Shadow Scrutiny Panel report on GST SR6/2005

Scrutiny Report

Proposed Goods and Services Tax

eptember 2005

6/2005

CONTENTS

1. PANEL MEMBERSHIP......................................................................................... 3
2. OPENING STATEMENT....................................................................................... 4
3. RATIONALE FOR THIS REVIEW......................................................................... 5
4. TERMS OF REFERENCE –................................................................................. 5
5. ADVISORS............................................................................................................. 6
6. PUBLIC HEARINGS.............................................................................................. 7
7. WRITTEN SUBMISSIONS –................................................................................. 9
8. FINDINGS OF THE SCRUTINY PROCESS:.................................................... 10
9. CONCLUSIONS................................................................................................... 15
10. RECOMMENDATIONS..................................................................................... 16
11. APPENDIX......................................................................................................... 17

1. PANEL MEMBERSHIP

The Shadow Scrutiny function was established by the States of Jersey as part of the reforms of the Machinery of Government. The principles and guidelines of Shadow Scrutiny in Jersey are set in the report and proposition of the Privileges and Procedures Committee P.186/2003, adopted by the States on 27th January 2004.

The Panel was constituted as follows–

Deputy R.C. Duhamel (Review Chairman) Senator E.P. Vibert (Lead Member) Senator J.A. Le Maistre

Deputy F.J. Hill, B.E.M.

Deputy P.J. Rondel

Deputy G.C. L. Baudains

Senator E.P. Vibert withdrew from the Review due to ill-health from 22nd June 2005. Deputy G.C.L. Baudains resigned from Scrutiny on 17th May 2005.

Officer support: Mr. C. Ahier and Mrs. C. Le Quesne, Scrutiny Officers.

2. OPENING STATEMENT

The Scrutiny Panel began its initial investigations by considering the Finance and Economics Committee's Report and Proposition (P.44/2005) entitled Fiscal Strategy' lodged au Greffe' on 8th March 2005. That document referred to an Act of the States dated 29th June 2004 in which the States had agreed that it would take steps to maintain a strong and competitive economy and to provide high quality public services. It also referred to an Act of the States dated 7th July 2004 in which the States had charged the Finance and Economics Committee to research measures to mitigate the loss of taxation revenues as a result of the agreed changes to the corporate taxation structure. The aforesaid Fiscal Strategy proposed a broad-based Goods and Services Tax (GST) to be introduced in 2008 at a rate of 3% to be fixed for a period of at least 3 years.

The proposition outlined the suggested changes to the way that Jersey might raise its taxes. The States had agreed when it considered P.106/2004 that in 2008 it would introduce a new 0% standard rate of corporate profits taxation, with a 10% rate of corporate profits taxation for companies in areas such as the financial services sector. These measures were proposed to bring the Island into line with other providers of international financial services. The aim of the change would be to safeguard the economy as a result of Jersey's tax take being expected to fall by £80-100 million per annum by 2010.

The Panel considered extensive background documentation, including the Oxera and the Crown Agents reports which are available to view on Customs and Immigration Website: http://www.gov.je/taxandspending/index.asp:

Evidence received and further background information is available on the States of Jersey Scrutiny Website at www.statesassembly.gov.je and a list of all documents considered is attached as appendices to this report.

3. RATIONALE FOR THIS REVIEW

The Panel decided to undertake a review of 0/10 proposals together with the Goods and Services Tax (GST) in order to clarify the reasons for the need firstly to move to a 0/10 rate of taxation and to assess whether or not the GST option would be an appropriate solution to the predicted deficit. It would also seek to ascertain whether Jersey would be compliant with E.U. rules if it were to pursue 0/10. The Panel was aware that some members of the public had expressed concern about the proposals with regard to issues of regressive taxation and compliance to European Union and United Kingdom legislation.

