11.01 ENTITIES LIABLE FOR CORPORATE TAXES
Corporate entities are liable to income tax. There is no separate corporation tax on the income of companies in the Isle of Man, although companies managed and controlled outside the Island that do not carry on a trade in the Island and that have made a non-resident declaration are subject to the flat rate non-resident duty of £750 per year already described.
11.02 TREATMENT OF OTHER ENTITIES
Partnerships are not themselves liable to Manx income tax, but each partner is liable for his share of the partnership income, which forms part of his total income for Manx income tax purposes.
The assessable profit of each partner is determined by computing the trading profits or losses of the partnership each year in accordance with normal income tax rules. These profits or losses are then divided among the partners according to their profit-sharing ratios. Strictly, partnership income should be divided among the partners according to their profit-sharing ratio in the year of assessment for which the income is assessable. In practice, however, where one or more of the partners is being assessed on a preceding-year basis (see "Accounting Periods and Tax Years"), the partnership income is usually divided among the partners according to their profit-sharing ratios in that preceding year. Where there is a change in the partners, a continuing partner will remain assessable on the normal preceding-year basis. A partner entering or leaving the partnership will be subject to the commencement or cessation rules described later, unless he has been or is to continue exercising his profession in a self-employed capacity (whether alone or in another partnership).
If all the partners in a Manx partnership are resident outside the Isle of Man and its income is derived from sources outside the Island, no Manx income tax will be payable by the partners.
11.03 RESIDENCE AND NON-RESIDENCE
A company resident in the Isle of Man is liable to the resident income tax on its world-wide income. A company is regarded as resident in the Island if its central management and control are exercised there. In practice, this means that policy decisions relating to the company's business must be taken at the highest level in the Island. In many cases this means that the board of directors meets there, although this may not be the deciding factor if, in reality, decisions are taken elsewhere. The place of the company's incorporation is not normally relevant.
11.04 TAXABLE INCOME
Companies are assessed to income tax only on their income; capital gains are not taxable. Income for this purpose is gross income less allowable expenses.
This is generally computed in accordance with the ordinary principles of commercial accounting but is subject to adjustments, such as the disallowance of non-deductible expenses and the replacement of depreciation charged for accounting purposes by tax depreciation allowances, known as capital allowances.
Dividends from Manx Companies
Dividends received from other Manx resident companies are fully taxable in the hands of the recipient company. This is because dividends paid by a resident company are allowable deductions against its taxable income.
Dividends from Foreign Companies
Dividends from foreign companies, gross of foreign withholding taxes, are subject to income tax. Foreign income taxes, either withheld from or charged directly on the dividend, are normally relieved by credit against Manx income tax. No double taxation relief is available, however, for foreign underlying taxes.
Interest and Royalties
Interest and royalties from Manx or foreign sources are subject to Manx income tax. Foreign income taxes withheld from, or charged on, such income received from outside the Island are normally available for credit against Manx income tax.
Rents receivable are subject to Manx income tax. Normal expenses of maintenance, repairs, insurance, and management charges are deductible.
Inventory Valuation Rules
Inventories and work-in-progress are usually valued at the lower of cost and net realisable value. Cost may be actual, average, or FIFO; LIFO and base stock valuations are not normally permitted. Appropriate overheads are frequently included in costs and, provided that the basis adopted is applied consistently, the extent to which this is done is left to the company's discretion. The valuation bases appropriate for financial statement purposes are usually, but not necessarily, accepted by the Assessor. Indexation to reflect inflation is not permitted.
11.05 ALLOWABLE DEDUCTIONS
The general rule is that only expenses incurred wholly and exclusively in earning the income in question are deductible for Manx income tax purposes. In addition, resident companies may deduct dividends paid. No deduction is allowed for capital payments, except where capital allowances are available.
