Fiscal Strategy

STATES OF JERSEY

r

FISCAL STRATEGY

Lodged au Greffe on 1st June 2004

by the Finance and Economics Committee

STATES GREFFE

PROPOSITION

THE STATES are asked to decide whether they are of opinion

( a ) to agree, in order to maintain a strong and competitive economy, that a 0% standard rate of

corporate profits taxation and a 10% rate of corporate profits taxation for companies in particular sectors, including financial services, be introduced by no later than 1st January 2008 and to charge the Finance and Economics Committee to bring forward for approval by the States the necessary legislation to give effect to the proposal;

( b ) to charge the Finance and Economics Committee to research measures to mitigate the loss of

taxation revenues as a result of the changes to the corporate taxation structure in paragraph  (a) above, without damaging the competitiveness of the Jersey economy, such measures to include –

(i ) t a x a tion provisions requiring Jersey resident participators to pay personal taxation based

upon the profits of the Jersey companies accruing to them as a result of their direct or indirect ownership of those companies;

( i i) m e chanisms for withholding tax from non-resident shareholders of local trading

companies;

(i ii ) d e v e loping such anti-avoidance measures as may be necessary to enforce (b)(i) and (b)(ii)

above;

an d t o b r in g forward detailed proposals for consideration by the States by February 2005;

(c ) to agree an overall strategy for addressing the funding deficit arising from (a) above, yet not fully

mitigated by (b) above, specifically –

(i ) t o a gree that the annual increase in total States' net expenditure should be limited to 1%

less than the underlying increase in the Retail Price s Index for each of the years 2005 to 2009 and to vary their decision of 18th September 2003 in P.118/2003 (Resource Plan 2004-8) accordingly;

(i i ) t o a gree that a target for economic growth of 2% per annum should be set for the period

2005 to 2009 and to request the Economic Development Committee, in conjunction with other Committees as necessary, to bring forward, for approval by the States, a strategy for delivery of this growth by February 2005;

( ii i) t o agree in principle that, in order to balance States' income and expenditure, any

remaining budget deficit arising be addressed by taxation measures, to be implemented by no later than 1st January 2008.

(d ) in connection with introducing a package of new tax measures which will be broadly progressive

to balance the States' income and expenditure –

(i ) t o a gree to the introduction of an Income Tax Instalment System (I.T.I.S.) and to charge

the Finance and Economics Committee to bring forward detailed proposals to the States to enable the system to be implemented from 1st January 2006;

(i i ) t o a g ree in principle that tax allowances for taxpayers on high incomes be phased out and

to charge the Finance and Economics Committee to bring forward detailed proposals to give effect to the proposal as part of the 2005 budget;

( ii i) t o c harge the Finance and Economics Committee to undertake further research into a

goods and services tax, a payroll tax, environmental taxes, development levies and further tax enforcement

measures in order to investigate the feasibility of their introduction, and to bring forward details to the States with recommendations for approval by February 2005;

( e ) t o charge the Finance and Economics and Employment and Social Security Committees, in

consultation with other Committees as appropriate, to take steps to ensure that the effect of any new tax proposals on those with low incomes can be mitigated by the prior or simultaneous implementation of a new income support scheme.

FINANCE AND ECONOMICS COMMITTEE

REPORT

THE REFORM OF PUBLIC SPENDING AND TAXATION

Introduction

This Report is the latest stage in a project which began in 1998, when the current review of Jersey's tax structure began and the external forces which were driving the need for change were first examined.

It is not the final stage, but it is an important milestone in the reform process. During the last 6  years, successive Finance and Economics Committees have undertaken probably the longest and most extensive consultation process ever seen in the Island. They have also initiated thousands of man-hours of work to examine the problems and to identify solutions. A note on the research and consultation undertaken by the Committee is included in Appendix 1.

This Report and Proposition is the result of all that research, analysis and consultation. It proposes a framework for the future which –

• s a fe g uards Jersey's principal source of prosperity by changing the corporate tax rate;

• a s s es ses the likely effects of making such changes;

• p r o p oses a strategy to bridge the potential revenue deficit of £80-£100 million per annum;

• r e c o mmends a package of measures which increases the tax-take from Island residents while, at the same time, ensuring that those who earn more shoulder the greater share of the burden.

