Seismic Changes for Gibraltar Tax System

On 16 June the long awaited text of the new Income Tax Act was published as a draft for public comment. Shortly after, on 1 July, the 2010 budget was announced. In the first week of September following the consultation period, the revised Income Tax Bill was published. The Bill came to Parliament at the end of October and its provisions are effective from 1 January 2011.

The implementation of the new Income Tax Act signalled the end of Gibraltar as a tax jurisdiction which relied on administrative and statutory ring fencing and secretive tax exempt companies and trusts to attract inward investment. By creating a level playing field for both local and inward investors, Gibraltar swept away the obstacles to it taking full membership of the company of respectable jurisdictions, which no other jurisdiction had grounds to black list or censure.

Corporate Tax rate: 10 per cent

Although the European Court of Justice, when the issue came before it, had not denied Gibraltar the opportunity to implement the zero per cent/eight per cent regime, which had previously been prepared for legislation and submitted for EU approval, the Government decided that it would be a more responsible approach and more consistent with the modern requirements for the acceptability and credibility of offshore finance centres to retain the principles of the current Act, modernise it and create a structure, which would enable an enduring reduction of the rate of tax chargeable on corporate entities from 22 per cent to 10 per cent. The only exception to this low rate of tax would be a surcharge of an additional 10 per cent on utility companies (electricity, telecommunications, water, petroleum and sewage) and any company which has a dominant market position and abuses it.

Gibraltar’s tax regime has, since its inception, been based on the colonial laws handed down by the UK government in the early and middle parts of the 20th century. A fundamental part of that body of law was to restrict the powers of the colony to its own territory. The Government, although now a dependent territory rather than a colony, has decided to retain and clarify this territorial basis in so far as it refers to taxation and will only tax income which accrues in or derives from Gibraltar. The new Act defines the concept of “accrued in” or “derived from” to amplify the meaning from binding Privy Council case law previously relied on and expands the definition to ensure that companies which operate under a licence granted by Gibraltar or passport into Gibraltar under a licence issued elsewhere (eg, insurance companies) are entitled to take advantage of the 10 per cent rate of tax while not suffering tax on the activities they undertake through a branch or permanent establishment outside Gibraltar.

It is interesting and re-assuring to note that the UK Government has recently launched a consultation paper exploring the possibility of moving parts of its own tax system to a territorial basis.

Sustainability of low tax rate

That the 10 per cent tax rate is sustainable over the long term was demonstrated by the details of the state of the economy announced in the budget. Gibraltar may have a small economy but, at a time when most of the economies of the Western World are in dire straits, the economy of Gibraltar is alive and well!

In the year to 31 March 2010, economic growth was 5.4 per cent and the budget showed a surplus of £29.4 million on a gross domestic product of £848 million. Public debt represented 15.2 per cent of GDP. Comparably, the UK and much of the rest of the developed world are struggling with huge deficits; debt is about 70 per cent of GDP in the UK and in many countries, approaching 100 per cent.

This state of economic health has enabled not only the reduction of the corporate tax rate to 10 per cent but also has several subsidiary effects.

Passive income

Gibraltar tax operates on the principle that tax is only due where there is a clear legislative imposition of tax on a source of income. In drawing up the legislation all forms of interest (apart from trading interest received by banks and similar institutions) and royalties were omitted from the list of taxable sources of income to reflect the Government’s policy that there is no intent to tax those sources.

Dividends are not excluded from taxation but their taxation is significantly limited. Dividends paid between companies are not taxed, dividends paid to non-residents of Gibraltar are not taxed and dividends paid to Gibraltar resident individuals are only taxed if they do not arise from quoted companies and, even then, only to the extent that the underlying income of the company is taxable in Gibraltar.

Overall advantages for individuals

The removal of the taxation of interest, royalties and the majority of dividends reflected an advance in the Government’s program of reducing the taxation of savings and passive income by removing from chargeability taxation on all interest on investments of both individuals and corporate entities. Parallel to the removal from taxation of this large swathe of investment income is previous legislation which reduced the rate of taxation on pension income for those over 60 years of age to zero per cent.

