t axation ag reements ( DTAs) ar e u sed by m any jurisdictions to ensure that income generated in one jurisdiction and remitted to another is, rightly, only taxed once. In the absence as yet of an extensive double tax treaty network, Jersey canonlypreventunnecessaryadditionallayers of taxation through the provision of a domestic tax neutral regime.
4. Tax neutralityalsomaximises the return toinvestors and hence,potentially,thetax revenues in theirhomejurisdiction. This is particularly important for structures that are set up to achieve a specific  purpose, where it is  desirable not to incur an unnecessary additional tax liability. Take, for example, a fund that is investing in a particular asse t cl ass  such as  emerging m arket eq uities  and w ants t o at tract investment from pa rties base d i n t he U K, t he U S and t he E U. I f t his  fund i s established in a jurisdictionthat does not provide tax neutrality, investors inthat fund may be subject to tax at the fund level in addition to their tax liability in their home country, potentiallyresultingindoubletaxation of thesameincome. Fu rthermore, such a fund maycreate different liabilitiesforinvestors depending on their location. By precludingadditional layers of tax, a tax-neutralregimeis efficient and creates a level playing field for multinational investors.

Returns taxed US investor  UK investor  EU investor  in home

jurisdiction

under domestic tax rules

Distributions

Jersey Fund  Distribution taxed at

0% in Jersey

Distribution

Investment  Profits taxed in home jurisdiction

Similar tax treatment is achieved by other higher tax jurisdictions using

DTAs or specific exemptions and reliefs.

5. As a consequence jurisdictions offering tax neutralityprovide an i deal platform for conducting business related to international finance and trade, structuring investment deals or infrastructure projects that involve participants across a numberof countries and establishing structures that can be used for a variety of other purposes, suchas securitisation or the protection ofassets. These legitimate activities will beprimarily motivated by realeconomic concerns – such as the raising of finance – rather than purely f or t ax pur poses, but l ocating them i n a t ax neut ral j urisdiction, w hether onshore or offshore, can avoid unnecessary extra taxation.

4. What the finance industry contributes to Jersey

1. The financial services sector is clearly the most economically significant in the Island, not justinterms of its direct impact(25% of private sector employment, 40.5% of GVA) but also because of the support it provides to other industries including:

• Tourism (business travel and conferences)

• Maintenance of vital air links and routes

• Construction (offices and accommodation)

• Retail (finance workers and business tourism)

• E-commerce (fulfilment and software providers)

• Agriculture (finance workers and hospitality)

2. As such, itis important notto underestimate the extent ofthe interaction between all sectors of Jersey's business communities.

5. What losing the finance industry would mean to Jersey

1. In 2004 the Finance and Economics Committee, the precursor to the Treasury and Resources Department, published a paper entitled "Facing up tothe future: reforming spending and t axation tosustain a pr osperous and co mpetitive economy"[2]. This paper included a reflection on the potentialconsequences for Jerseyoflosing the finance industry, part of which is reproduced in Appendix II. Although this analysis was undertaken in 2004, the key findings remain valid.
2. That paper considered how the Island economy might look in the absence of the international financial services industry at its then level. It considered that this might have been t he out come i f t he S tates failed t o i ntroduce m easures to reform t he corporate tax structure inresponsetothepressures then beingapplied and w hich are discussedinmoredetailinSection6. In particular, itlookedclosely at thatpart of financial se rvices industry t hat p rovides services to t he i nternational m arkets including those serving non-resident clients.
3. It found thatthis part oftheindustryis highly mobile and i t would probably be t he most pr ofitable par ts that w ould l eave first i f the I sland's corporate t ax st ructure became uncompetitive and unstable. T here could be a su bstantial changeinthe structure of t he financial se rvices industry within a r elatively sh ort per iod. There would be a major shock to the Island economy during the first few years after companies had gone, although they would be unlikely to leave the Island atthe same time. The l oss of so me co mpanies could h ave a bi gger e ffect on t he ov erall economy than others.

4. In the first few years after the shock of the emigration of these key companies:

• Employment in financial services would fall from the 12,000 then employed to around 1,200 – 1,500 jobs. Employment outside the finance sector would also fall as demand for goods and services fell.

