Jersey: The Tax Tango Continues

Last Updated: 5 September 2011
Article by Marc Guillaume

Jersey's intricate ballet with ECOFIN (the Economic and Financial Affairs Council of the European Union) over the acceptability of Jersey's tax structure is moving into a new phase which sees an attempt to equalise the fiscal position of shareholders of Jersey companies whether or not they are resident in Jersey.

Those with greater experience of using Jersey companies as part of corporate or private client structuring will recall that, prior to the introduction of the zero-ten regime, Jersey resident companies in which a Jersey resident individual had an interest paid income tax on their worldwide profits at a rate of 20% (subject, of course, to deductions and allowances). Jersey resident companies with no Jersey resident individuals holding an interest in them could, however, generally apply for exemption from Jersey income tax. A two tier system was thus created – some Jersey companies paid tax at 20% and some (those without Jersey resident owners) did not. The latter, which were generally referred to as "exempt" companies, instead paid a nominal annual fixed fee and then attracted no Jersey income tax on profits other than profits arising within the Island. Even interest accruing on Jersey bank accounts was exempted from income tax by concession.

Zero-ten Tax Regime

The European Union however, decided that this differential treatment of Jersey resident shareholders and non-resident shareholders constituted a "harmful" tax measure which needed to be replaced. The Jersey government's response was the introduction of the zero-ten regime which we currently have, pursuant to which the great majority of Jersey companies (regardless of ownership) pay no income tax in Jersey, thus preserving their usefulness in the context of multi-jurisdictional structuring (whether for wealth management or transactional purposes).

The problem has been that, although the companies themselves pay no income tax on their profits, in order to store up local tax revenues the legislation implementing zero-ten included provisions which allowed the Comptroller of Income Tax in Jersey to tax Jersey resident shareholders in companies on the profits which those companies made (commonly referred to as "deemed distribution" and "full attribution" provisions), as soon as such profits were realised by the companies (i.e. prior to any actual distribution to the shareholders). ECOFIN however, has since made it clear that these elements of the zero-ten regime are also a "harmful" tax measure since they continue the discrimination between resident and non-resident shareholders in Jersey companies.

This brings us to the current change in legislation. The Income Tax (Amendment No. 38) (Jersey) Law 201- was adopted by the States of Jersey on 7 July 2011 and will, with effect from 1 January 2012 have the effect of deleting the deemed distribution and full attribution provisions from the Jersey tax system. We will instead have a system where the majority of Jersey companies pay no income tax on profits arising from that date forwards, and where the shareholders of such companies (regardless of whether or not they are resident in Jersey) will also pay no tax on those corporate profits until such time as they are distributed to them. At that point, Jersey resident shareholders will pay Jersey income tax as normal. Non-Jersey resident shareholders, however, will escape the Jersey taxation net completely.

It follows that non-Jersey source profits can, seemingly, be accumulated in companies free of Jersey income tax and need not be distributed until such time as is convenient for the shareholders, regardless of whether or not one or more of the shareholders is itself a Jersey resident. Being able to decide in which particular tax year company profits pass to an individual shareholder may well be advantageous depending on the financial situation of that shareholder from time to time.

Capital Distributions

Another potential area for exploration might simply be not distributing accrued profits. Rather, it may be beneficial to wait until the company undergoes a solvent liquidation and then to extract value as a distribution on a winding-up. On the face of it, that distribution may well be treated as a capital distribution which, depending on the jurisdiction of residence of the relevant shareholders, may be preferable to a dividend or other distribution which might have the character of income. In short, the change in regime may present opportunities for effective tax planning that go far beyond what this short article can speculate on.

Jersey's relationship with ECOFIN does not always run smoothly as there is the issue of how the Comptroller of Income Taxes in Jersey may look to implement the new legislation with a view to protecting the Island's revenue sources. Taking the latter point first, I would sound the following notes of caution.

The Comptroller will not allow abuse of the new regime for the purposes of tax avoidance. The Income Tax (Jersey) Law 1961, already confers a broad power on the Comptroller to prevent the legal avoidance of tax and, in a statement in February this year, the council of ministers made it clear that they would also act should it become clear that the new regime was being abused in any way.

Finally, we return to ECOFIN. The Jersey government hope (and seem to expect) that the abolition of the deemed distribution and full attribution provisions will be sufficient to make Jersey's taxation regime acceptable to Europe – i.e. that the removal of a distinction in treatment between resident and non-resident shareholders will mean that the zero-ten regime ceases to be "harmful" in the eyes of Europe.

Currently, ECOFIN is expected to make its decision in December this year. If that decision is not to sanction these amendments to the Island's taxation structure, then the States will need to revisit the regime again and consider whether or not the zeroten system really is capable of being adapted in such a way that will satisfy the "fairness" requirements of ECOFIN. If ECOFIN does agree with the States of Jersey, then the convoluted dance may come to an end.

This article originally appeared in the June issue of Private Client Practitioner.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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