These fair isles

The UK’s offshore tax havens, only just recovering from the storm over financial regulation whipped up by the Edwards report, now face a new threat – tax harmonisation.

Tax competition has suddenly become the bogeyman of international economics, and the world’s tax havens have been cast in the role of its major stooges.

The European Union and various European governments have already started sinking their teeth into the issue, with the low-tax regimes in both the Isle of Man and the Channel Islands coming under scrutiny from pro-harmonisation German politicians.

But the threat is not just coming from Europe. The islands also appear on a hit list of tax havens put together by the Organisation for Economic and Commercial Development, which wants to stamp out what it calls ‘harmful tax competition’, particularly in financial services.

The islands stand accused of draining tax revenues from other jurisdictions.

In the words of the OECD, offshore low-tax regimes are adopting ‘predatory policies whose main purpose is to siphon off part of another country’s tax base’.

‘Name and shame’ report due

It is not yet clear how these threats will eventually manifest themselves.

But fears have already been stirred among the tight-knit financial communities on the islands.

On the Isle of Man, concerns about tax harmonisation have refuelled the debate over whether the Crown dependency should seek greater independence from the UK. Like the Channel Islands, it is responsible for setting its own laws and fiscal policy, with the UK only responsible for defence and international relations.

Contrary to widely held belief, the dependencies are also outside the EU, although the UK government is supposed to use its ‘best endeavours’ to persuade them to follow EU policies.

Politicians in both the UK and Europe have said little to calm growing fears on the islands. Gunther Verheugen, a German foreign minister, in January called for the Channel Islands’ and the Isle of Man’s tax privileges to be scrapped to protect the rest of EU.

The islands were quick to focus on the fact that he apparently didn’t realise the islands were outside the EU. The Guernsey press heralded clarifications made by Verheugen a month later as a German U-turn on the issue.

In the House of Commons last month, Paymaster General Dawn Primarolo fended off questions from a Tory backbencher about whether the European savings directive – the most concrete step yet towards European tax harmonisation – would be imposed on the islands.

The questions provoked discussions about whether the UK government would be required to ‘bully’ the offshore islands into submission on the issue, and whether this would lead to them opting for complete independence.

Primarolo was careful not to make any provocative statements, saying it would not be appropriate to comment until an OECD report on harmful tax competition, expected to ‘name and shame’ tax havens, comes out later this year.

The islands and the Isle of Man see their non-membership of the EU as their best defence against European harmonisation moves. Indeed, there is hope that they will actually benefit from them.

Manx chief financial officer John Cashen says that if it is eventually imposed, funds will flow out of the EU and into Switzerland and the Crown dependencies. The Isle of Man and the islands could therefore benefit from something that is meant to curb their activities.

Non-membership of the EU, however, will not protect the islands against OECD moves.

Although it has no legislative powers over its 29 members, the OECD is recommending that member countries take moves against tax havens such as strengthening their controlled foreign company legislation or even terminating their double tax treaties.

Cashen says the OECD’s initiative is simply an example of the big nations ganging up on small jurisdictions. Commenting on the organisation’s list of tax havens, he says: ‘What they all have in common is that they are all small.’

The usual argument against tax havens is that they reduce tax revenues for other countries. According to EU tax commissioner Mario Monti: ‘If you create a tax haven for a few people, you condemn the rest to a tax hell.’

But Mike Warburton, tax partner at Grant Thornton, argues the issue is more about tax avoidance, and that Germany’s support of harmonisation arises more from concerns about its citizens avoiding tax. ‘The solution is an effective policing of people’s tax affairs with a greater emphasis on enquiry and investigation,’ he says. He argues, as do many others, that any moves against Europe’s tax havens will simply lead to funds flowing out of the EU to other offshore centres.’

Chas Roy-Chowdhury, senior technical officer at ACCA, agrees. ‘The Germans need to target tax evasion rather than let these funds flow elsewhere. If there are going to be such measures, then they need to be at OECD level.

The last thing they want is savings to migrate out of the EU into other tax havens.’