• This would be accompanied by a considerable fall in total population, possibly by 20,000 – 22,000, with the working population falling by 14,000 – 16,000. The age structure o f the I sland w ould ch ange as younger peopl e would be l ikely t o dominate the leavers, or those who no longer chose to come to Jersey as they sought employment elsewhere. This would have a knock-on effect on supporting an aging population.

• States revenues could decline by 55% - 67% per annum, but States spending could decline by much less because it would tend to be older people who would remain in the Island and the immediate liability for pensions would hardly fall at all.

• Meeting any shortfall in public revenues through tax increases or service level reductions would require higher tax rates, or deeper cuts, than meeting a similar shortfall would require from the current tax base, because the population of individuals and businesses would be lower, as would their incomes.

5. The Island would probably begin to recover after the initial shock, but the economy would look very different from the way it does now.
6. In conclusion, protecting the position of the financial services industry is key to Jersey's ongoing economic well-being. Theresponsesto the Business Tax Review identified the current company tax regime as important to the industry and as such, it should be continued and protected into the future. No action should be takento jeopardise the existing regime.

6. DEVELOPMENT OF ZERO/TEN

1. Jersey's previous company tax regime

6.1.1  Until 2008 Jersey's company tax system included the following features:

• Exempt company status was available to any company owned by non-residents and which, broadly, did not carry on a business activity in Jersey. Exempt companies were exempted from tax on all income earned outside Jersey and interest arising from Jersey bank accounts. An annual fee of £600 was payable.

Exempt companies were typically used by clients of the finance industry to act as tax-neutral vehicles for the holding of investments outside of Jersey. A s such, they were an i mportant par t o f Je rsey's ability to at tract private client, f unds, insurance, se curitisation, t rust and financing bu siness to Je rsey, i .e. t he co re businesses of Jersey's financial services industry. The trust and fund industries alone employed just over a q uarter of those employed in the financial services industry in 2011, and 6.4% of all Islanders in work[3].

• International Business Company (IBC) st atus was also onl y a vailable t o companies owned by non-residents. Tax was charged at 30% on Jersey-source income and at rates between 0.5% and 20% on international income. The average annual effective tax rate (the percentage of profits before adjustments paid in tax) payable by IBCs was approximately 14%.

Typically, I BCs were b anks, group service co mpanies and o ther bus inesses which had a presence in Jersey but whose work was "international" in nature; i.e. derived from clients based outside of the Island. The banking industry is the single largest employer in Jersey, with 5,270 employees in 2011, representing nearly 10% of total employment[4].

• All other companies were liable to income tax at 20% on their worldwide profits.

2. The Code of Conduct on Business Taxation

1. The EuropeanUnion has no jurisdictionoverdirecttaxationmatters and therefore individual Member States retain the right toset their owntaxrules,including their own taxrates. However,during the 1990s there was a concernthatMemberStates were usingtheirtaxregimestounfairlyattract business away from otherMember States.
2. A set of principles was devised (theCode)to which all Member States agreed to adhere. The C ode r equires Member S tates to r efrain from i ntroducing any new harmful t ax m easures (standstill) and t o am end any laws or pr actices that ar e deemed t o be har mful under t he principles of the Code(rollback). It co vers tax measures (including laws,regulations and administrativepractices)whichhave, or may have, a significant impact on the location of business in the EU. The Code sets out criteria for identifying potentially harmful measures:

• An effective level of taxation which is significantly lower than the general level of taxation in the country concerned

• Tax benefits reserved for non-residents

• Tax incentives for activities which are isolated from the domestic economy and therefore have no impact on the national tax base

• Granting of tax advantages even in the absence of any real economic activity

• The basis of profit determination for companies in a multinational group departs from internationally accepted rules, in particularly those approved by the OECD

• Lack of transparency

6.2.4 When determining whether a tax measure is harmful, the Code asks whether:

• Advantages are acco rded onl y to non -residents or i n r espect o f t ransactions carried out with non-residents

• Advantages are ring-fenced from the domestic market, so they do not affect the national tax base

• Advantages are granted even without any real economic activity and substantial economic presence within the territory offering such tax advantages

• The rules for profit determination in respect of activities within a m ultinational group of companies depart from internationally accepted principles, notably the rules agreed upon within the OECD

• The tax measures lack transparency, including where legal provisions are relaxed at administrative level in a non-transparent way