In February 2004, the Finance and Economics Committee published a package of proposals which could provide this framework and embarked upon a programme of consultation. This included public meetings, seminars, discussions and an on-line forum. The Committee's objective was to explain its thinking and to stimulate public discussion and debate. As a result, the Committee has modified its original proposals to some extent, as the proposition reveals, but the feedback generally was one of support for the overall direction but concern over a lack of detail, particularly in respect of new tax measures. The Committee appreciates these concerns, and the Proposition makes it clear that having confirmed the need to move to a 0/10% tax regime, further work is needed on many areas of detail.

The core purpose of this package of proposals was to safeguard the financial services industry, which is paramount to the economy of Jersey. The consultation did not produce any evidence that this was not the right approach.

To safeguard this industry, the Committee proposed changing corporate taxation. The consultation did not produce any credible alternative. Furthermore, it became even clearer from the responses received that doing nothing is not an option, and that delaying a decision increases the risk of a loss of jobs and revenue.

Changing corporate taxation will result in a revenue shortfall – the States will be unable to fund sufficiently the social services and benefits which Islanders currently enjoy. The Committee proposed to deal with this shortfall by three measures –

(1 ) p u blic sector efficiency savings, (2 ) ec o nomic growth, and

(3 ) in c reased taxation.

The consultation revealed little dissent that these 3  elements should be used, but did raise some questions as to whether the growth or efficiency targets could actually be met.

The consultation programme, subsequent discussion, and also feedback obtained through Imagine Jersey', showed no significant support for cutting the services provided by the government, which would have been a possible alternative means of dealing with this shortfall. There was, however, strong support for improving the efficiency of the public sector.

The Committee, therefore, still believes that using these 3 elements is the best strategy for Jersey, and while the efficiency and growth targets might be challenging, they are realistic and achievable. However, the questions raised about achievability reinforce the Committee's belief that any new tax structure should be capable of raising up to £100 million per annum. If the efficiency or growth targets were not met, we would have to lean more heavily upon increases in taxation. £100 million is – in the view of the Committee – the worst case' shortfall which would be caused by changing corporate taxation.

This has focused the Committee's thinking – and the debate throughout the period of consultation – on the critical decision about the nature of the new taxes that should be introduced.

A number of alternatives to the Committee's tax proposals have been put forward both in the consultation and subsequently in the independent evaluation of the Committee's proposals carried out by Price waterhouseCoopers ("the Whiting Report"). These include income taxes, environmental taxes, payroll taxes, visitor taxes, foreign worker taxes, wealth taxes, capital gains taxes, accommodation taxes etc.

The Committee has examined these suggestions and concludes that some of them merit further research and analysis.

This work has already begun. Officers are looking at a range of extra taxes which – while not adequately dealing with the full shortfall – might help to broaden Jersey's tax base and reduce the Island's over-dependence on income tax. Some of the suggestions, such as environmental taxes, would also have the benefit of encouraging behavioural change which would be to the benefit of the Island. However, it would be irresponsible to view these measures as feasible alternatives to the Committee's main tax proposals if they are not capable of meeting the revenue requirements identified, or if they would have a significant detrimental impact on the economy.

However, there are other principles to consider. In designing the tax structure the Committee is concerned to ensure that as far as possible any new tax structure –

• i s e ff icient;

• i s f ai r;

• m  a in tains Jersey's competitiveness in the global financial services industry;

• i s a s simple as possible;

• i n c re ases the flexibility of the tax system;

• p r o d uces reasonably stable tax revenues.

The Committee was particularly concerned about fairness, and this led to the conclusion that the relatively well- off on the Island should pay more than the less well-off.

Compared with most other jurisdictions, the level of income at which people first start to pay income tax is extremely high. The Committee, therefore, also believes it to be fair that some of those households which do not pay income tax should also contribute to helping to deal with the shortfall. Indeed it is almost impossible to design a system capable of generating £80-£100 million without most members of society making some contribution. Those on very low incomes should clearly be protected. The Committee concluded that keeping the basic rate of personal income tax at 20% has significant advantages for Jersey. The consultation has not led the Committee to change this view.

The Committee believed – on the grounds of fairness – that as far as possible both earned and unearned income should be taxed. The consultation has not led the Committee to change this view. Therefore on these grounds payroll taxes only affecting employees and/or employers would not provide the best solution.

Employers' payroll taxes would put up the cost of business. The consultation has reinforced the view that employer's payroll taxes would adversely affect the Island's competitive edge in the global finance industry.

It is these objectives and constraints, and the feedback which has resulted from 4 months' discussion and consultation, that have guided and reinforced the Committee's proposals.