Comments made Jeffrey Owens, the OECD’s head of fiscal affairs, appear to bear this out. He says: ‘The existence of low or no income taxes is not in itself enough to constitute harmful tax competition. Rather, when low or no taxes are combined with other legislative or administrative features, such as ‘ring-fencing’, a lack of transparency and the absence of exchange of information, then harmful tax competition may arise.’

The islands themselves have signalled their intention to put up a fight against the European initiatives, although they appear ready to accept changes in world attitudes towards tax harmonisation.

Manx Treasury minister Richard Corkhill took the opportunity of this presentation of the island’s budget last month to spell out his position.

The Isle of Man, he said, would defend its existing rights to determine its own taxation, and would not do anything unilaterally that would damage its economy. But he added: ‘When international attitudes and standards change, as they surely will, we will act responsibly, play our part and move with the rest of the world.’

Charles Parkinson, director of Pannell Kerr Forster in Guernsey, says both the Channel Islands and the Isle of Man may well be able to incorporate any changes forced on them without significant damage to their economies.

‘I don’t think that at the end of the day the Channel Islands and the Isle of Man face a cataclysmic change in the technical environment.’ He adds: ‘I don’t know what they will recommend, but I am pretty sure we can accommodate what they will have to say.’

He also comments that the OECD’s threat to get countries to terminate their tax treaties with non-compliant tax havens contradicted its stated intention of encouraging the flow of information between different jurisdictions. ‘I think they have a certain amount of development to do in their own thinking.’

It has yet to become clear whether the EU savings directive will be agreed between EU members states, let alone how the UK’s offshore centres will be affected by them. What form other EU initiatives and the OECD’s moves will take, remains to be seen.

But it is clear that attitudes are changing and that the concept of the tax haven could eventually disappear. Although they see this as a distant prospect, the islands appear to have accepted this. In the words of Cashen: ‘If the international scene changes the Isle of Man will fall in, but there is no way we will be in the vanguard.’

WHAT IS TAX HARMONISATION?

The main worldwide moves towards harmonising taxes, or curbing ‘harmful tax competition’ are:

– EU code of conduct for business taxation: Dawn Primarolo-led group has targeted over 80 low tax arrangements in European Union countries which, it says, are causing harmful tax competition.

– EU savings directive proposes a 20% withholding tax on payments of interest to individuals in other member states.

– European Courts of Justice decisions: ECJ is striking down an increasing number of member state tax laws which violate non-discrimination principles of EU treaty.

– OECD: initiative aimed at curbing harmful tax practices is looking at around 50 tax havens and expected to report by October this year.

DUBLIN REDUCES RATE TO BEAT CRITICS

Ireland is combating European Union accusations of unfair tax competition by standardising its corporation tax rate at 12.5%.

Although the low rate is likely to attract criticism from pro-harmonisation politicians in Europe, the Irish government is confident it will not fall foul of EU competition rules.

Irish tax incentives have recently come under scrutiny from Brussels.

Its 10% corporation tax rate for manufacturing and for companies based in Dublin’s International Financial Services Centre have both been declared illegal state aid by EU authorities. The standard corporation tax rate is 28%.

The country is, however, moving towards a blanket 12.5% rate for all trading activities, which is expected to come into effect in 2003; by that time the ‘illegal’ 10% rates will have been phased out. The tax rate has been falling gradually from rates as high as 50% in the late 1980s.

Conor O’Brien, tax partner at Arthur Andersen in Dublin, says: ‘The Irish view is that tax harmonisation is just not going to happen.’

He describes the issue of harmonising corporation tax rates as a ‘scapegoat’ for Germany’s economic problems.

‘The Irish economy has been doing very well with low tax rates, whereas the German economy has high rates and is not doing as well. Countries like Germany should be cutting their rates.’

O’Brien also denies that new business now contributing to the Irish ‘tiger economy’ is replacing business in other EU countries. ‘We don’t believe tax harmonisation will achieve anything for Europe.’