The Government’s emphasis on doing away with the taxation of savings and pension income is, in itself, not only an incentive for the population of Gibraltar to invest for their future, but also, when combined with the lack of capital gains tax or any sort of estate/wealth tax, a powerful attraction for those with savings income who wish to relocate from a high tax jurisdiction to a more economically friendly jurisdiction.

The budget also went on to announce reductions in the tax rates applicable to individuals who have income which is taxable. The top rate of tax for those earning up to £353,000 will be 29 per cent. Above that level tax rates begin to fall. The effective rate of tax on earnings of £1m is 20 per cent, anything above that is charged at five per cent. The stated intention of the Government is to continue the reduction of the rates of taxation charged on individuals across the board to bring it closer to that of companies.

The quid pro quo for the significant reductions in the levels of corporate and personal taxation and an integral part of the plan to produce the income which will allow future reductions in individuals’ taxation, is that the Government has taken measures to enable it to feel confident that it will be able to collect the tax it intends to collect and has introduced self assessment, legislation to modernise the collection of tax and extensive measures to counter the avoidance or evasion of tax.

Trusts

Although the taxation of trusts and beneficiaries of trusts has been introduced    where the beneficiaries of a trust are outside Gibraltar, the taxation position remains much the same as it was before.

Taxation on the income of a trust is limited to those trusts which have Gibraltar resident beneficiaries (for this purpose, those High Net Worth Individuals who have Category 2 status and their spouse and children are treated as not resident). If a trust has Gibraltar residents amongst its beneficiaries or potential beneficiaries, the absence of taxation on savings or passive income applies just as much to the trust as it would to an individual.

The taxation on the beneficiaries of a trust rather than the trust itself is limited to those beneficiaries (other than the Category 2 individuals and their families) who are resident in Gibraltar and even this is restricted to taxing the distributions which can be matched with the taxable income of the trust and the offsetting of any underlying tax which has been paid by the trust.

If neither the trust nor the beneficiaries are subject to tax, a licensed trustee will have no need to make returns for the trust or to make the trust known to the Commissioner of Income Tax.

Funds

The principle of reducing the taxation of savings and passive income is carried on into funds and their investors.

The position of the fund itself is unchanged by the new Act and the same exemptions apply as before strengthened by the further exclusion of categories of savings and passive income from taxation.

In the case of the investor into a fund there are changes which make the trust regime even more attractive.

Income from a fund which is available to the general public is no longer taxable regardless of how the income arose in the fund.

If a fund is not available to the general public, a look through basis is used and taxability is limited to whatever the tax would have been if the recipient had received the income from the entity underlying the fund. Again the entity will have the advantage of the absence of tax on savings and passive income, which means that with very few exceptions (eg, a fund investing in Gibraltar real estate), there will be no tax payable by the investor.

Treasury/Holding Companies

Taxation on interest is limited to that interest received by banks or moneylenders as trading receipts. In the case of both, trading receipts are defined to exclude the interest which would arise from a Treasury function. This gives banks and moneylenders the same advantages as all other companies where the possibility of using Gibraltar as a Treasury base arises. Effectively a non-Gibraltar group company can borrow money from the Gibraltar Treasury company, receiving a deduction in accordance with the laws of its jurisdiction, and the Treasury company will not be taxed on the receipt of the interest.    

The changes made in the new Act are also beneficial for those companies receiving dividends from their subsidiaries.

Gibraltar is already in the position that it does not tax the receipt of dividends from EU subsidiary companies, it has added to this by taking away the taxing rights to any part of a dividend received from a company which carries out its profit making activities elsewhere. With neither liability to tax nor withholding on dividends paid to non-residents, group profits can flow through or be invested in Gibraltar without taxation.

Conclusion

There is a lot more detail to the legislation but, all in all, its aim is to create a corporate low tax environment and lay the foundations for, not only the security of the corporate environment, but also the continued reduction in the tax burden on individuals.

The environment created by the new legislation not only places Gibraltar amongst those jurisdictions who comply with all international codes of conduct relating to tax behaviour but also leaves it as an attractive and tax efficient location for individuals and businesses who wish to locate either in whole or in part to a pleasant, tax efficient, new home.