Guernsey Foundations and Taxation

“Foundations will provide the financial services industry with a new structure that will provide greater flexibility for its clients. This is an opportunity for the finance industry to have an input at a key stage of the development process”[1].

GUERNSEY FOUNDATIONS AND TAXATION

Carey Olsen, Guernsey Comments on question 20 of the Foundations (Guernsey) Law Consultation Document issued 11 April 2011.

“Question 20: what is the most appropriate basis for taxation of Guernsey foundations?”

Executive Summary

The tax treatment of foundations should be set out in Guernsey’s tax law using terminology from the new Foundations Law.

Tax neutrality underpins the success of financial products in Guernsey.

There are a number of structures which provide excellent case studies.

Is it not possible for the tax treatment of foundations to enable clients:

• to pick and choose those characteristics available in other structures;
• to apply those characteristics in terms which resonate with the terminology of the new Foundations Law;
• so as best to achieve the clients’ objectives;
• in a framework which results in tax neutrality?

Introduction

The commentary from the Commerce and Employment Department (the “Department”) on Question 20is set out on page 11 of the Consultation Document. The Department explains that there are two broad options: taxation along the lines of trusts or alternatively taxation as companies. The Department’s preference is for foundations to be treated as trusts for the purposes of Guernsey’s tax law but it will consider the issuefurther depending on feedback from the Consultation. Any decision on tax treatment will be a matter for the Treasury and Resources Department.

When offering a Guernsey foundation to potential new clients, the financial services provider is likely to be faced with the following 3 questions:

1. Will the taxation of foundations in Guernsey be clearly and comprehensively set out in law?

1. Will there be any tax payable in Guernsey?

1. How will the tax treatment of foundations in Guernsey affect the tax treatment of Guernsey foundations abroad?

1. WILL THE TAXATION OF FOUNDATIONS IN GUERNSEY BE CLEARLY AND COMPREHENSIVELY SET OUT IN LAW?

1.1Whatever the basis for taxation of Guernsey foundations, it should be clearly and comprehensively set out in Guernsey’s tax legislation. Any statement of practice should be by way of clarification or guidance only. This approach would be consistent with the new Foundations Law in echoing the civil law tradition of having relevant provisions set out in primary law supplemented byregulations. As such, this would greatly assist with understanding the tax treatment of Guernsey foundations both in Guernsey and abroad. It should also help with clarifying from a tax perspective, the roles played and interests held by the various principals involved with the structure, be it the founder, the councillors, the beneficiaries, or others.

1.2In addition, tax provisions relating to foundationsshould use terminology which is consistent with the new foundations law itself. Wherever possible, the draftsman should avoid using concepts drawn from company or trust structures so as to avoid the risk of blurring the distinction between those entities and Guernsey foundations. Therefore, for example, it would not be appropriate for any amendment of the Income Tax Law to be made by simply expanding the existing definition of a settlement or of a company, so as to include to a Guernsey foundation.

1. WILL THERE BE TAX PAYABLE IN GUERNSEY?

2.1The Consultation Document offers 2 broad options: taxation along the lines of trusts or alternatively taxation as companies. The Department’s preference is that foundations are treated as trusts for the purposes of Guernsey tax law. On one level it can be said that it does not matter whether a foundation is taxed as a trust or as a company, provided the end result is tax neutrality for the structure, namely that there should be no additional tax payable in Guernsey, over and above the tax liabilities of parties in their home jurisdictions. Since the finance industry’s market is primarily based on offering structures and services to those individuals who are not resident in Guernsey for tax purposes, the existing product range available in Guernsey of trusts, companies, exempt companies and limited partnerships, each carry with them tax significant characteristics, which when taken together result in tax neutralityfor that vehicle under current law and practice. The basis chosen for the taxation of Guernsey foundations should replicate this approach by identifying the tax significant characteristics of a foundation in terms which are consistent with the new Foundations Law, so as to achieve tax neutrality.

1. HOW WILL THE TAX TREATMENT OF FOUNDATIONS AFFECT THE TAX TREATMENT OF GUERNSEY FOUNDATIONS ABROAD?

3.1The tax treatment of foundations in a foreign jurisdictionis likely to take into account the mechanisms that are used in Guernsey to determine the basis of taxation here and the characteristics which are identified in Guernsey tax law as having tax significance. We have a number of successful productsin Guernsey which are tax neutral and carry with them characteristics which are tax significant in achieving the client’s objectives.