The Panel has decided to issue an interim report based on the work undertaken to date. It recognises that a significant amount of work remains to be carried out to provide answers to all of the questions raised in the first part of the review. It is hoped that, as a result of a completed review, States members will be better informed about the issues involved when the draft Goods and Services Tax Legislation comes to be debated in the States.

4. TERMS OF REFERENCE –

1. To review the economic and fiscal environment that has led to the need to consider the introduction of a Goods and Services Tax particularly in respect of:

1. recent events within the European Union;
2. recent events within the financial offshore community;
3. the consequences of moving to a 0/10 tax structure;
4. the consequences of not making such a move.

2. To review the specific proposals put forward by the Finance and Economics Committee to introduce a Goods and Services Tax particularly in respect of:

1. the level of tax;
2. the range of goods and services covered by the tax;
   3. the administrative arrangements required to collect the tax, including arrangements to collect tax on goods ordered by mail or over the Internet;
3. the impact of the tax on various sectors of the community.

5. ADVISORS

The Panel engaged the following advisers to assist it with the review –

Mr. Paul Frith, Fellow of the Chartered Institute of Taxation, Member of the Society of Trust and Estate Practitioners.

Mr. Richard Murphy, BSc, FCA, Chartered Accountant, Director, Tax Research Limited. The appointment process

The Panel approached a number of official bodies including The Chartered Institute of Taxation (CIOT) and the Institute for Fiscal Studies (IFS) to identify potentially suitable individuals to undertake the role of advisor for the review.

In this instance the organisations approached were unable to assist in the identification of a suitable individual due to time constraints. The Panel also approached individuals from the local finance industry to assist them in the selection of potential advisors. Both of the review advisors were selected upon recommendation and were appointed on the basis of their individual expertise in addition to their availability. The Panel interviewed both advisors prior to their engagement.

Advisor selection

The Panel received correspondence expressing concern over the selection of Mr. Murphy as one of its advisors. The Panel responded to the concern, following consultation with the Privileges and Procedures Committee and it decided to retain the advisor of its choice. At the time of the appointment of its advisor, the Panel was aware of his views on the local tax position; however, it did not consider that the outcome of the review could be pre-judged on that basis. The Panel retained the services of Mr. Paul Frith, a locally-based professional to ensure an alternative view and to provide what it considered would be a balanced approach to the review. This model of two advisors working on other reviews with differing views or perspectives had previously been successful. The Panel was of the opinion that it was difficult to identify an expert individual who would not have made a statement in public on one side or another on this important subject.

6. PUBLIC HEARINGS

Full verbatim transcripts of the public hearings are available on the Scrutiny website at www.statesassembly.gov.je or through arrangement with the Scrutiny Office.

The following witnesses attended a public hearing on 16th June 2005 –

Senator T.A. Le Sueur , President, Finance and Economics Committee; and Mr. C. Powell, former Chief Advisor to the States.

The following witnesses were scheduled to attend on 11th July 2005 –

Mr. J. Laity, Institute of Directors;

Senator F.H. Walker , President Policy and Resources

Committee;

Mr. W. Ogley, and Mr. J. Harris ;

Mr. D. Wild, Mr. A. Ohlsson, Mr. J. Shenton, Mr. J. Riva,

Working Party Representatives, Jersey Finance Limited; and

Mr. B. Henkhuzens– Jersey Chamber of Commerce. Hearing deferral and subsequent suspension of the review

The Panel made the following statement on that day and deferred the hearing until further notice.

"The Shadow Scrutiny Panel chaired by Deputy Rob Duhamel convened at 8 a.m. on 11th July 2005 to discuss correspondence received at short notice from the Institute of Directors (IOD). The IOD advised the Panel that they were unable to attend as they had found that the two-week period of notice had proved to be an insufficient time in which to prepare for the hearing. They also expressed reservations regarding the make up of the Panel."

