Money maketh Man

How is the three-legged island coping with new realities? James Featherstone finds out

Out of season, Douglas looks uncomfortably like what it is: a smallish, Northern seaside town habitually challenged with having to make a living in an inherently precarious position. During the TT races, which are, apart from offshore finance, what the island is famous for, and the place appears vibrant and prosperous. Go in February, and it looks like a smaller, sea-salt-faded version of Skegness or Bridlington.
Thank God, then, for the offshore financial services industry, which has kept the island in funds for the past few decades and has made up for unstable tourist-based revenue. After the Channel Islands, the Isle of Man is probably the best known of the offshore jurisdictions. It even got a mention in The Sopranos.

New challenges

Now, though, the island is having to work out how it will survive a new era of greater pressure on tax confidentiality and the advent of the EU Savings Directive, which will mean tax levied at source (the so-called ‘witholding tax’) for the first time ever. Some banks and deposit-takers on the island are gloomy about the future, some are not. The island’s motto – Quocunque Jeceris Stabit: “Withersoever you throw it, it will stand” – refers to the famous three-legged symbol on its coat of arms. Manxmen will have to hope that the motto remains true.

Of course, the same pressures are on other offshore jurisdictions too. The Channel Islands, Bermuda, the Caymans: all are variously rejigging their financial service sectors to cope with the new realities. But each has a slightly different profile in the industry and starts from a different base. The Isle of Man’s traditional business has been in deposit-taking, banking and – increasingly important – insurance. It has considerably fewer corporate entities located there than, say, Jersey. Its trust sector is smaller, too.

It also has a longer tradition of UK-based investors placing their money on the island – whether they realised the tax implications or not. The big question for the Isle of Man government and the financial service sector is whether the relative prosperity of the island can be maintained in the face of the Savings Directive in particular, and the increased pressure on offshore centres in general. The last thing residents of the Isle of Man want to do is revert to being reliant on Irish, Scottish and Northern English tourists – with a once-a-year influx of bikers.

It’s difficult for the layman to work up much enthusiasm about EU directives. But the Savings Directive really will be an important watershed for the offshore world. In a nutshell, it means that people from EU countries with money in another EU country will either have the details of that money passed back to their own revenue agency, or have tax levied on it by the jurisdiction it sits in. Governments across the EU have finally lost patience with their citizens’ tax-avoiding habits.

Several billion German euros find their way to Luxembourg, Switzerland and the Channel Islands each year, for instance. Almost all the European ‘onshore’ countries have opted to share tax information; all the offshore jurisdictions have opted for a withholding tax so as to preserve banking secrecy (for now at least: banking secrecy is meant to vanish altogether by 2011).

Responding to the directive

The Isle of Man’s response has been to opt for a withholding tax so as to avoid, for the time being, tax disclosure. Information, if not actual total disclosure, has been shared with the UK and Irish revenue services for years now. But even those two revenue agencies have increased their search for tax-evaders. Recently the Irish revenue sent letters to thousands of individuals and companies politely ‘informing them’ that they had better have their tax affairs in order, or else. The Isle of Man, long a place for canny Irishmen to keep their cash, is under pressure from this too.

The response to all this among the Douglas banks and deposit-takers is mixed. Some, like the managing director of the Alliance & Leicester International, Simon Hull, are pessimistic about the directive and critical of the government’s inability to mitigate some of its harsher effects. “The government should have pressed for access to the EU’s financial service sector as a quid pro quo,” Hull says. “It could be bad for the industry.” Other companies have the appearance, at least, of being unconcerned. In the words of one banker on the island, “In fact, we see the directive as a welcome opportunity. It will focus customers’ attention on the actual abilities of a company and not just on the basic tax mitigation” – all said with a wave of the hand.

The truth is, nobody knows how the directive will affect the offshore world. Nobody even knows for certain whether the deadlines it stipulates will be kept. It would be a foolish government not to assume the worst, though, and the Isle of Man government has at least tried to tackle the issues head on. The Tynwald (the island’s ancient parliament) agreed a “taxation strategy” in 2000 as a direct response to the EU and the other supranationals.

A new, zero-rate corporation tax was the key element. Other changes included zero-rate tax for fund administration and tax breaks for the island’s small film industry. The island must “remain competitive” but “within an acceptable international framework”, says the Treasury. For that, read “must hang on to its offshore businesses while staying out of trouble with some very powerful organisations which could make life difficult for us if we don’t”.

Future prospects

There is little doubt, in fact, that the island’s financial services industry will emerge from these choppy waters in some form. A previous EU directive – the Code of Conduct on Business Taxation – which stated that there should be no “discrimination” between the way that foreign and local businesses were taxed, was neatly side-stepped by the government by reducing corporation tax to zero for all companies as part of the taxation strategy.

The Channel Islands followed suite shortly thereafter. About 12,000 so-called ‘exempt’ companies are registered on the island whose shareholders must live elsewhere, and which pay no tax. Requiring them to pay the 20 per cent local rate overnight would have driven most if not all away and devastated the island’s offshore financial services industry.
Putting in place a zero corporate rate is simply easier for the Isle of Man to achieve than many of its rival jurisdictions.

The Manx government charges VAT, while Jersey and Guernsey do not. The VAT take amounts to 50 per cent of the government’s revenue. Deleting corporation tax from the statute books is harder for jurisdictions more dependent on this tax. This means, say some, that the zero-rating will have an effect bigger than the immediately assumed one. “Reducing the tax take is just more feasible for us,” says Chris Eaton, chief executive of ILS Group, an administration company servicing the island’s exempt companies. “We should become Europe’s leading offshore jurisdiction.”

That would bring great relief to the government – and the locals. It is difficult to over-estimate the importance of financial services to the island’s life. Some 42 per cent of GDP comes from the financial sector.

The equivalent figure in the UK as a whole is 5.1 per cent. Assuming that the various little islands and land-locked principalities dotted around the world do survive as financial centres, there is no reason why the Isle of Man should not remain as part of the respected core group of them.