To maximise the contribution from the well-off, while keeping the basic rate at 20%, the Committee has proposed to withdraw tax allowances from this section of the community. The effect of this will be that for those who can afford to pay, the 20% rate of tax will mean 20%. The consultation has not resulted in any significant challenge to this approach, nor feasible alternatives. The principle therefore remains.

However, the consultation did identify concern about the way in which allowances should be phased out, so that people's personal circumstances can be taken into account. The Committee is carrying out further work to find a way in which this can be achieved.

The Committee continues to favour a goods and services tax – whether it be a VAT-style tax or a sales tax – a view with which the local business community generally concurs.

The disadvantage is that it does tax those with very low incomes. The Committee takes the view that this undesirable effect can be dealt with through a modified income support scheme.

The combination of removing tax allowances from the well-off, a goods and services tax and a new income support scheme meets the Committee's objectives of maintaining Jersey's international competitiveness, diversifying the tax base to reduce the over-dependence on income taxes, being sufficiently flexible to respond to future needs and ensuring that most members of society contribute to the cost of public services.

The consultation and resulting public debate has not produced a better approach which would meet these objectives.

This Report and Proposition proposes a framework which would be capable of reforming Jersey's tax structure so that the Island retains a competitive finance industry and maintains its existing level of services and benefits without unduly damaging any section of our society.

Many of the implementation details still need to be worked out, particularly to ensure that the other objectives of efficiency and simplicity are met. The Committee will report back to the States by February 2005 when these details have been developed.

Another result of the consultation was a clear message from the business community of the Island that the worst outcome would be delay.

Again, the Committee wants to act on the outcome of the consultation.

To keep our Island competitive and prosperous, the basic framework needs to be decided soon. Background

Jersey's underlying position is strong. The Strategic Reserve stands at around £400 million. Record sums are invested in the Island. Figures published by the Jersey Financial Services Commission (JFSC) show that bank deposits alone currently stand at £156 billion. Successful negotiations with the E.U. mean the challenges faced from new E.U. laws will not start bearing down for at least another 5 years despite a much faster timetable originally having been sought.

So why is it necessary to do anything now?

• B  y acting now and planning ahead Jersey will keep its competitive edge, encouraging the financial services industry to thrive.

• T h e business community will have the certainty it needs to formulate its future plans.

• B y f acing up to these issues in good time, Jersey will keep its economy secure and will avoid far tougher choices in the future.

• P h a s ing in changes to the tax structure over the next few years means being able to spread the impact of the reforms.

• I n t h e interests of future generations the Island has to act now to raise more money to put the economy on a sound footing for the long-term. Everyone will be asked to make more of a contribution to Jersey's

future because by sharing the burden the load can be spread more fairly.

Although there are some difficult choices ahead, the Finance and Economics Committee is confident that the States can agree that the prudent course of action for Jersey is to act now to secure a bright and prosperous future.

When considered alongside the proposed reforms to the machinery of government and the aims of the Island's Strategic Plan, States Members can, with this package, create a successful economy backed by a modern and effective administration.

From the 1960s onwards, the people of Jersey have enjoyed a rising standard of living. Tax rates have been kept low at the same time as investment in high-quality public services has risen. It is the growth of the financial services industry which has made this possible.

Today it is the engine of our economy and generates two-thirds – about £250 million – of all taxes. Other industries and sectors are important, albeit they too derive much of their business flow from interaction with the financial services industry and, given the right conditions and encouragement, might be able to increase the contribution they make. However, if the Island's current way of life is to be maintained, the financial services industry must remain at the heart of the economy. Without it, tax revenues would fall substantially, public services decline, and jobs – and people – would leave the Island.

The starting point for any long-term fiscal plan for Jersey must be the preservation and strengthening of the financial services industry. For Jersey to thrive, it is essential to ensure that it remains competitive internationally and is able to attract companies to invest, do business, employ people and pay tax on-Island.

In recent years, Jersey has faced increasing competition and a number of challenges to its position from the OECD and the E.U.. Through successful negotiation, Jersey has minimised the threat it faces and bought itself more time to prepare for the future. Specifically, in the negotiations with the E.U. on harmful tax practices' Jersey achieved a recognition that in seeking to remedy the harmful features of the regimes identified in Jersey, the Island would need to undertake a significant amount of general tax reform. The E.U. conceded that, as Jersey had maintained, the degree of complexity and scope of this was such that it could not be undertaken and implemented in less than 5 years, whereas the original demand being placed on the Island would have required reform within the period 2003-2005. We now have until 2008/9 to achieve the necessary reforms which, although more manageable, is still likely to be the minimum time period necessary and which still demands a successful start to the strategy sooner rather than later.