No deduction is allowed for depreciation, amortisation, or losses on disposals of fixed assets as charged by a company in its financial statements. Instead, wear and tear on most fixed assets is deductible in the form of capital allowances, which is the term used for tax depreciation.
Capital allowances to which a company is entitled under the tax rules may be claimed irrespective of the amount charged for depreciation in the financial accounts.
Generally, the total tax allowances given on any asset may not exceed its cost. Cost is reduced by any grant that the taxpayer may receive from the Island's Government as a contribution towards the cost of an asset eligible for capital allowances. For certain types of expenditure, particularly in the tourist trade, tax allowances in excess of cost are given and Government grants are not taken into account. Capital allowances are reduced proportionately if any asset is used for non-trade purposes. Annual writing-down allowances, but not initial or first-year allowances, are similarly reduced if the trade is not carried on for a full year. In some cases capital allowances are very generous, the whole of the cost of the asset being allowed in the year of acquisition (for example, tourist premises, industrial buildings, agricultural buildings, most plant, machinery, and equipment). In other cases no allowances are given at all (for example, expenditure on land, office buildings, or goodwill, although there is a special concession available until April 1997 granting first year allowances of 100% on the development cost of office and commercial buildings in a designated area of Douglas). The main types of capital allowances are as follows.
Industrial Buildings. Broadly, this expression means buildings or structures used for such purposes as manufacturing, transportation, mining, or power production. A warehouse used to store raw materials for manufacturing purposes in the course of a trade is included, and so is a warehouse that is used by a manufacturer to store his finished products. Specifically excluded are offices, showrooms, hotels, retail shops, and similar premises. Where part of a building qualifies as industrial but the rest does not, the allowance is given proportionately, except that it is given in full if the cost of the non-qualifying part is 25% or less of the total cost.
An initial allowance of 100% is currently available in the period in which the expenditure on the construction or improvement of an industrial building is incurred, excluding the purchase of the land on which it is built but including site preparation costs. The whole or part of the initial allowance may be disclaimed if the taxpayer does not wish to take the full amount in the period in which it is due. That part of the construction cost not dealt with by an initial allowance is relieved by a straight-line writing-down allowance of 4% per year, commencing in the year in which the building is brought into use . The allowances are available to the company incurring the capital expenditure concerned, both if it occupies the building for its own trade purposes and if it leases the building to another trader.
Expenditure incurred on purchasing an industrial building used by a previous owner does not qualify for an initial allowance. If such a building is less than 25 years old (or, if constructed before 6 November 1962, less than 50 years old), that part of the cost to the new owner equivalent to the original cost of construction as reduced by industrial buildings allowances is relieved by straight-line writing-down allowances over the remainder of the unexpired term of 25 (or 50) years. No writing-down allowances are given if the building is more than 25 (or 50) years old.
When an industrial building that has been in use for less than 25 (or 50) years is sold or otherwise disposed of, if the proceeds (or the original cost, if less) exceed the written-down value for tax purposes, the excess (that is, up to the original cost) is taxed through a balancing charge as a trading profit of the period in which the disposal takes place. If the proceeds of sale exceed the original cost, the excess is not taxed. Conversely, a balancing allowance is given if the proceeds of disposal are less than the written-down value for tax purposes. The tax charge or allowance made on the sale of an industrial building is subject to adjustment where the property was not in use for industrial purposes throughout the whole period during which it was owned.
Hotels. Capital expenditure incurred on the construction or improvement of hotels and other buildings used as lodgings for tourists qualifies for allowances as if the expenditure had been incurred on industrial buildings, the initial allowance is 100% Machinery and Equipment. This category (often referred to in the Isle of Man as plant and machinery) includes all moveable and immovable assets kept for permanent employment in the trade; for example; machinery, manufacturing equipment, fixtures and fittings, vehicles, aircraft, and ships. Intangible assets are excluded.
