Guernsey is currently on course to address EU demands that island companies have “substance” (described here). But suppose the EU does not finally end its persistent scrutiny of our tax arrangements. And suppose, further, that the “black hole” in the public finances does not look like being fixed. What then?
Start with these two suppositions. We have long faced EU attempts to end our tax regime of the past decade called “zero-10” – meaning a rate of zero on corporate taxes, save for a (now significant) array of exceptions with taxes of 10% or 20%. And we have long felt there is a sub-plot focused on shutting down our financial services. Do we really think these international pressures will abate?
As for the “black hole”, it may be true that the public finances are coming under better control, but it is equally plain that the gap has proved to be bigger and longer-lasting than was ever envisaged when it was first foreshadowed. Some of this was due to external events – the global financial crisis for one – but it was also due to poor spending controls and inflexibility on tax. Can this state of affairs continue?
So the serious question to be addressed is this: what might the alternative to zero-10 look like?
At the time zero-10 was being evaluated over a decade ago, another tax system was also being considered – “territorial-10”. Basically, territorial taxation is the idea of taxing activity where it takes place rather than where a company has its HQ. This is a spreading and internationally admissible structure of taxation: the proposals for the so called “Google tax” are, essentially, territorial.
Most elements of territorial-10 might well work fine for Guernsey. It is not unusual, inside the EU or outside, to exempt investment funds from taxation entirely. That important leg of the finance industry should, therefore, be unaffected.
Banks and other financial services businesses operating here are now subject to corporate taxation at 10%, as one of the burgeoning current exemptions to zero, so nothing would change there.
As long as no other reputable jurisdiction can maintain a zero rate, the private wealth industry would also probably be able to handle the change in large part. Even better, all non-financial businesses on the island would once again contribute to the island’s coffers, not just Boots and a couple of other retailers. Black holes in the public finances might be a thing of the past.
So why didn’t the island simply introduce territorial-10 a decade ago? Two main reasons stand out. Firstly, it did not suit the then rapidly growing captive insurance industry and would, in all likelihood, have risked snuffing out that strand of financial activity over the medium term. That threat remains, although the true extent of the threat was unknown then and remains unknown today. Chances are, some will go and some will stay.
The principal reason, however, was that Guernsey felt that it could not sustain a headline of 10% if others were at zero. Business might simply divert elsewhere, possibly as close as 26 miles south east. That was the big threat.
As long as other jurisdictions don’t come up with clever wheezes that we haven’t thought of, that threat is much diminished today. Jersey, Guernsey and the Isle of Man all face the same dilemma and are in close dialogue. Many other international financial centres are also sitting alongside us on the naughty step. No one wants to blink first but this is less like “the prisoner’s dilemma” and more like the solution to it – collaboration saves lives. For once, dialogue can lead to sensible international cooperation. It is likely that few will seek to sustain zero over the long term.
More interestingly, could the EU threat actually be an opportunity? If we could sustain the vast majority of our existing financial services industry under territorial-10, it would permit a number of benefits. Some regressive revisions to other taxation seen over the last decade could be rolled back. It might be possible to ensure that low earners again take home more than they would in the UK. Some of the recent aggressive claw-backs against high earners could be rethought and this might make Guernsey a more attractive home for entrepreneurs and professionals. A sales tax regime as a pure revenue-raiser could remain off the agenda.
Even better, it may be possible to eliminate the black hole without our pockets being picked time and again. It could even give us sufficient money to invest in a more diversified future away from finance.
Possibly, just possibly, the EU will be doing us a good turn without realising it. And the puzzle we see, of a jurisdiction which is able to write its own fiscal policy ceding its self-determination to faceless bureaucrats in Brussels, may work in our favour.