Jersey has helped shape an outcome to these negotiations, which means that it has the potential to continue to be a world-class centre for financial services. The result of the E.U. negotiations is far better for Jersey than at one time seemed possible. Nevertheless, the financial cost to us will still be significant. The bottom line is that by 2008, Jersey may need to generate up to a further £80 – £100  million a year in taxes (or the equivalent in expenditure cuts and efficiency improvements) to balance its books.

1. T h e needtochange to 0/10% Safeguarding the Financial ServicesIndustry

International financial services are by far the most profitable of the Island's industries. They also tend to pay the highest wages.

As a result of the high level of profitability per worker – in the order of £90,000 per worker a year – and high average salaries, the total tax contribution from this industry is very considerable. In the rest of the economy the average profitability per worker is very much lower – roughly £5,000 a year. It is mainly because of the very high profits in this sector of the economy that the States are able to deliver public services broadly similar to that of the U.K. with very much lower tax rates – in particular personal tax rates.

It would be difficult to imagine an industry, other than financial services, which was better suited to a small island economy such as Jersey. It is one of the most profitable industries in the world and it uses relatively little land. Any alternative international industry that might be tempted to locate in Jersey would be very unlikely to be able to contribute so much to the economy and tax revenues. Therefore, losing the international financial services sector would reduce average wages and reduce the average profitability per worker on the Island. To continue to deliver the same public services would inevitably mean higher tax rates, for fewer people, on the significantly lower income and profits that would be left to tax.

The Committee has concluded that the future economic well being of the Island is dependent on ensuring that Jersey is, and remains, internationally competitive as a place to provide international financial services.

There are 2 key elements which influence the competitiveness of Jersey's financial services industry in the current international environment in which the industry must work. These elements have arisen independently of each other  but do  interact in terms of  the solution to be proposed to the  different  challenges  they  pose.  These 2  elements are –

• t a x c ompetition generally by rival jurisdictions competing for the establishment and/or retention of large financial services providers such as banks and fund managers; and

• c h a n ging E.U. rules on harmful tax practices, applicable to corporate taxes only, which affect the corporate vehicles used by customers of financial services providers.

General tax competition

To meet recent and growing international competition, the Committee has concluded that the rate of corporate profits tax applied to the providers of international financial services needs to be at, or close to, a maximum of 10%. This would bring it in line with what Jersey's competitors are doing (Singapore, Guernsey and the Isle of Man are moving to a rate of 10% and Dublin already has a rate of 12.5%). Above this level Jersey would rapidly become uncompetitive as a place to locate providers of international financial services. It should be stressed that this situation would have arisen irrespective of the E.U. tax rules which also lie at the heart of the fiscal strategy. In that respect, Jersey would in any event have been facing significant pressure on its revenues derived from the corporate taxes of large Jersey-based financial institutions because of the need to stay aligned with rates being offered by major competitors. The competition element is calculated to account for up to £50 million of the potential £80-£100 million shortfall identified as the monetary consequence of a move to the new fiscal structure.

E.U. rules on harmful tax practices

In addition to a competitive rate of corporate profits tax, the providers of international financial services also require the legal mechanisms to be able to deliver the type of financial services their customers require. One very important service is the provision of a corporate legal entity, resident in Jersey, that does not have its profits taxed. Such legal vehicles are currently available in Jersey through the Exempt Company structure. However, these company structures are not available to Jersey residents. International pressure, particularly from the E.U. and the U.K. resulting from the initiative on harmful business taxation (known as the Code of Conduct on Business Taxation), means that we can no longer maintain this discrimination. Failure to address this issue could well result in action by the U.K. or the E.U. which would very seriously undermine the ability of international financial institutions to continue to operate from Jersey. Again the consequences for the Jersey economy would be serious.

In order to ensure that the providers of financial services can provide the products they need for their international customers, the facilities of the existing Exempt Company structure will be made available to residents as well as non-residents of the Island. This will be achieved by introducing a general rate of corporate profits tax in Jersey of 0%. This removes the discrimination between companies with resident and non-resident shareholders, and hence removes the threat of unilateral action by the U.K. and E.U.

However, in order to safeguard as much as possible of the tax revenue generated from corporate profits tax, those entities regulated by the JFSC, and a few others, will be excluded from the 0% rate and a higher rate applied to them. In particular the 10% internationally competitive rate will be applied to the financial services sector.