Machinery and Equipment. [Other than Private Automobiles and New Ships.] An initial allowance, in the case of machinery and equipment called a first-year allowance, at present of 100% of cost, is given in the accounting period or periods in which the expenditure to provide the asset is incurred. Exceptionally, an asset acquired on an instalment basis is treated as if its full capital cost is incurred on the day it is first used.
No first-year allowance may be obtained when second-hand (used) assets are acquired from an associated company or connected person (although an annual writing down allowance is then available), or in the period in which trade ceases.
No first-year allowance is granted to the owner of machinery and equipment bought for leasing to a person resident in the Island if, at any time in the first four years of use, it is not used for a qualifying purpose. Qualifying purpose includes use of the asset by a lessee in a trade where, had he bought the asset himself, he could have obtained a first-year allowance; use by the lessor for short and varied hire; and hire of the asset by a non-trading lessee for not more than two years out of the four (provided that the usual hire period does not exceed 365 days). Companies that lease plant and machinery to users outside the Isle of Man qualify for a 100% first-year allowance. This can result in substantial losses arising by way of excess capital allowances, and regulations have therefore been introduced which restrict the use of such losses.
The whole or part of the first-year allowance entitlement may be disclaimed, and any portion of the expenditure not relieved by a first-year allowance is available for a writing-down allowance in subsequent periods.
Writing-down allowances are given on any residue of expenditure disallowed brought forward from previous periods, and are thus calculated on a declining-balance basis. They are reduced proportionately for accounting periods of less than 12 months, and are not given in the period in which trade ceases. The rate is usually 25% per year for all assets.
When an asset is disposed of, the proceeds (for example, actual sales consideration or market value if higher, or insurance claim proceeds) are deducted from the residue of expenditure disallowed, thus restricting the amount on which a writing-down allowance may be claimed in the period of disposal. In cases where disposal proceeds exceed total written-down values brought forward from past periods, the excess proceeds received are taxed by way of a balancing charge in the period in which the disposal occurs.
Automobiles. Private automobiles do not receive first-year allowances. A writing-down allowance of 25% per year is available (up to a maximum of £3,000 per year for each car) in the year of purchase and thereafter.
Ships. A system of free depreciation exists for expenditure on new ships (and on second-hand ships from 1 April 1985), which means that the taxpayer may take the first-year allowance, wholly or partly, in any period or periods he may choose. The balancing charge for capital allowances purposes which may arise on the sale of a ship can be deferred by roll-over into the cost of a new ship.
Mines. Oil Wells, and Other Wasting Mineral Deposits. Allowances are available for capital expenditure incurred in searching for, discovering, testing, gaining access to, or purchasing mineral deposits, whether such deposits are situated in the Isle of Man or abroad. Allowances are given in proportion to output for the period compared with expected total output, for expenditure incurred on the construction of works, except that allowances on purchases of deposits, land, and rights within the Island are based on royalty values.
Scientific Research. When capital expenditure is incurred for trading purposes on scientific research, the whole of the expenditure in the period concerned is deductible (except for that on land and houses, from 1 April 1985) . Scientific research for this purpose includes any activity for the extension of knowledge in the fields of natural or applied science. Revenue expenditure on research and development for the purposes of the trade is deductible as incurred.
Patent Rights. Allowances are given for capital expenditure incurred in the acquisition of patent rights, whether for trade purposes or not. Where the rights are acquired for use in a trade, the allowance is given as a deduction from the profits from that trade; but in other cases, the allowance is given as a deduction from the income from the patent rights.
For rights acquired before 1 April 1986, a straight-line writing-down allowance is given over 17 years beginning with the acquisition of the rights, or over any shorter period for which they are acquired.
For rights acquired on or after 1 April 1986, allowances are given by way of an annual writing-down allowance of 25% on a declining-balance basis.
Disposal consequences will then be the same as for machinery and equipment.
