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Guernsey ready to adapt to maintain private equity appeal

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In a new world where offshore financial centres are being called upon to adopt a wide range of regulatory and transparency standards in order to continue to access investment and other financial se

In a new world where offshore financial centres are being called upon to adopt a wide range of regulatory and transparency standards in order to continue to access investment and other financial services business in onshore markets, members of Guernsey’s private equity industry remain convinced that the island will retain its appeal to global investment houses that have long gravitated toward its legal environment, professional expertise and extensive experience of the sector.

Until now the island’s political status outside the European Union has been appreciated by fund promoters happy to escape what some see as the bloc’s over-prescriptive approach to regulation, particularly in financial areas. But right now Guernsey, along with fellow crown dependencies Jersey and the Isle of Man as well as offshore centres elsewhere in the world, is having to grapple with the impact of EU rule-making on some of its core businesses.

At the centre of concerns is the Directive on Alternative Investment Fund Managers, whose first draft threw offshore fund jurisdictions into a spin when it was unveiled last April. The original proposal appeared to put non-EU managers and funds at a significant disadvantage compared with their counterparts based within the union, although since then a more sanguine view has emerged that the Channel Islands should be comfortably capable of satisfying any demands made on outside jurisdictions in order to be recognised as “equivalent”.

In addition, there is growing confidence that the directive may well see significant revision during the legislative process, removing or softening some of the aspects that caused particular alarm among both outside jurisdictions and managers of alternative funds. Any new version of the legislation is likely to incorporate much more input from the fund sectors affected than did the original, which is widely viewed as having been rushed out to meet political imperatives.

But a fresh complication for the crown dependencies, and probably other offshore centres, has arisen since the UK government confirmed to the three territories in mid-October that at least some EU member states are unhappy about their so-called ‘zero-10’ corporate tax regimes, introduced over the past three years to eliminate any discrimination between the way domestic and international companies are taxed. Because the systems mean that the income tax rate for most companies is zero, the EU members are now arguing that the regimes are “predatory” and breach at least the spirit if not the letter of the union’s Code of Conduct on Business Taxation.

The Code of Conduct, a political declaration rather than a legally binding rule, was unveiled by the EU in 1997 and was designed to end more than 60 tax measures eventually identified in member states and their dependent territories that were deemed to constitute harmful tax competition. The code notably targeted 26 measures implemented in EU dependent territories and Gibraltar, an associate member of the union, including tax benefits reserved for non-residents and businesses outside the domestic economy, and notably tax-exempt status for international companies.

The crown dependencies responded by eliminating the differential treatment of domestic and international companies through a single standard zero rate of corporate taxation for all companies, local and international (bar certain types of company, such as banks and utilities, that would pay a rate of between 10 or 20 per cent). This elegant solution allowed offshore financial centres to offer an attractive tax regime and was initially grudgingly accepted by EU members and the European Commission as removing the “harmful” element of their tax regimes. But now at least some countries have changed their minds and are insisting that a zero standard corporate tax rate is a predatory measure that deprives EU members of revenues.

Recognising which way the wind is blowing, the crown dependencies have decided to work together to revise their tax regimes in a way that will satisfy the EU and that will not offer tax arbitrage between them. Says Guernsey’s chief minister Lyndon Trott: “Our zero-10 strategy was always intended to be a multi-stage process, to ensure that our tax revenues are sufficiently sustainable in the light of changing economic uncertainties.  

“As a result of the changes in international attitudes, the terms of consultation on this issue will be broader than had previously been envisaged, and will aim, working with the UK and other EU member states, to ensure that our fiscal regime remains competitive and within international standards.”

In theory this move, which seemingly spells the end for the zero-10 approach and will mean financial services and other companies paying at least some corporate income tax in the future, could discourage international business that was attracted to the island by the zero rate. However, Guernsey officials believe that working in lockstep with the other crown dependencies will minimise the impact on international competitiveness, and that the changes will also offer companies greater certainty over the future stability of the island’s tax regime.

Says Peter Niven, chief executive of Guernsey Finance, the promotional agency for the island’s finance industry: “The Guernsey government is reviewing this strategy in conjunction with the other crown dependencies with a view to delivering corporate tax regimes broadly similar to each other that remain competitive, yet also within international standards.

“We are acutely aware that businesses and their clients require certainty and are reassured that the government have indicated that they intend to move as speedily as possible to agree a corporate tax regime that is sustainable for the future. Early indications from our financial services and business community appear to support the approach outlined by the government and we look forward to seeing progress in the coming weeks and months.”

In truth, a resumption of corporate taxation will help to resolve a growing dilemma for the Guernsey government, which initially hoped that the shortfall in tax revenues resulting from the zero rate would be compensated by rising levels of income from corporate fees and charges as well as personal and indirect taxation. This calculation has been confounded by the decline in new business over the past two years resulting from the global environment, leaving officials looking for ways to plug the gap.

The need to satisfy the EU on corporate tax is all the more important in the light of efforts by Guernsey and others to persuade the union to amend the alternative fund managers directive. Says Niven: “The way the directive was written was very narrow and from a Ucits point of view, which is what the Europeans are used to. However, we are working with Jersey, onshore financial centres such as Dublin and the City of London, and talking with the UK government and directly with the Swedish presidency of the EU, with the European Parliament’s rapporteur and shadow rapporteur for the directive, and even with the French to put our case forward. From the soundings I’m getting, we are having an effect.”

Joe Truelove, head of business development for corporate clients at Kleinwort Benson in Guernsey, believes that a key initial concern about the directive, the proposal for a three-year waiting period before outside jurisdictions can be accepted as “equivalent” in regulation and tax compliance, allowing its funds and managers to benefit from the directive’s provisions for marketing within the EU, should not be a problem for Guernsey.

“We don’t believe there is anything in the directive that we can’t comply with,” he says. “We have always dealt with additional burdens and regulations when they are imposed on us, and we always will. We are a high-quality jurisdiction with appropriate regulation – without being over-regulated – and we’ve always met any outside regulatory prescriptions without difficulty.” 

Truelove points out that up to now Guernsey funds have not needed an EU ‘passport’ enabling them to be marketed throughout Europe to retail investors, because they are typically distributed through private placement to large institutions. “We see no reason why that shouldn’t continue,” he says. “Guernsey has always been a good home for private equity funds, and we expect to be able to meet the requirements of the legislation should all funds be captured under it and become an equivalent jurisdiction very quickly. If private placements can continue under the legislation, business will continue as normal for Guernsey.”

Darren Bacon, head of the Guernsey office of law firm Mourant du Feu & Jeune, is more cautious. He says: “We are somewhat dependent upon what happens between the French, the Germans and everybody else. We will have to react to whatever proposals are put into force. We will say we are very well regulated, but we will do whatever is required to make sure we comply.

“We may be outside the EU, but our major markets are London and Europe, so if there is any damage to London, Guernsey will suffer as a result. We hope we will be no worse off under the directive, but it’s difficult to predict what the outcome will be. It depends on the objective of the directive. Is it protectionist or anti-offshore? What is it trying to achieve?”

Niven believes that wiser counsel will prevail in Brussels and Strasbourg. “They do realise it’s been put together in haste and needs to be looked at differently,” he says. “Pundits may say this may be the death knell for Guernsey, but we’ve heard this before, for instance about the EU Savings Tax Directive. We worked with the EU on the savings directive and continue to do so. These are not stupid people – they understand cogent arguments and are prepared to compromise, which is all we can ask for.”


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