Following the deferment of the Hearing the Panel discussed whether –

1. there would be sufficient time to reschedule Public Hearings and the opportunity to call witnesses to attend;

3. the summer recess for States members would render the Panel inquorate;
   1. the heavy workload of States business from September and the full evaluation of Shadow Scrutiny process would not allow sufficient time for the review to be properly concluded;
4. the temporary suspension at this point in the review would provide the new scrutiny process with important information on the vitally important questions that remained to be addressed in respect of both the black hole' and GST.

The Panel decided to produce an interim report based on the written submissions following its call for evidence, together with the oral evidence it had received at its first hearing.

The Panel discussed how the selection of the review had provided significant challenges to the Shadow Scrutiny process, and therefore had raised important issues which would require addressing to ensure that Scrutiny could operate fully and effectively with Ministerial Government.

The Panel agreed that this particular review subject had been an important matter, and that the difficulties in seeing it to its conclusion in the time available had identified the need for Scrutiny to be in a position to set and develop its work programme and select review subjects. The review had also shown the level of expertise members required in order to successfully undertake a specialised review subject. It had also identified the need for Scrutiny to be provided with the necessary powers to require the provision of documents and the attendance of witnesses at Public Hearings.

7. WRITTEN SUBMISSIONS –

The Panel received the following written submissions listed in date of receipt order. They are available to view on the Shadow Scrutiny Website –

26.04.05 Mr. Chris Parlett;

26.04.05 Dr. R.A. Kirsch;

28.04.05 Mr. John K. Shield;

28.04.05 Mrs. Lyn Viney;

13.05.05 Mr. David Wild, Jersey Finance;

15.05.05 Mr. Chris Whitworth;

16.05.05 Mr. Robert Andrew Brown;

17.05.05 Mr. I. Ridgway, Finance Director, Jersey Post;

19.05.05 Mr. Craig Leach;

5. Mrs. K. Stevens;
   6. Mr. Colin Powell;

06.06.05 H.M. Attorney General, Mr. W.J. Bailhache , Q.C.;

08.06.05 Mr. Malcolm Campbell, Comptroller of Income Tax;

08.06.05 Mr. Mike Robinson, Customs and Excise;

09.06.05 Mr. Dougie Peedle, Economic Advisor;

13.06.05 Senator T. Le Sueur , President Finance and Economics Committee;

14.06.05 Senator F.W. Walker , President Policy and Resources Committee;

15.07.05 Mr. Preston Hobbs.

8. FINDINGS OF THE SCRUTINY PROCESS:

The written evidence received expressed concern over the possibility of the proposals within the Fiscal Strategy not being compliant with the European Union Code of Conduct.

Of particular concern was the proposed provision for look-through' as explained in a submission from Mr. R. Brown –

the OECD dictum would demand that a zero corporation tax is applied equally to both residents and non-resident. Jersey residents will be subject to a look-through tax. Non-residents will not be subject to such a look-through' tax.'

This view was supported by the Panel's Advisor Mr. R. Murphy, who suggested that the proposed look-through would be unacceptable due to non-compliance to the E.U. Code of Conduct on Business Taxation due to it possibly being perceived as a form of ring-fencing.

The concern was expressed in Mr. Murphy's report dated 15th June 2005 as follows–

Any system that breaks down that divide for a selected group of share-holders defined solely on the basis of their residence appears to create a ring-fence.

When that ring-fence acts to the detriment of resident-owned companies to ensure the protection of domestic revenues, as is undoubtedly the case in the proposed look-through' tax in Jersey, then it is apparent that the E.U. Code has been broken.'

The full report is available on the Scrutiny website.

The Panel explored the issue of compliance with the E.U. Code in respect of the proposed look-through' as outlined on page 46 of the Fiscal Strategy (P.44/2005) and the following evidence was received from Senator Le Sueur as a result of questions from the advisors in relation to the amount of discussion with the E.U. and the U.K. on the acceptability of the 0/10 proposals–

Mr. Frith If I could just quote from that, it says: "Some attention has been given to the durability of the 0/10 corporation tax structure in a fast-changing world. The E.U. agreement specific to our proposal 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 recognised the acceptability and the timescale for implementation of the 0/10 proposals to the European Union."

