Spurred in part by the fiscal requirements of the European Union, Gibraltar's decision to pursue a policy of "low tax" rather than "no tax" continues to make the jurisdiction attractive to international investors and its appeal has been enhanced by the announcement in the 2007 fiscal Budget of plans to steadily reduce corporate taxes over the coming three years to an eventual target level of between 10 and 12 per cent.

The timetable to reduce corporate taxes, announced by Gibraltar's Chief Minister, whose party returned to power for a historic fourth term in October, could even be accelerated. However, there has been disappointment in Gibraltar's financial and commercial communities that the bold new reduced flat rate in corporate tax of approximately 12 per cent that had been widely anticipated was not delivered in the 2007 fiscal Budget.

Instead, corporate taxes for 2007/08 are to be reduced by only 2 per cent – from 35 per cent to 33 per cent and in the following tax year by a further 3 per cent to 30 per cent – and, finally in the 2009/10 tax year there will be another 3 per cent cut to 27 per cent. The new, low flat corporate rate which is expected to be put in place by mid-2010 will be no higher than 12 per cent, bringing Gibraltar on a par with other beneficial tax regimes in Europe such as those of Malta and Ireland.

While the financial services sector had hoped for a bolder approach to the corporate tax question, the Government clearly has felt constrained by the pressures to phase out tax exempt companies by 2010 and the anticipated decision of the European Court on Gibraltar's appeal against the European Commission's ruling on "regionality" in relation to Gibraltar's broader corporate tax proposals.

Though last year's helpful "Azores" decision by the EU Court has strengthened Gibraltar's optimism about the eventual outcome of its legal challenge, the uncertainty which the litigation has engendered and continues to fuel is one of the few clouds on the jurisdiction's financial horizon. A ruling was expected to have been handed down by the EU Court by September last year. However, the Court's dealings with the high-profile Microsoft question has delayed its deliberations on Gibraltar's proposed tax structures and a decision is now not expected before the first quarter of 2008.

The legal clash between Gibraltar and the European Commission stems from the Gibraltar's decision in 2002 to set a zero rate of corporation tax for all companies but introduce new taxes on staff employed and premises occupied - proposed to be capped at 15 per cent of profits. There would also be an annual companies registration fee of £300 for companies generating income or £150 for companies with no income. Subject to EU clearance, two sectors of the economy - financial services providers and utility companies – would also pay a new tax on profits.

The new taxes were to take effect in 2003, and in March that year the EU's Council of Finance Ministers confirmed that the proposed reforms did not constitute harmful tax measures. However, in April of the following year the European Commission argued that, in terms of "regional selectivity", the new tax regime would give Gibraltar-domiciled companies an unfair advantage over their counterparts in the United Kingdom. It also argued that because the taxes were based on payrolls and the occupation of business premises, offshore companies registered in Gibraltar would be unlikely to incur any tax liability. It rejected the reforms and, in effect, suggested that for taxation purposes, Gibraltar should be regarded as part of the United Kingdom.

In January 2005 and in an action aimed to make its corporate tax legislation compliant with EU State Aid Rules, Gibraltar abolished its "qualifying companies" (companies that were able to elect the tax rate that applied to them) tax regime. This move cost the Gibraltar government an estimated GBP1.5 million in annual tax revenues. The remaining 80 "qualifying companies" were allowed by the Government to switch to the "exempt companies" tax regime. However, later the same month it was announced that Gibraltar had been given until December 2010 (2007 for new exempt companies) to phase out its exempt company tax regime after the European Commission ruled that the scheme also violated EU State Aid Rules.

"Grandfathered" companies will be able to continue to enjoy their tax exemptions with the blessing of the EU Commission for three more years before tax exempt companies are phased out at the end of 2010. Accordingly the Government has gone out of its way in the 2007 fiscal Budget to stress that in order to sustain a successful economic model post 2010 Gibraltar will have to adopt a very competitive tax model. On the basis that it is no longer acceptable to have one set of taxes applicable to resident companies and a different one to non residents (as has been the case under the "exempt companies" regime), the Government has made it clear that it is firmly committed to a system of low taxes for all companies.

Any suggested exit of foreign companies – at least on a scale that could severely damage Gibraltar's economy is highly unlikely irrespective of the outcome of the impending EU Court decision. Nevertheless, it is clear that the decision of the European Court will have a significant impact on Gibraltar's economy and, in particular, on its thriving finance centre. Even if the anticipated global economic slowdown does materialize, a favorable ruling from the EU Court is expected to open the doors to an unprecedented inflow of international investment – in the fast-growing funds industry, insurance and financial services as well as from numerous global banks seeking to use Gibraltar in increasingly complex structured finance transactions.

In the unlikely event that the EU Court rejects Gibraltar's arguments, the Government is believed to have an alternative plan though "it is playing its cards close to its chest" understandably reluctant to be seen to be anything but confident about the outcome. Apparently, there are legislative loopholes which would despite a negative Court decision permit the introduction of an alternative tax structure providing a tax regime slightly higher than that of Dublin.

The first few months of 2008 should bring about the highly anticipated judgment from the EU Court that will hopefully clear any lingering doubts over the future development of Gibraltar's Finance Centre and help to further enhance Gibraltar's competitiveness in the international finance world.


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