Ernst & Young’s Channel Islands Media Briefing On Deemed Distribution

| June 27, 2012 | 0 Comments


In 2009, the UK Government told the governments of the three Crown Dependencies that it had concerns regarding their zero 10 regimes. Shortly afterwards the European Union’s Code of Conduct Group (CCG) began a formal review into the regimes in Jersey and Isle of Man.

A review of Guernsey’s regime was started alongside those of Jersey and the Isle of Man, but it was suspended when Guernsey announced it was carrying out its own review, with a presumption of a 10% tax rate.

In its assessments of Jersey and the Isle of Man, the CCG determined that the regimes of both islands led to a deliberate, current and structural method of taxing business profits through the personal income tax system and that the effect was to ring fence the zero rate of tax so that it was available to non-residents only. On this basis, the CCG ruled that both islands had harmful regimes. However, once Jersey and the Isle of Man had removed their deemed distribution and attribution regimes, their zero 10 regimes were considered no longer harmful.

In February 2012, the CCG turned its attention to Guernsey and a formal assessment was prepared and presented by the EU Commission Service in which Guernsey’s regime was judged to be harmful. In April 2012 the CCG determined Guernsey’s current corporate tax regime to be non-compliant with the Code of Conduct on Business Tax. In particular the deemed distribution provisions within the current regime are considered ‘harmful’.

The judgement said that it was harmful because it effectively ring fenced the zero rate, meaning that non-residents were favoured over residents. As a result, the States of Guernsey are debating Billet XVI 2012, which – if approved – would remove the deemed distribution regime from 1 January 2013 and should ensure that Guernsey’s zero 10 regime is considered code of conduct compliant.

What is zero 10?

It is a shorthand term for Guernsey’s company tax regime. Most companies pay tax at 0% on their profits. Banks pay tax on part of their income at 10%, hence zero 10.

(Zero 10 is not actually an accurate name. Regulated utility companies pay tax at 20% on their income, as does any company that earns income from real estate in Guernsey. So strictly it should be called zero 10 20!)

What is deemed distribution?

While most companies in Guernsey are taxed at 0%, shareholders who are Island residents are taxed at 20% on the dividends they receive from a company (non-residents are not taxed on dividends in Guernsey, but may be taxed on those dividends by the jurisdiction in which they live). Guernsey (along with Jersey and the Isle of Man) introduced rules to tax Guernsey-resident shareholders at trigger points when – although there had been no dividend payment – income would be deemed to have been distributed (deemed distribution).

In Guernsey there are two basic types of deemed distribution: Shareholders’ investment income is taxed as it is earned by the company and trading profits are taxable upon the occurrence of certain ‘trigger events’ such as leaving the Island, selling the company, and death.

(‘Attribution’ is another term used to describe deemed distribution. Income is ‘attributed’ to a shareholder even when they do not receive an actual dividend.)

Why is Guernsey’s regime considered to be harmful?

It is considered harmful because of ‘ring fencing’ – having beneficial tax regimes available for ‘foreigners’ which are not available to Guernsey residents. Non-residents are able to take advantage of 0% tax on elements such as dividends, while residents cannot, in part because of deemed distributions. The proposal being debated by the States is to remove both types of deemed distribution, so that a shareholder in Guernsey will be taxed only when they receive a dividend (remember, a non-resident is not taxed by Guernsey, but may be taxed by the jurisdiction in which they live).

What will the change mean for Guernsey businesses?

The change will have no direct impact on companies, other than removing certain administrative requirements, and the need to pay tax on behalf of shareholders on deemed distributions. It will benefit locals who have shares in companies as they will now only be taxed on actual distributions. In a wider context, it will allow Guernsey to keep our zero 10 regime, so that the Island can remain an internationally competitive IFC (International Finance Centre).

What will it mean for Guernsey?

It will allow Guernsey to keep its current corporate tax regime, if the States and Treasury decide to do so, but it is likely to mean a reduction in the amount of tax collected,  an estimated £3-4 million per annum, although it is impossible to know with certainty. It is proposed that this amount will be met, in whole or in part, by changes to the ’10’, with more companies paying 10% tax than is currently the case. It has been suggested we will follow Jersey, taxing regulated financial services companies including fund administration companies and trust companies.

How will Guernsey compare to Jersey and the Isle of Man after the changes?

If Guernsey just removes the deemed distribution regime, we will be broadly the same as the Isle of Man, although it too may make changes. Guernsey will have a competitive edge over Jersey as long as the range of companies paying 10% tax remains more limited in scope than Jersey, but as noted above that is likely to change very soon, assuming that Guernsey sticks with its code-compliant zero 10 regime.

What are the main issues for Guernsey businesses?

It is important that all Guernsey business owners carefully consider the changes to the tax regime before undertaking any significant transactions or changes to ownership between now and when the new regime starts on 1 January 2013. In particular, we would recommend that tax advice is sought prior to the sale or purchase of shares by a Guernsey-resident shareholder, when considering company reorganisations, or if a Guernsey-resident shareholder wishes to become non-resident.

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Category: Finance & Business

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