Implemented in this form, the E.U. harmful tax rules element is calculated to account for up to around a further £30  million of the potential£80-£100  million shortfall identified as the monetary consequence of a move to the new fiscal structure.

It is a feature of the way the E.U. interprets its approach on harmful tax practices that a top-up' sector at a higher rate of corporate tax (10%) than is the general rate in the economy (0%) should be acceptable. It is nevertheless important to consider 2 further points in this respect, one of which legitimises the higher rate, and the other which limits the wider application of a 10% rate in the Jersey economy –

• I t i s considered acceptable to have a higher rate in the economy than is the norm on the basis that the sector chosen is effectively being discriminated against' compared to the general rate of corporation tax

applied.

• I n o rder to justify that the general rate is indeed 0%, it may be unwise to seek to add any additional

sectors to that defined for financial services and subject to the higher 10% rate. This would call into question the viability of the general 0% structure which, as can be seen, is vital for the separate purpose of maintaining the benefits of Exempt Companies by another method.

The Committee has concluded, therefore, that in order to keep the financial services sector competitive, the zero profits tax legal entity must, in general, be made available to all companies, irrespective of the place of residency of the beneficial owners. This involves setting the general rate of corporation tax at 0%.

These 2  measures will, inevitably, lead to a substantial loss of tax revenue from the current economy. However, the Committee has concluded that the alternative of leaving the current tax structure unchanged would result in a considerably worse outcome. The financial services sector of the economy would become uncompetitive in its international markets, and companies would move to more competitive jurisdictions. This process of moving both jobs and business to more competitive jurisdictions is not just a theoretical threat, but can already be seen to be happening worldwide as mobile business, such as financial services, seeks to maximise its advantages in terms of differential costs, of which labour costs and total tax burden are 2 key determinants in location decisions.

Some attention has been given to the durability of a 0/10% corporation tax structure in a fast-changing world. The E.U. agreement specific to our proposals is contained in the record of the meeting of the combined E.U. Finance Ministers, known as ECOFIN, on 3rd June 2003. These ECOFIN Council Conclusions recognise the acceptability and timescale for implementation of the 0/10% proposals to the European Union, which throughout the negotiation process had also gained the full support of the United Kingdom Government. It should be stressed, however, that the proposals from the side of the States of Jersey were presented as subject to the approval of this Assembly. For this reason the present proposition hereby invites States Members to put in place the final element to formalise the ECOFIN agreement of 3rd June 2003 and to create the full certainty on future corporation tax structure for the Island which our business community urgently requires.

It must be acknowledged that future developments within the E.U. or in other international bodies, or even matters involving individual countries, could evolve over time to bring the 0/10% structure back for further debate. However, we have received specific assurances from the U.K. Government that the issue at the heart of these reforms is one of perceived harmful tax practices, i.e. discrimination in tax treatment between different types of company and differing residence of shareholder, and that in our proposals we have addressed these issues. In addition, we have been assured by the U.K., the E.U. and the OECD in different discussions that the various international initiatives on taxation with which we are involved do not have the harmonisation of tax rates as their objective. Second, the U.K. Government, together with other like-minded nations such as the United States, Australia, Canada, Ireland and some others, are clearly working to an agenda which recognises and espouses tax competition internationally as the acceptable norm. Given that the 0/10% structure is inherently about tax competition then alignment with those countries on the acceptability of the tax competition approach should provide some comfort as to the potential durability of the proposed 0/10% solution.

Some attention has been given to the prospects for defying the E.U. rules – since Jersey is not within the E.U.'s fiscal territory – and therefore avoiding the need for change contained within the fiscal strategy. The Committee strongly believes that this would be contrary to the interests of the Island and regard the following as the principal reasons for this stance –

• T h e E.U. element of the proposed changes only accounts for some £30 million of the identified£80-

£100  million shortfall identified as the monetary consequence of the proposed change in the Island's fiscal system. The remaining part is derived from downward pressure on corporate taxes generally from increasing international competition. A policy of refusal to consider aligning ourselves with E.U. rules which, even on the best possible outcome, might result in addressing less than 50% of our actual problem would not seem to represent an acceptable balance between risk and reward.

• J e rs e y is positioned on the periphery of the European Union and conducts much trade with it and derives

significant opportunities from such positioning to develop financial services and other business with E.U. nationals. A policy which contemplates not just isolationism in this respect, but also one which would have the effect of undermining the E.U. Code of Conduct exercise, with attendant damage to the U.K. relationship with its E.U. partners, would seem again to represent a very high-risk approach.