Now, it seemed to us in reading this and your comments recently that the fundamental issue which has been raised by Mr. Murphy has actually already been covered and agreed, but it does seem now that what you are saying is that, whilst the principles are understood, there has still got to be some refinement possibly in terms of the final legislation. So it seems that we are at the position at present where we still do not know for sure whether Jersey's proposals will in fact satisfy the E.U. Do you think that is a fair comment?

Senator Le Sueur : No, I don't, because I think the E.U. is concerned with the general principle of a rate of zero tax across the board, with a limited exception. I think how that is implemented is not a question which that Ecofin document covered on 3rd June certainly. At that stage, we hadn't even thought how we might address the issue, so I am sure it wouldn't occur to them to put it into a document. I would in fact say that that document is a very general document, which would be quite hard to

read and understand. It is not addressed simply to Jersey, but it is a general statement of

principle for all territories. So I think one shouldn't try to read into that document more than there can reasonably be expected to be. Anything that happens to implement either the zero or the ten will need to be consistent with the principles which earlier Mr. Murphy put down.

Deputy Duhamel: Does Mr Murphy wish to come in?

Mr. Murphy: Well, to some extent, Senator Le Sueur has now actually answered the point that in fact I was anticipating putting, which is about the fact that there is obviously the forward-looking part of this, and it seems that, therefore, there is this two-stage process of approval here. On 3rd June 2003, it seems very likely that Ecofin did -- I don't think there is any dispute -- agree that Jersey had accepted that it would get rid of all unacceptable practices.

Senator Le Sueur : Yes.

Mr. Murphy: And there is a record of that.

Senator Le Sueur : Yes.

Mr. Murphy: But it didn't actually approve look-through, for example, did it?

Senator Le Sueur : It didn't specifically approve look-through. I don't think it would have been likely that it would have been put to them.

Mr. Murphy: Right, but I have had it said to me by some people in Jersey that it did specifically approve look-through, by people who were apparently quite close to that discussion, but that is not true, it did not approve look-through?

Senator Le Sueur : As far as I am aware, but if someone with experience and in authority is telling you differently, then maybe they are right. But, as far as I am concerned, there is a limit to what that document says.'

The written and oral evidence received supported that the outline proposals for a new tax system made by Jersey to the E.U. in June 2003 did, in principle, comply with the requirements of the E.U. Code of Conduct on Business Taxation, namely, look-through' taxation, the 0/10 proposals and a Goods and Services Tax. However, none of the detail of these proposals had been submitted to either the U.K. or the E.U. for consideration as they were currently only overarching principles. There was no evidence to confirm that the proposals would or would not be acceptable to the E.U. subsequent to that detail being finalized.

It was confirmed by Senator Le Sueur that the proposals approved by the States in May 2005 had not been sent to the U.K. government for approval.

The Panel Chairman asked of Senator Le Sueur –

Question: Have any meetings actually taken place with any U.K. or E.U. authorities to actually determine whether or not the compliance is actually acceptable to those authorities?'

Response: the indication I have is that these proposals are commonplace elsewhere and are within the spirit and acceptable to the E.U. Whether any meetings have been held, I can't say. I certainly have not been privy to any myself.'

The Panel had previously requested meeting notes or correspondence relating to contact with U.K. authorities in relation to compliance to its own and E.U. requirements. No documents or information had been forthcoming in this connection. The Panel faced difficulty in undertaking its review when not all documentation had been made available, particularly as it had offered to deal with any confidential issues in closed session.

The Panel was advised by Senator Le Sueur that the look-through' provisions may not operate as suggested in the proposals approved in May 2005 and may instead require each individual shareholder to declare the share of the taxable profit attributable to them in each company in which they own shares on their personal tax returns, without tax having previously been paid by the company on their behalf. This would have serious resource implications for both the States and taxpayers. It was accepted that a final decision and extensive consultation would be required prior to the final draft legislation being made available.

