Originally published on 7 June 2002
No sooner had Jersey reached an agreement with the OECD on its harmful tax competition initiative, than attention was focused on the EU’s so-called tax package and how it might affect Jersey, as well as the other Crown Dependencies and British Overseas Territories. The issue was brought to public attention in mid-April when, shortly before the UK Budget speech, Ms. Dawn Primarolo, HM Paymaster General in the UK Government, contacted Senator Pierre Horsfall, President of Jersey’s Policy & Resources Committee, and demanded a commitment from Jersey to cooperate with implementing the EU’s Code of Conduct on Business Taxes. In spite of intense pressure from the UK Government, Senator Horsfall refused to give this commitment. This article examines the background to the tax package and considers the extent to which Jersey might cooperate with the EU in relation to the package.
At the same time as the OECD was developing its harmful tax competition initiative, a debate was starting within the EU on what needed to be done to prevent ‘harmful’ tax competition within the EU from distorting the single market. The debate centred upon business taxation and on the taxation of savings income. This led to the development of a proposed tax package consisting of (1) the Code of Conduct on Business Taxation (the "Code of Conduct"), and (2) a draft Directive on the Tax Treatment of Savings Income (the "Directive").
THE CODE OF CONDUCT ON BUSINESS TAXATION
The Code of Conduct (which was developed by a group chaired by Ms. Primarolo) is set out in a report that was published in November 1999 that defines ‘harmful’ tax measures as being those that:
"provide for a significantly lower effective level of taxation, including zero taxation, than those levels which generally apply in the Member State in question are to be regarded as potentially harmful and therefore covered by this code.
Such a level of taxation may operate by virtue of the nominal tax rate, the tax base or any other relevant factor.
When assessing whether such measures are harmful, account should be taken of, inter alia:
- whether advantages are accorded only to non-residents or in respect of transactions carried out with non-residents, or
- whether advantages are ring-fenced from the domestic market, so they do not affect the national tax base, or
- whether advantages are granted even without any real economic activity and substantial economic presence within the Member State offering such tax advantages, or.."
The Code of Conduct includes a commitment by EU member states not to introduce new tax measures that are ‘harmful’ (a ‘standstill’ commitment); and to remove existing ‘harmful’ tax measures (a ‘rollback’ commitment).
Whilst the Code of Conduct is not an EU directive, but rather an agreement between EU member states, it is expected that member states will (provided that the tax package as a whole is adopted) seek to work within its terms. The Code of Conduct will commit member states to promoting its principles in other countries outside the EU; in particular, the Code of Conduct provides that:
"Member States with dependent or associated territories or which have special responsibilities or taxation prerogatives in respect of other territories commit themselves within the framework of their constitutional arrangements, to ensuring that these principles are applied in those territories."
The Code of Conduct group chaired by Ms. Primarolo identified 66 measures in various EU member states (indeed, in every member state other than the UK) and their dependent territories, which it classified as potentially ‘harmful’. As regards Jersey, the group identified tax-exempt companies (international business companies), captive insurance companies and treasury operations as being potentially ‘harmful’.
DIRECTIVE ON THE TAX TREATMENT OF SAVINGS INCOME
The European Council’s original proposals for taxation of savings income, put forward in 1997, contemplated that EU member states would be permitted to choose either to apply a withholding tax to such income, or to organise an exchange of information on such income. The UK government objected to this approach, arguing that the Directive should provide only for the automatic exchange of information. The UK government’s objections were driven by bankers and professional advisers in the City of London who believed that the draft Directive would damage the Eurobond market, which is centred in London.
At the Feira European Council in June 2000, the UK government prevailed and agreement was reached on the terms that EU member states would agree to a Directive to organise information exchange on savings income. The agreement provides that: the withholding tax option would be dropped, though member states may apply a withholding tax for a transitional period of up to seven years; it is subject to agreement being reached for ‘equivalent’ measures being implemented by other key third countries (in particular, the USA, Switzerland, Liechtenstein, Monaco, Andorra, San Marino); and that dependent and associated territories of member states will implement the same measures.
It was agreed that the text of the Directive would be settled by the time of the ECOFIN meeting in Laeken, in Belgium, in December 2001; however, in the event that proved not to be possible, partly because Austria, Belgium and Luxembourg expressed resistance to any agreement that binds them to automatic exchange of information (with or without a transitional period) unless Switzerland has agreed to implement the same measures.
OTHER THIRD PARTY COUNTRIES
As will be clear from the foregoing, both elements of the tax package depend to some extent on agreement being reached by the EU with other third party countries to introduce the same or equivalent measures. The EU member states appear to have recognised that without such an agreement, capital will flow out of the EU to other countries.
The two most important of these third party countries are the USA and Switzerland.
On 22 January 2002, Frits Bolkestein, European Commissioner for the Internal Market and Taxation, said that "The Commission has been in touch with all the six countries mentioned in the conclusions of the Feira European Council and we are in the process of opening negotiations with them on their applying equivalent measures to the EU's savings tax Directive. We are due to conclude these negotiations by the end of June." It appears, however, that little progress has been made with the negotiations with either the USA or with Switzerland.
JERSEY, THE OTHER CROWN DEPENDENCIES AND THE BRITISH OVERSEAS TERRITORIES
The UK government attaches great importance to the success of the tax package; to some extent, its credibility both with fellow EU member states and within the City of London depends upon the implementation of the tax package. It is also concerned that if the package fails and the EU reverts to the original withholding tax option, this would represent another major step towards tax harmonisation across the EU, which would most likely generate a significant anti-EU backlash within Britain.
Assuming that the tax package is agreed, the UK government would be committed by both the Code of Conduct and the Directive to ensuring, so far as it is able to do so within the framework of the constitutional arrangements, that the principles of both parts of the package are applied in the Crown Dependencies and British Overseas Territories.
At the end of October 2001, the UK government formally approached the authorities in each of the Crown Dependencies and British Overseas Territories and sought a commitment from them to apply the Code of Conduct and the Directive within their jurisdiction. Jersey’s response, delivered at the beginning of December 2001, was to the effect that it would be willing to engage in negotiations on implementing the same or equivalent measures as those contemplated by the Directive (subject to a level playing field with competitor jurisdictions, in particular Switzerland); but that it couldn’t contemplate negotiations in relation to implementing the Code of Conduct, until the Island’s fiscal reform review1 has been completed.
The matter rested there until mid-April 2002 when, as mentioned in the introduction, Ms. Primarolo contacted Senator Horsfall and demanded a firm commitment from Jersey on the Code of Conduct, failing which the UK government would contemplate unspecified measures. Senator Horsfall’s response robustly defended Jersey’s position, as set out in the December 2001 response, whilst making it clear that Jersey is willing to enter into constructive discussions on the tax package.
On 14 May 2002, it was announced that, after an analysis of the Directive and following consultation with the finance industry, Jersey intends to introduce legislation that will support the exchange of information as contemplated by the Directive. The implementation of this legislation will depend upon the Directive coming into force within the EU member states and in other third-party countries, in particular Switzerland. Once implemented, it will be necessary to develop a process for the automatic and spontaneous exchange of information in relation to the income covered by the Directive arising for the benefit of EU residents.
The Code of Conduct represents a more difficult challenge for Jersey. Negotiations for implementing the Code of Conduct cannot realistically commence until the Island has completed the current review of its fiscal strategy. However, a number of commentators within the Island are now arguing that it will be necessary to consider removing those elements of the Island’s tax regime that discriminate between residents and non-residents of the Island. This includes tax-exempt companies and IBCs.
The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.