Having introduced a radical response to the challenge posed by the EU Code of Conduct Committee, Ian Kelly explains the motivation, the practical implications and the future of the Isle of Man's low-tax strategy
We knew this year's budget would be scrutinised more than ever before, especially by other international finance centres. When the Treasury minister, Allan Bell, took to his feet on 18 February, he had to demonstrate a continuing commitment to the implementation of the Isle of Man's low taxation strategy, at the same time as presenting a budget with provision for increased public service spending and support for people on low incomes.
Bell did not simply demonstrate a notional commitment; he put in place tangible measures to reduce the island's income tax burden. And at the same time he raised net spending on public services by 7.6% and introduced a Personal Tax Credit to provide lump sum payments of up to £200 to individuals who do not fully utilise personal allowances. Something of which Gordon Brown would be envious.
When the Manx government's taxation strategy was first approved by Tynwald, the Isle of Man parliament, in October 2000, its key targets included the reduction of standard income tax rates for businesses and individuals to 10%, within a timeframe of three to five years. Without any further ado, the 2001 Budget cut the lower rate from 14% to 12% and the target 10% rate was achieved the following year.
In the 2003 budget, the profits threshold at which the standard rate of 15% becomes payable by resident trading companies was increased from £500,000 to £100m. In practice, this will effectively ensure all resident, tax-paying trading companies will pay tax on their trading profits at the rate of 10%. The higher rate of 18% remains for all other companies for the time being. This extension of the 10% band will cut business costs on the island by a further £7m.
low direct taxation route
Of course, events have moved on apace since the Isle of Man first decided to go down the low direct taxation route. In 2001, the Government announced a workable solution to the challenge laid down by the European Union's Code of Conduct on Business Taxation, and one that would enhance the competitive position of the island at the same time. To the disbelief of many, we made a public commitment as part of a revised taxation strategy to cut the standard rate of company income tax to zero. This was one of the most radical steps ever taken by an international finance centre.
The EU's Code of Conduct on Business Taxation, together with its Savings Tax Directive, had been on the offshore radar for some time. With the completion of stage one of the Organisation for Economic Cooperation and Development's (OECD) initiative on harmful tax competition in March 2002, attention switched to the threat ' and opportunity ' posed by the EU's drive to level the tax playing field and introduce widespread exchange of information.
As background, the Code of Conduct states tax measures that provide for a significantly lower level of taxation than those levels that generally apply in the member atate are potentially harmful. In particular, the assessment of harm should take account of whether advantages are accorded only to non-residents, or in respect of transactions carried out with non-residents.
Of course, the Isle of Man is neither part of the United Kingdom ' it is a British crown dependency ' nor a member of the EU in its own right. There is some free trade between the island and the EU member states, as a result of its being a signatory to Protocol 3 of the UK's Treaty of Accession, but by virtue of its constitutional relationship with the UK the Isle of Man is not obliged to comply with EU laws and directives.
However, the island is committed to upholding established international standards, as was demonstrated by its constructive engagement with the OECD. It was streets ahead when, at the end of 1999, it successfully removed any threat of blacklisting by the OECD, some 15 months before most of its peers managed to achieve a similar concession.
So the Isle of Man plans to introduce a standard zero rate of income tax for all companies based on the island, except for a small number of regulated financial sector businesses, by 2006. It is an elegant solution to the 'harmful tax measures' identified within the EU's Code of Conduct that simultaneously takes the low tax environment one stage further. But how can it possibly be achieved?
It has been estimated that the net revenue cost of the Isle of Man's proposal will be in the region of £23m. However, despite the low tax environment already in operation on the island, the island can spend a larger proportion of its national income per capita on health, education and welfare state benefits than the UK.
We must remember that, unlike the Channel Islands for example, a significant proportion, over 60% in fact, of the island's income has in recent times been collected through indirect taxation: Value Added Tax and excise duties. The Isle of Man Treasury has compiled detailed forecasts of future income and expenditure and calculated the phasing out of company income tax is, indeed, financially viable. The explanation for this lies in the fact that a zero tax rate should enhance the island's competitiveness and attract more companies to its shores. In turn, a greater uptake in local products and services subject to indirect taxes will compensate for the loss of income tax.
As the time of writing, the island's government faces a busy time. An economic strategy, co-ordinating with the taxation strategy, is in the latter stages of development. The EU has deferred again final resolution of its tax package and we are consulting extensively with finance industry representatives to determine the most appropriate response. It is a challenging time but in rising to these challenges the island's motto, beneath the three legs of Man, remains at the forefront of our thinking: 'Whichever way you throw it, it will stand.'
In the 2003 Budget, the profits threshold at which the standard rate of 15% becomes payable by resident trading companies was increased from £500,000 to £100m.
The Isle of Man is not obliged to comply with EU laws and directives.
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