The Panel remained concerned that the arrangements for look-through' might not be acceptable to the E.U., although it accepted Senator Le Sueur's assertions that there was–

a tremendous amount more to be done yet. That will need to have the involvement of no doubt tax professionals, law professionals and maybe people from the E.U. to make sure it is compliant with that, with Human Rights and everything else. Yes, one of the reasons for debating the Fiscal Policy so early is that we know there is still a lot of work to do on detail, of which this is just one example of many.'

Other general issues raised were the regressive nature of Goods and Services Taxes, on the basis that lower income groups spent proportionately more of their income on essential items that would become subject to the tax, together with the potential negative impact on those lower income groups, and the areas of exemption inclusive of small businesses. This concern was reflected in the submission from Jersey Finance dated 3rd December 2004, although it was stated that the proposal would be acceptable subject to adequate safeguards being put in place for low-income groups. The following statement was made in the submission –

GST is generally regarded as a regressive tax, in that it applies to all consumers of goods and services, and will have the greatest impact (in percentage terms at least) on individuals and households with lower income levels. Accordingly, appropriate safeguards will also need to be introduced to protect low income groups. In that regard we endorse the proposals to review and reform income support measures for such groups.'

The difference of approach between Jersey and Guernsey and the resulting proposed solutions were questioned in a submission from Mr. Parlett, who contended that the difference in deficit between the two Islands was as a result of methods of calculating capital expenditure.

The Panel was provided with both written and oral evidence which suggested that Jersey had been under a considerable amount of pressure from the United Kingdom to comply with the European Union Code on Business Taxation. Evidence was received that confirmed that Jersey had given irrevocable undertakings to the E.U. under pressure from the U.K. to commit itself to compliance with the E.U. Code of Conduct on Business Taxation. The evidence was in the form of correspondence dated 15th October 2002, between the then President of the Policy and Resources Committee and Ms. Dawn Primarolo, Paymaster- General, H.M. Treasury. Within that correspondence there was an agreement by Jersey to remove the "harmful" tax practices as identified by the E.U., together with a further assurance that it would introduce no new tax practices which breached the spirit of the E.U. Code of Conduct on Business Taxation.

In the oral evidence received from Senator Le Sueur , he confirmed that Jersey had agreed that it would remove any items included in the rollback' section of the code and which outlined practices unacceptable to the E.U. and that with regard to the section to the Code entitled standstill'. It would not introduce any new laws which offended the Code. The proposed look-through' provision was raised as a potentially non-compliant proposal. The suggested non-compliance to the E.U. Code would be on the basis that the practice would ring-fence an advantage from the domestic market, so that it would not affect the national tax base. This interpretation was considered to be subjective by Senator Le Sueur , who did not concur with the view. He asserted that the proposals were just that, and that a significant amount of work remained to be done with regard to the detail and drafting of the legislation that would be required.

The Panel discussed with Senator Le Sueur the criteria for companies paying the proposed 10% rate in the context of a written submission from Jersey Finance, and during the oral evidence it was noted that regulation by the Jersey Finance may not be the criteria for companies paying the 10% tax rate. It was noted that areas of exemption remained to be finalized.

The Panel was apprised by its advisor that the United Kingdom has passed legislation that it could impose on companies with subsidiaries in Jersey, should it fail to co-operate with it over the implementation of the changes required by the E.U. Code of Conduct on Business Taxation, or if it introduced new measures that failed to comply with that Code. That facility is contained within the U.K.'s Controlled Foreign Company legislation.

The Panel explored the estimated "tax gap" outlined within the submission from Senator Le Sueur , which suggested that it may be up £110 million. This was refuted by Senator Le Sueur , who maintained that the estimate was between £80-100 million. It was accepted by the Panel and Senator Le Sueur that there was no guarantee that the GST rate would be maintained at 3% in the long-term, and that the percentage rate would remain open to review along with other taxation method options.