• T h e United Kingdom is determined to ensure compliance by its Dependent Territories with the E.U. Code

of Conduct with similar pressures faced both by Guernsey and Isle of Man in this respect. Although there are constitutional arguments to invoke to resist this, Jersey has already seen the U.K. prepared to contemplate a highly pressurised approach to forcing this compliance with threats of unilateral action by them against the Island to achieve such an outcome should the Island ignore the Code of Conduct requests. One such measure would be the revocation of the exemptions permitted to Island-based businesses within the U.K.'s Controlled Foreign Companies legislation. Such revocation would have a rapid and detrimental tax impact on all U.K.-owned businesses in the Island and probably force them to re-evaluate their options for representation on the Island over time. Where this would create most immediate concern would be in the banking sector with a handful of large U.K.-owned banks accounting for a very high share of the Island's direct tax revenues and nearly 50% of the Island's financial services workforce. There are other areas where the U.K. could take unilateral economic actions with severe consequences for Jersey, such as in withdrawing existing double tax exemptions, and the possible implementation of withholding taxes on inter-bank deposits by Jersey-based institutions into the U.K. All such measures are potentially serious for any large U.K.-owned business, particularly in financial services, in the Island. Therefore, they do not in the eyes of the Committee represent an acceptable balance of risk if our policies were to invite their implementation or even threat, recognising that business cannot function well in the face of uncertainty and that threat alone may be sufficient to create such uncertainty and attendant adverse economic decision making.

Consequences of delaying decisions

A final, but vital, component of the need for change is the requirement to act quickly and decisively. Whilst the Island was successful in winning a longer period to enact tax reform than had originally been likely, there is no doubt that competition for financial services business worldwide is accelerating, based in no small part on the attraction of low rates for providers in key competitor jurisdictions and the absolute minimum requirement of being able to continue to provide tax neutral vehicles to global investors by finding a solution to replace the Exempt Company structures on which so much of the business flow of our financial services industry depends.

Business in the Island will not welcome any drawn out period of uncertainty regarding the Island's recognition of these challenges and the willingness to address them quickly. Customer business can be lost unless certainty of applicable tax treatment can be given on any given structure for the whole of its intended life span – sometimes up to 20 years. Separately, large multi-national financial services providers, who are represented in Jersey and in many of our competitor jurisdictions at the same time, have many options for switching business, capital and jobs at a rapid rate away from the Island to such competitor jurisdictions with relative ease. It should also be borne in mind that once such economic activity is lost by Jersey to competitor places then it is unlikely to return in the future without a very compelling reason to do so – if at all.

The potential impact of not adopting 0/10%: Jersey without an International Financial Services Industry

In considering its options, the Committee has looked at how the Island's economy might look in the absence of the international financial services industry at its present level. This might be the outcome if the States failed to introduce measures to reform the corporate structure in response to the changes which are taking place in competitor jurisdictions. It looked particularly closely at that part of the financial services industry that provides services to the international markets including those serving non-resident clients. This industry is highly mobile and it would probably be that the most profitable parts that would leave first if the Island's corporate tax structure became uncompetitive. There could be a substantial change in the structure of the financial services industry in the Island within a relatively short period.

There would be a major shock to the Island's economy during the first few years after companies had gone, though they would be unlikely to leave the Island at the same time. The loss of some companies could have a bigger effect on the overall economy than others. The following effects would be likely to be felt in the Island during the first few years after the shock of the emigration of these key companies –

• E m p loyment in financial services would fall from today's level of 12,000 jobs to 1200-1500 jobs;

• a la r ge fall in demand for goods and services (for example in the shops) since employees in the financial services industry have the highest disposable incomes and spending power;

• e m p loyment outside the financial services sector would also fall. Significant unemployment outside the financial services sector would be likely;

• p ro p erty prices would fall and the age structure would alter as younger people would be likely to dominate the leavers, or those who would no longer choose to stay in or come to the Island;

• t o ta l population would fall, and the fall could be considerable – possibly by 20-22,000 (with the working population falling by 14-16,000);

• u n d e r the current tax structure, States' revenue could decline by £250-£300 million per annum compared to the present total of £450 million;

• i f c u rrent levels of services were maintained, States' spending could fall by much less (perhaps only by £100 million or less) because it would tend to be older residents who would remain in the Island. The immediate liability for States' pensions would hardly fall at all;

• t h e p otential deficit in the States Budget could amount to £200 million in each and every year;

• t h e p otential tax base on which to make up this shortfall would be much smaller than it is now;

• t o m eet any shortfall by tax increases or service level reductions would require higher tax rates, or deeper

cuts, than meeting a similar shortfall from the current tax base.

