Moving with the times

The Isle of Man has worked hard to change its tax regime over recent years. Simon Cain, partner at Isle of Man-based Dickinson and Cruikshank, looks at the advantages offered to the shipping community

ABOUT four years ago, the Organisation for Economic Co-operation and Development (OECD) launched a project to investigate and tackle perceived tax havens around the world which were considered to be harmful to OECD member countries.

Although, at the time, politicians and business people in offshore jurisdictions around the world were fairly alarmed by the prospect of this investigation into their activities, in retrospect, certainly from the perspective of the Isle of Man, the entire process appears to have been of great benefit. Not only has it enabled such jurisdictions to stand on their own two feet and represent themselves properly on the international stage, it has also enabled them to influence international policy towards low-tax jurisdictions and, in some cases, enhance their reputations as stable and respected business locations.

All this, of course, is of immense importance to the shipowners and operators who use jurisdictions such as the Isle of Man for the purposes of asset-holding companies and corporate tax planning. Incidentally, the Isle of Man is not on any blacklist.

As with many offshore jurisdictions, during the 1980s the Isle of Man government saw an opportunity to develop its corporate sector by passing legislation enabling overseas investors to establish Isle of Man corporations to hold assets within an entirely tax-free environment. On the Isle of Man, the main legislation was the Non-Resident Companies Act 1986 and the Income Tax (Exempt Companies) Act 1984. Exempt companies, in particular, became a popular and well-recognised vehicle for shipowners. The Isle of Man became a favourable jurisdiction as shipowners could also flag ships on the Isle of Man International Ship Register and banks were, and are, more than happy to lend to Isle of Man companies and take security over Manx ships.

In common with the Channel Island jurisdictions of Jersey and Guernsey, the Isle of Man was subjected to close scrutiny of its financial services industries by the new British Labour government, which came into office in 1997. This process, known as The Edwards Review, enabled the governments of all three jurisdictions to demonstrate to the British government that they each had robust local laws in place for the regulation of their financial sector industries and combating money laundering. The Isle of Man's current legislation combating money laundering was put in place in late 1998. Also during this period the Isle of Man government was in the process of introducing local laws regulating the provision of corporate services so that no company could be incorporated under Isle of Man law without engaging professionals who had been scrutinised and licensed by the Isle of Man financial services regulator.

Looking again at the exempt companies regime, one of the key features of the legislation is that tax-free companies are essentially not available to local Isle of Man residents or to offshore investors in respect of businesses generating income locally on the Isle of Man. This type of dual tax system became referred to as 'ring fencing' owing to the fact that the local income was ring-fenced and taxed, whereas the international investor was granted a special tax-free status.

When the OECD began its review, one of its political motives was the objection to ring-fencing in offshore jurisdictions, which was considered harmful and discriminatory. Taken from the perspective of the tax authority of a mainland European country, it is understandable that they would object to their own citizens being granted tax-free status by the Isle of Man, and yet the Isle of Man would not grant that same status to its own citizens. The concept of dual tax systems or ring-fencing has always been open to this criticism and certainly was of principal concern to the OECD. However, its remit was also to tackle secrecy laws and obstacles to international investigations into money laundering and other criminal activities.

In June 2000, the OECD published its preliminary list of 35 jurisdictions around the world practising what it called 'unfair tax competition' and 'harmful practices' which were deemed to be 'unco-operative'. Although people from many of the jurisdictions concerned questioned the status and motives of the OECD, on the Isle of Man the issue was taken extremely seriously. It has always been felt that it is essential that the Isle of Man not only co-operates but is also seen to be co-operating with the international community in meeting international standards on combating international crime and is also seen to be a fair and normal place in which to do business. There is no future for the Isle of Man or any other jurisdiction as some type of maverick state.

Several jurisdictions, such as the Cayman Islands, entered into negotiations with the OECD at an early stage and avoided being on the preliminary list of 'unco-operative countries'. The Isle of Man was on the original list but then engaged in negotiations with the OECD which led to it being one of the first jurisdictions to be removed in December 2000.

One of the commitments made by the Isle of Man government was to develop an exchange of information mechanism with external authorities and a system of ensuring that information on persons using the jurisdiction would be available to regulatory authorities in the event of criminal investigations (referred to as 'transparency'). It also involved the removal of ring-fencing tax regimes such as the exempt company regime and the non-resident company regime.

The Isle of Man also introduced the concept of the 'level playing field' whereby it insisted that, as a condition of its commitment, the OECD would require the same standards of its own member jurisdictions as it did of offshore jurisdictions. This condition for a level playing field was followed by virtually all the other jurisdictions which subsequently entered into similar commitments with the OECD and has now become OECD policy.

The final blacklist of countries which the OECD considers to be unco-operative tax havens was published in April 2002. Representatives of these jurisdictions are in negotiations with the OECD for the purposes of removing themselves from the list, although no details are currently available.

On the other hand, the experience of all the offshore jurisdictions which have concluded successful negotiations with the OECD seems to have been beneficial. Ironically, for the Isle of Man and similar well-regulated jurisdictions, the international concern on money laundering post- September 11, and the international concern for proper corporate governance following ENRON, has enabled them to be held out as a model for the type of legislation required to combat those issues.

The Isle of Man sees the regulation of corporate services and its anti-money laundering legislation as a selling point when marketing itself to international investors and, of course, when put into the context of the shipping industry, the standards sit very well alongside the standards and reputation of the Isle of Man International Ship Register.

The OECD's original strategy was to target jurisdictions which operated discriminatory ring-fencing tax regimes. This focus has now shifted to requiring international co-operation and transparency. Nevertheless, those basic objections to ring-fencing regimes will always remain and it will be of great benefit to all offshore jurisdictions to remove those issues.

There is no doubt that jurisdictions which had no corporate tax were at an advantage in that area. For this reason, 2002 has seen the Isle of Man government announce its intention to abolish corporate tax. Effective from 2006, the concept of non-resident companies and exempt companies will be phased out, and all companies incorporated on the Isle of Man will be taxed at zero rate. In addition, in its Spring 2002 budget, the Isle of Man government announced that this regime would be introduced immediately for shipping businesses. For the shipowner, the exempt company regime is still fully available and will be replaced in due course by zero-rate.

Of course any jurisdiction can make such announcements. What is important is whether such policies are sustainable. This depends on the political situation of the jurisdiction and whether that country can afford it. At current levels of business, for the Isle of Man to introduce the zero rate of corporate tax, it will lose from its annual tax receipts approximately £20m (the most important taxes for the Isle of Man are VAT and other indirect taxes). However, the Isle of Man had a budget surplus last year of over £100m, so even the worst pessimists cannot imagine a scenario where there would not be a budget surplus in the foreseeable future. For this reason, both Moodys and Standard & Poors have given the Isle of Man an 'AAA' rating in respect of its sovereign debt.

The Isle of Man is a jurisdiction of extraordinary political stability. The general consensus is that the zero rate of corporate tax is absolutely sustainable for the long term. This deals with the arguments over dual tax regimes and ring-fencing and will enable the Isle of Man to continue to be considered an acceptable and normal jurisdiction in the eyes of the outside world for the foreseeable future, as well as offering a tax-free corporate regime.

The issues that have been faced and addressed by the Isle of Man also illustrate the international pressures on those offshore jurisdictions which have played an important role in ship finance structures over many years and will continue to do so.