The Senator stated in respect of the tax gap' and the level of GST required –

Yes, it is, and certainly from our point of view we have said, and I stand by that figure, that 80 to £100 million is the right sort of estimate. But we are not going to know until about 2012 just what the overall effect has been, and it will be at that stage that we will be in a better position to assess whether a GST rate of 3% is adequate.'

The Panel discussed with Senator Le Sueur and Mr. C. Powell the issue raised in some submissions from finance professionals that Jersey-registered Special Purpose Vehicles (SPVs) were not taxable on the basis that they did not trade in the Island. However, it was suggested in the Jersey Finance submission that they do in fact supply services to each other within Jersey. The Panel questioned both witnesses as to whether the correct taxation treatment was currently applied to SPVs and discussed the discretionary powers afforded to the Jersey Financial Services Commission in respect of determining whether a company would be taxed or not. Following the hearing the Panel agreed it would require further clarification on the issue. The Panel was provided with an explanatory note from Mr. Powell dated 26th July 2005, outlining SPVs where they fall within the scope of regulation as applied by the Jersey Financial Services Commission, together with the legal definition of an SPV which is outlined in a schedule of the Financial Services (Jersey) Law 1998. The Panel suggested that further analysis of this issue should be undertaken.

9. CONCLUSIONS

The Panel agreed to suspend the Review due to the reasons given earlier in the report and especially due to difficulties in obtaining the information requested. The Panel was aware that it had only had the opportunity to begin examining the first part of its Terms of Reference, namely the issues relating to the economic and fiscal environment that had identified a need to consider new tax arrangements. That should have led to a review of proposals for the introduction of a Goods and Services Tax; however, the Panel had not begun to address any arrangements or proposals relating to the introduction or administrative arrangements for the Goods and Services Tax itself.

It agreed that, had it been in a position to pursue the review fully and effectively, it would have wished to address the following questions–

• Whether or not the tax gap would be £100 million or less?
• Could economic growth contribute an additional tax income of £20 million annually?
  • Would the look-through' proposals made in May 2005 comply with the requirements of the E.U. Code of Conduct on Business Taxation?
• Whether or not the 0/10 proposals made in May 2005 would comply with the requirements of the E.U. Code of Conduct on Business Taxation?
• Would the GST proposals made in May 2005 comply with the requirements of the E.U. Code of Conduct on Business Taxation;
• Should the States seek positive assurance that its new taxation requirements would meet the requirements of the U.K. and E.U. once they are finalized?
• Would the proposed GST be unacceptably regressive?
  • Would the £300,000 registration threshold for operation of the GST by a business be appropriate or not?
    • Would the proposed GST arrangements for the finance industry be appropriate and has sufficient attention been given to anti-avoidance measures?
  • Would the new look-through' and 0/10 proposals require the extension of Jersey's anti-tax-avoidance provisions beyond those included in section 134a of the current tax code and would such measures be just and equitable?

What research, if any, has been undertaken to examine the approach of competing territories that might have come to differing conclusions as to the way in which they should meet the challenge, and what might the implications of their actions be for Jersey?

10. RECOMMENDATIONS

The Panel decided to make the following recommendations–

1. that the review subject was of such significance that it should be pursued under the new Scrutiny process as a matter of high priority; and,
2. that to enable the Scrutiny process to operate efficiently and effectively it would be essential that it be provided with full powers of subpoena.

11. APPENDIX

Goods and Services Tax - Background reports

paper

18. The Future of Jersey's Tax and Spending Oxera July 2001 Policies
19. The Future of our Tax and Public Spending FEC

Policies First Consultation Paper

20. Paying for Local Investment - New Finance Richard Murphy March 2005 Mechanisms for Local Government also for NEF

(Curriculum vitae for Richard Murphy)

21. Tax Research: The inevitability of decline in Richard Murphy April 2005 the financial services industry in Jersey
22. Will the Isle of Man be EU tax compliant? Richard Murphy