4. Having agreed on the principles of the Code, the EU Member States formed the Code Group, whose role is to assess tax measures against the Code principles. The Code Group then makes recommendations to ECOFIN, the European Union's Economic and FinancialAffairs Council, made up of the finance ministers of the 27 EU Member S tates. Ultimately, it is ECOFIN's responsibility t o co nsider t hese recommendations and determine whether or not to endorse them.
5. Between 1997 and 199 9, theCodeGroupundertook an i n-depth review of thetax regimes of every EU Member State and their associated and dependent territories. This review identifiedsixty-six t ax m easures withharmful features, of which forty were in EU Member States, three were in Gibraltar and twenty-three in dependent or associated territories of Member States[5]. In response, EU Member States agreed to stand still and to roll back harmful tax policies and practices identified.
6. As part of the its commitment to the Code process, the UK committed that its overseas and dependant t erritories would a lso co mply with t he C ode. Je rsey voluntarily agreed to comply with the terms of the Code.
7. The measures identified in Jersey as being harmful were:

• Exempt companies

• International Business Companies

• Specific rules for international treasury operations carried on through the Jersey branch of an international bank

• Specific rules regarding the treatment of captive insurance companies.

Further details of these regimes and the Code Group's rationale for finding them harmful are included in Appendix III.

8. By thetimetheEUcametoreviewthemeasures,themeasures applying tocaptive insurance companies and to international treasury operations had either already been closed to new entrants or were not used in practice. However, this was irrelevant totheCode Group, whichlooks at how measures could be used rather than how they are or have been used.
9. As part o f Je rsey's voluntarily co mmitment t o t he C ode, Je rsey ag reed not t o introduce new har mful t ax m easures and t o t ake s teps to unw ind t hose har mful measures that then existed. As part of that process, it was agreed that having closed the I BC r egime to new ent rants from 1 Ja nuary 2004, ex isting I BCs could be "grandfathered" and continue to benefit from the regime until 31 December 2011. The exemptcompanyregimewasto be permittedtocontinueuntiltheend of 2008. 0/10 came into force for all companies from 1 January 2009, and all formerly exempt companies were then subject to the general company income tax rate of 0%.
10. Tax regimes which had similar effect in Guernsey and the Isle of Man were also identified as harmful. In r esponse, t he I sle of M an announce d i ts intention o f abolishing thethencurrentsystemofcompanytaxation and introducing a form of 0/10 to apply from 2007 onwards. The scope of the 10% rate of tax was relatively limited, applyingto certain income of banks and to income derived from property in the Isle of Man.
11. Following Jersey's decision to follow the Isle of Man's lead and introduce a form of 0/10 albeitwith a g reater scopeofactivities taxable at a posi tive rate,Guernsey followed suit shortly afterwards, although Guernsey introduced its new regime slightly earlier than Jersey. See Appendix IVfor a comparison ofthe scope of the 0%, 10% and 20% tax rates in Jersey, Guernsey and the Isle of Man.
12. The C ode w as one o f a pac kage o f measures which were i ntended t o al ign tax treatments across the EUmembers. Another feature oftheso-called"taxpackage" was the EUSavings Directive, which was intended todiscouragetaxevasion and which has led toinformation on cross-borderinterestpayments made toindividuals being sharedwithtax authorities in otherEU members. Jersey committed tocomply with theEUSavings Directive but didso,along with theIsle of Man and Guernsey, on the same basis as Luxembourg, Austria and, at the time, Belgium. As a result, interest paid from Jerseyfinancial institutions to EU resident individuals is subject to withholding t ax ( currently at t he r ate o f 35% ) which i s then pai d t o t he r evenue authorities in the territory i n w hich t he i ndividual i s resident. A lternatively, t he individual can choose forhis information to be shared with the tax authorities in his home territory and inthatcase, interest payments will not be subjecttowithholding tax. Jersey has committed toabolishing the withholdingtaxoptionwhencertain conditions are met, including that all EU Member States also do so.

13. Comment on the subsequent review of Jersey's zero/ten regime by the Code Group between 2009 and 2011 is set out in Section 6.5.