The Island would probably begin to recover after this initial shock, but the economy would look very different from the way it does now. Exactly how the economy would look would depend on what, if anything, replaced financial services. In the absence of a replacement the following chain of events would be likely to unfold after the first few years following the shock –

• W  a g es in the Island would fall as firms would be able to offer lower wages with the rise in unemployment and in response to the decline in overall profitability;

• t o m aintain anything like the current population, an alternative export industry would be required. This industry would need to be one where any additional costs arising from Jersey's physical location were at least off-set by some cost or quality advantage of operating from the Island;

• a s s u ming such an industry could be found, output in the Island would start to recover, though almost certainly with much lower levels of profits and wages compared to now;

• p o p u lation would stabilise, and might even start to grow again, though the new people coming into the Island would have a different set of skills;

• h o u s e prices would stabilise, but very likely at levels considerably lower than now. It is likely that many younger people would find that their mortgage debts were larger than the (now lower) value of their

properties.

If the population had fallen significantly (which is likely), it might take a considerable time for property prices to recover. The problem of "negative equity" in property could last for a considerable time. The reduction in both property prices and wages would make tourism and, possibly, agriculture more competitive. In the absence of a significant new industry they would probably become the dominant industries again in Jersey.

Unless any new industry was capable of generating similar tax revenues for the States and wages for residents it would not be possible to maintain the current position of low tax rates with similar public spending per head as the U.K. Either tax rates would need to increase very significantly (i.e. up to the equivalent of U.K. rates) or public services would need to be cut drastically. If the former was adopted, high-income residents, particularly those with significant investment income, would be discouraged from remaining in Jersey because of the higher tax rates. To the extent that such residents left the Island this would lead to further downward pressure on tax revenues.

Exactly where the economy would end up is impossible to predict with any accuracy as there are too many unknowns. However, the typical pattern for small Island economies is that they tend to have lower average (economic) standards of living than their relevant mainland'. Among other things, this reflects the additional transport costs of getting to and from the Island. The exceptions are where the Island has some clear and significant underlying economic advantage over the mainland. In the case of Jersey there is currently little evidence that the advantages of the Island for agriculture or tourism are that significant. The economic value of the Island's characteristics for these 2 industries may, therefore, be limited. As a result, levels of Gross National Income per head might fall from the present level of £24,000 to £25,000 (in 2003 – based on £21,000 in 1999 and inflated by 4% per annum) to around or below the average U.K. level – £18,000 (2002), once the economic adjustments had worked through the Island.

The delivery of the current level of public services combined with the current tax structure could result in a deficit in the States Budget of around £200 million every year. This is not sustainable, even in the short term, so some very large adjustments in either taxation or spending would be needed.

Conclusion

In the absence of a high-profit, high-wages alternative, the flight of international financial services from Jersey would lead to an economy that could not sustain the current public services on the current tax structure.

This loss of tax revenue would be likely to be bigger than the shortfall produced by altering the tax structure to meet the changing competitive conditions in international financial services, and thus keeping this business on Jersey.

In addition, the total economic activity on the Island would be likely to be lower, but with a less than proportionate decrease in the demand for public expenditure (including States' pensions). The net result is that for any given level of public services delivery, tax rates for residents would be likely to be significantly higher in the absence of the international financial services business.

2. M i tigating the loss of corporate tax revenues

The estimated loss of some £80 – £100 million in tax revenues arising from the move to 0/10% is likely to be a worst case scenario which can be broadly categorised as follows –

International business companies – up to 10%. Many of the international business companies who pay substantial tax revenues are already close to an effective rate of tax of 10%, so the majority of that business should stay once the proposed 10% rate is introduced, but a few may well go.

Exempt Companies – up to 10%. This relates to the loss of the exempt company fee of some £10 million as they will all be categorised as zero rate. However, it should be possible, subject to international competitive pressures, to recoup this loss through, for example, increasing the annual filing fee.

Non-finance business. In broad terms, some 40% of the potential loss relates to non-finance business. Some 20% to 30% relates to non-finance business trading locally whose shareholder base is outside the Island and the balance (10% to 20%) relates to locally owned business.