Agricultural Buildings. The owner or tenant of agricultural or forestry land is entitled to a 100% initial allowance for capital expenditure on buildings, fences, or similar items used for the trade. The whole or part of the initial allowance entitlement may be disclaimed. The proportion of the cost not relieved by initial allowance is written off at 10% per year on a straight-line basis, commencing in the year following the year of expenditure. On a sale of the land or transfer of the tenancy, the purchaser is usually entitled to any remaining writing-down allowances, and no balancing allowances or charges are made to the seller.
Manx income tax is not a deductible expense. Other taxes, such as local property taxes (rates), license fees, and irrecoverable VAT, necessarily incurred in the course of earning profits, are usually deductible.
Foreign direct income taxes are usually relieved by credit against Manx income tax as described under "Unilateral Relief" in the section on "Double Taxation and Tax Treaties."
Formation and Start-up Costs
Expenses incurred in organising a company and raising its capital, including associated legal expenses, are generally not deductible. However, revenue expenses incurred prior to the date on which trading commences are allowable and are treated as being incurred on the first day of trading. Capital expenditure incurred before a trade commences may be treated for capital allowance purposes as incurred on the first day of trading.
The date when trading commences depends on the facts of each particular case but as a general rule is taken as the date when the business holds itself open to begin trading; for example, when a retail shop first opens its doors to the public or when a manufacturing company receives its first delivery of raw materials.
Interest paid wholly and exclusively for the purposes of a trade is deductible. Additionally, any interest payable on a mortgage or loan is also allowed as a deduction provided that the mortgagor or lender is liable to Manx income tax on that interest.
A dividend paid by a Manx resident company is deductible from taxable profits in the year of assessment in which it is paid.
Rents and Royalties
Commercial rents and royalties are deductible as trade expenses if they are incurred wholly and exclusively in earning the income of the trade.
Bad and Doubtful Debts
Bad debts arising from the company's trade are deductible in the period in which their recovery is considered improbable, and any subsequent recoveries are taxed in the period of receipt. Provisions for doubtful debts are deductible only to the extent of expected losses on trade debts individually valued. General provisions are not deductible.
Transfers to tax-free reserves are not permitted in the Isle of Man. The nearest approaches to the tax-free reserve concept are the accelerated tax depreciation allowances.
Expenditure on repairs and renewals is generally deductible when incurred, but provisions made to equalise repair charges over several years are not. Provisions for repairs to be incurred at some future time are also not deductible.
The remuneration of directors is deductible in full to the extent that it is incurred wholly and exclusively for the purposes of earning the company's income.
Profit-sharing payments in the form of cash bonuses to employees or directors are deductible in the year in which they are charged in the financial statements.
Annual contributions to approved pension schemes are deductible. Exceptional contributions (such as to create a fund to pay pensions for past service) are also deductible, although the deductions may have to be spread over a number of years.
Expenditure on entertainment is deductible to the extent that it is incurred wholly and exclusively in earning the income in question.
Gifts and Donations
Gifts are deductible only if they can be justified as incurred wholly and exclusively for the purposes of earning the income of the company. Donations to charities up to a maximum of £4,500 are tax deductible.
Transactions with Related Parties
If, in the opinion of the Assessor, one of the main purposes of any transaction is the avoidance or reduction of any person's liability to Manx income tax, the Assessor is empowered to make whatever tax assessments he considers appropriate to counteract the avoidance or reduction of tax. This power does not, however, apply to bona fide commercial transactions not designed to avoid liability to income tax.
11.06 CORPORATE TAX RATES
Manx income tax is charged at a single rate of 20%. Since, however, dividends are deductible expenses, this rate is effectively charged only on a company's undistributed profits, and on the profits of branches. Withholding tax on dividends is described later in the "Withholding Taxes" section.
The information given is not exhaustive and is based on conditions existing at 5 May 1999. Readers are advised to consult with professionals, such as independent accountants, legal counsel, and investment bankers, before taking any formal action. Deloitte & Touche would be pleased to discuss specific problems.