3. International competition

1. The early 2000s saw a general reduction in company tax rates across the EU and further afield. Former Eastern Block countries like Estonia and Hungaryintroduced low r ates in an ef fort to m ake t hemselves more at tractive t o foreign i nvestment. Ireland dropped its company taxrateto 12.5% and Cyprus to 10%.
2. Closer to home, the Isle of Man announced its intention to introduce a 0/10 company tax regime,with a generalrate of companytaxof0%forthemajority of companies and a higher rate of 10% for certain financial services profits.
3. Faced withthesepressures,itwas clear thatJersey's top rateofcompanytax of 20% w as no l onger at tractive i n an i ncreasingly co mpetitive i nternational environment. After much consideration and public consultation, the decision was taken that Jersey should also introduce a form of 0/10.
4. International competition continues to be a factor in assessing the suitability of any tax regime for Jersey. The years leading up to the global financial crisis saw sustained downward pressure on company tax rates worldwide10, and although the rate of this trend has slowed in recent years, countries are still reducing company tax rates. The UKfor example, is in the process of gradually reducing its highest rate of corporation tax from 30% in 2008 to 22% by 2014. The current UK government, in its Coalition Agreement,has set its aim to"create the mostcompetitivecorporatetax regime in the G20."11 This theme has been further developed: "the primary aim of the taxsystemistoraiserevenue, and therefore providethe fiscal stabilitythatis a precondition for business success. Atthesametime, the Government believes that the co rporate t ax system ca n and should be an asse t for the UK,improving the business environment and helping to attract multinational businesses and investment to the UK to support the recovery."12
5. The average rate ofcompanytax in the EU in 2012 is 23.5% and in the Eurozone, 26.1%. Between 1995 and 2012, company tax rates were reduced 113 times across the current EU members, and only increased 16 times, despite more than one economic downturn inthattime. Decliningcompanytax rates would appearto be a continuing trend.
6. The EUis not Jersey's only competitor, but itis significant, particularly when Jersey is so often competing for business with financial centres such as Luxembourg, Malta and Cyprus which canoffertheadvantages of EU membershipto their businesses, together with competitive company tax regimes.

10 For example, the top statutory tax rates on corporate income in the EU Member States declined from an average of 35.3% in the mid-1990s to 23.5% in 2012. Source: "Taxation trends in the European Union, Data for the EU Member States, Iceland and Norway", Eurostat/European Commission, 2012 edition (http://ec.europa.eu/taxation_customs/taxation/gen_info/economic_analysis/tax_structures/index_en.h tm)

11 HM Government, "The Coalition: our programme for government", May 2010: http://www.cabinetoffice.gov.uk/news/coalition-documents

12 HM Treasury and HM Revenue and Customs, "Corporate tax reform: delivering a more competitive system", June 2010: http://www.hm-treasury.gov.uk/d/corporate_tax_reform_part1a_roadmap.pdf

4. Designing the current company tax regime

1. 0/10 was designed to meet the following key objectives:

• To ensu re co mpliance w ith t he C ode of C onduct on B usiness Taxation b y removing discrimination between companies based on the place of residence of their shareholders.

• To maintain the ability of Jersey to offer a t ax-neutral vehicle to clients of the finance industry.

• To ensure that Jersey could offer a co mpetitive rate of company income tax to the Island's financial services sector, recognising that this industry is the largest employer in Jersey.

• To protect States' revenues as much as possible, recognising that the finance sector was the single largest contributor to States' revenues.

2. Following its commitment to comply with the EU Code of Conduct, Jersey decided to abolish i ts existing co mpany t ax regime and t o r eplace i t with a general r ate o f company income tax of 0%. This applies to over 95% of the companies in the Island.
3. Under t he pr evious tax r egime, the general r ate o f tax was 20% and sp ecial treatment was given tosome companies allowing themto be taxed at lowerrates,orto pay no tax at all. Under the replacement regime, the majority of companies pay at the 0% rate and a minority of companies are ineffect "discriminated against",which is permissible under the Code.
4. The financial services sector was chosen for the higher rate of tax on the basis that it was the singleindustry with the highest profits and therefore the greatest scope to generate taxcontributions. Also,chargingthis industry sometaxwould not affect Jersey's competitive position provided the rate charged was not too high. The industry had previously paid tax at rates of up to 20% but, as set out in Section 6.3, the competitiveness of this rate was under increasingpressure due to the general downward trend of company tax rates globally.
5. Companies which are regulated by the Jersey Financial Services Commission as follows are subject to income tax at therate of 10% onall of their profits: