“It is the first ever EU list of tax havens” said Pierre Moscovici, the European Commissioner for Economic and Financial Affairs when he described the EU list of non-cooperative jurisdictions for tax matters (the so called tax blacklist). And guess what folks, we are not on it. We weren’t included on the list when it first came out on 5 December 2017 and we are not on it following ECOFIN’s meeting on 12 March 2019, during which the EU list was once more considered.
So why weren’t the Channel Islands, together with the Isle of Man, blacklisted by the EU? The simple reason is that these three jurisdictions did what they said they would do and introduced economic substance legislation for resident companies undertaking certain relevant activities. Furthermore and importantly, the islands have the necessary infrastructure to implement, monitor and enforce the legislation given that they have been dealing with direct tax compliance for over 90 years. As such, the EU Council must have taken the view that the islands could be trusted in discharging their obligations under the new law.
This was not the case for the many of the other financial centres in the Caribbean. The Cayman Islands and the BVI remain on the grey list despite introducing legislation, the contents of which were very similar to our law. However, it seems they were not considered to have our wealth of knowledge and experience in dealing with direct tax compliance matters and so the implementation of their law will be closely monitored by the EU.
But how did we get here?
In November 2016, the EU commenced work on a list of “non-cooperative jurisdictions” for tax purposes. Through 2017, the EU screened some 92 jurisdictions against criteria based upon transparency, fair taxation and the implementation of measures under the OECD’s Base Erosion and Profit Shifting (“BEPS”) initiative. The one area of the screening process that posed a potential challenge for the Channel Islands related to the requirement that the jurisdictions should not facilitate offshore structures or arrangements aimed at attracting profits which do not reflect real economic activity in the jurisdictions (Criterion 2.2 of the Fair Taxation heading). Although both Jersey and Guernsey have for many years sought to move away from providing services to entities with little substance, neither island had legal substance requirements for entities doing business in or through the islands.
In November 2017, both Jersey and Guernsey made a commitment to introduce legislation to deal with the EU’s concerns in this area. As a result of the commitments, the Channel Islands were not ‘blacklisted’ but were placed in Annex II (the grey list) of the list of jurisdictions produced by the Code of Conduct Group for Council in December 2017, which essentially meant that our commitments would be monitored by the EU.
The Channel Islands put much effort in discussing the requirements with various representatives of the EU Code of Conduct Group and OECD’s Forum on Harmful Tax Practices (“FHTP”). This cumulated in lodging economic substance legislation based on the EU technical guidance contained within the EU June 2018 Scoping Paper and the FHTP guidance on substance in the context of preferential tax regimes. The EU Code of Conduct Group reviewed our laws and did not find fault with them.
This legislation is now effective and applies to companies that undertake relevant activities from accounting periods starting on or after 1 January 2019.
Although the economic substance rules should not be confused with global transfer pricing principles, companies resident in the Channel Islands have for a number of years sought to justify their internal pricing policy by ensuring that the real economic activities, which give rise to the profits, are conducted in the island. This has, in certain cases, necessitated increasing the company’s presence in Jersey and Guernsey. As such, there is a view that for those companies that undertake relevant activities, there is currently adequate substance in the islands and with relatively minor amendments to, for example, its record keeping, the company should be able to demonstrate that it passes the respective economic substance test.
Given the relatively narrow definition of relevant activities, it is expected that only a few companies will need to make material changes to the manner in which they operate if they are to satisfy the requirements and a smaller amount of companies that will simply not be able to satisfy the requirements.
Some businesses will ultimately conclude that they cannot (or are unwilling to) satisfy the requirements and thus will, presumably, leave the island. In many ways that is exactly what the EU and the OECD are trying to achieve. On the other hand, there will be businesses located in other jurisdictions that are struggling with the equivalent legislation and may conclude that the Channel Islands provide the right environment to cement their business going forward - after all, we are well placed in terms of people, expertise and space.
Clearly, the conclusion of the EU Council listing Jersey and Guernsey as ‘white-listed’ jurisdictions was a huge endorsement to the Islands’ policies with regards to their finance industries. For some time now the finance industries in the Islands have followed a business model based on tax neutrality and transparency. These businesses will now need to adhere to the new economic substance requirements although the expectation is that they have already, to some extent, been doing so. As such, although the Islands’ finance industries continually need to adapt and grow, unlike a number of their competitive jurisdictions, there ought not to be any great requirement to change radically their business model in light of the new world. And for perhaps the first time, Jersey and Guernsey can enjoy the fact that the EU has publically agreed that the Islands are not tax havens. Given the potential loss of the UK from the EU voting group, the timing of this announcement could not be better.