Finance industry companies. The majority of the loss, perhaps 50%, is estimated to come from income tax companies involved in the finance industry currently paying at an effective rate of tax close to the standard rate of 20% which will fall to be taxed at 10% under the proposals.

The above represents an analysis of a constantly changing picture, and although carried out many months ago on the basis of the tax information available at that time, the Committee is confident that it does remain a realistic estimate of the size and nature of the potential problem.

2. Minimising the potential tax loss throughlookthrough' provisions

It will be possible to contain the loss of tax from locally owned businesses to the levels shown above by taxing the Jersey resident participator of such a company on the actual profits of the company under look through' arrangements.

In essence, the profits arising to a Jersey resident corporate will be imputed to any Jersey resident participator in proportion to his participation in the corporate so that any Jersey resident participator who has the income of the corporate accruing to him, no matter how many structures or other corporates or trusts are placed between the Jersey resident participator and the Jersey corporate, will be assessed on that person as personal income.

The corporate income that accrues to a Jersey resident participator will be defined in the Income Tax (Jersey) Law 1961 as amended and will have a wide meaning attributed to it.

All Jersey residents will have to declare on their Income Tax Returns all of the corporates in which they are a participator, whether Jersey or foreign corporates, as well as declaring the profits which accrue to them in all these corporates in proportion to their participation in each of them.

Prior to the introduction of the new regime, and by virtue of new powers to be introduced into the Income Tax Law, a return will be issued to all Jersey resident taxpayers, asking for a declaration of all the Jersey resident corporates, as well as all the foreign corporates, in which the Jersey resident has a participation. The return will also ask for a declaration of all trusts, including offshore trusts, in which the Jersey resident taxpayer has an interest, whether as settlor or beneficiary, and whether he has, through that trust, an interest in any Jersey resident corporate, foreign corporate or a similar structure.

The Jersey resident corporate will also be required to make a declaration on the Income Tax Return issued to it, by virtue of new powers to be introduced into the Income Tax Law, of the names and addresses of all Jersey resident participators in the corporate.

A Jersey resident participator in a foreign corporate will also have the corporate profits of that foreign corporate imputed to him in proportion to his participation in that foreign company. Where a Jersey resident is a participator in a non-resident corporate and his participation in that corporate and the corporate itself has been established for a bona fide commercial reason and not designed in any way for the avoidance of Jersey tax, the corporate profits will not be attributed to that Jersey resident participator but all dividends received by him from that non-resident corporate will be charged to tax under Case  5 of Schedule  D. The Jersey resident individual will need to satisfy the Comptroller of Income Tax that his participation in that non-resident corporate and the corporate itself is for a bona fide commercial reason and not designed in any way for the avoidance of Jersey tax, so he will need pre- clearance of any and all such transactions from the Comptroller.

There will be a de minimis' limit, yet to be decided but likely to be around 2% – 5%, so that those Jersey resident participators with a participation of less than that de minimis' limit in a corporate will not have the corporate profits applicable to that holding imputed to him.

Special purpose vehicle companies used, for example, in off-balance sheet' financing, are typically owned by the trustees of a charitable trust and the company in question is commonly referred to as an orphan'. The profits made by the trustees are paid to charities or applied for charitable purposes so these profits will not be imputed to the Jersey resident trustees, or, where the trustee is a company, to that company's Jersey resident participators.

Penalties will be imposed, under revised Articles 136 and 137, on any taxpayer who makes a false declaration in relation to these new provisions.

(b)(ii) Possible withholding tax on profit distributions by non-Jersey owned companies

It is a direct consequence of the zero tax strategy that companies operating in Jersey which are owned by non- resident shareholders pose a much more difficult challenge to any proposed look through arrangement similar to that proposed for Jersey resident shareholders. In the first place this is because those shareholders resident outside the Island are not in the ordinary course assessable nor chargeable to Jersey tax on any dividends or other profit distribution that they receive. This admittedly creates an imbalance in terms of available tax recovery measures with non-resident shareholders arguably enjoying an advantage over their Jersey resident counterparts. However, whilst this may be the case purely in terms of what takes place in Jersey itself it does not represent the full picture of those non-Jersey based shareholders' full liabilities. This is particularly the case for U.K.-owned businesses, which account for the vast majority of locally operated businesses outside the financial services sector which are owned by overseas residents, either corporations or individuals. The Committee has therefore focused primarily on such U.K.-owned businesses in considering the issues raised.