3.2Here are the mechanisms and characteristics used by some of ourexisting key financial services products, where the underlying participants are not all resident in Guernsey for tax purposes:

Trusts

3.2.1Trusts are tax transparent in that they are not taxable in their own right. The trustees are assessableon income within the trust if they are resident in Guernsey. However, by concession, where all the beneficiaries are resident outside Guernsey, foreign source income and interest from Guernsey bank accounts in the hands of Guernsey resident trustees, is not taxable in Guernsey. As a result, the trust benefits from tax neutrality whilst being administered in Guernsey for the benefit of non-Guernsey resident beneficiaries.

3.2.2A similar approach would be attractive for those clients who would like the assessment to Guernsey tax of the foundation to be linked to a specific characteristic of the foundation, such as the residence of its councillors, or the place in which the council meets combined with the non-Guernsey residence of the beneficiaries. Unlike assessment based on the place of establishment or initial registration, these linkages could be changed in practice to suit evolving circumstances.

Companies

3.2.3Companies are taxable in their own right and the basis of taxation in Guernsey is either incorporation or control. The test for control in Guernsey is different from “central management and control” or“effective management”. These differences can often be crucial in internationaltax planning for cross-border structures.

3.2.4The standard rate of tax in Guernsey is currently 0% for Guernsey resident companies whose income does not come from certain banking business, the trading activities of regulated utility providers or the ownership of land and buildings in Guernsey. Thus, although a company may be resident in Guernsey, the rate of tax charged will depend on the type of its income. This approach can often assist with negating a taxable presence, and / or off-setting a liability to tax, in a foreign jurisdiction. A similar approach to this basis of taxation would be attractive to clients who wish the foundation to have a taxable presence in Guernsey with an accompanying liability to tax at a net rate which is commercially acceptable. However, it may be prudent to bear in mind the possible effect of any changes to the corporate tax regime, should the taxation of foundations be perceived to be too closely allied to companies. Adverse perception by association would not assist with the marketing of foundations as a new product for Guernsey’s financial services industry.

Exempt Companies

3.2.5It is anticipated that the on-going corporate tax review in Guernsey will not affect the taxation of exempt companies. These are companies that operate as part of a collective investment schemeor funds structure. Under the relevant Ordinance, an exempt company is treated as not resident in Guernsey even if it is incorporated or controlled here. Foreign source income and Guernsey bank interest of an exempt company is not taxable in Guernsey. This can be beneficial, both for Guernsey non-residents as well as resident investors, as the latter would otherwise be taxed on the underlying investment income of the company through the deemed distribution regime if the company were not exempt.

3.2.6Whether a company is taxed at 0% or exempt from tax has broadly the same effect financially. However, clients may prefer the exempt status because of the perception that the 0% rate of tax may, in the future, increase. Alternatively, clients may prefer the structure to be Guernsey resident and taxed at the standard rate of tax then applicable, so as to claim relief from double taxation under foreign tax agreements, to the extent that they are, or will become, available.

3.2.7A key characteristic of the exempt company regime is the ability to renew its exempt status on an annual basis on the payment of the prescribed fee (currently £600). The status will be granted if the company continues to meet the requirements of eligibility. The advantage of following this approach for a foundation is that it carries with it the opportunity to review and renew the tax status of the foundation on an annual basis, depending on prevailing circumstances at that time.

Limited Partnerships

3.2.8The profits of a partnership are assessed and chargeable in the hands of each partner in respect of that partner’s share. This treatment applies to all partnerships, including limited partnerships, even where the limited partnership has elected to have separate legal personality on formation. The profits from international operations of a limited partnership which accrue to non-resident limited partners arenot regarded as arising from a source in Guernsey. As a result, there is no tax to pay in Guernsey on partnership income paid to limited partners who are not resident in Guernsey for tax purposes.

3.2.9This approach would be attractive for clients who, as with a trust, do not want the foundation to be taxable in its own right, even though it may be a separate legal person under the new Foundations Law,but would prefer to look to a source based mechanism for determining tax liability. In the case of the limited partnership the term “international operations” is defined in the law. In practice,it is where the economic activities take place to produce the partnership’s profits, that is key. This is different from the source based test of income of a Guernsey resident company, which looks at the type of income to determine the rate of tax applicable.

3.2.10A particular attraction of thetreatment for tax purposes of limited partnerships is that it is grounded in the tax law itself, without the need to apply for exemptions or concessionary treatment. The combination of tax transparency with a territorial based approach, results in tax neutrality for the limited partners and makes for a very successful investment vehicle.

1. OTHER ISSUES

It is, of course, accepted that there are no easy answers and in coming up with a tax regime for foundations we have to deal with a plethora of issues, not least:

How does the UK and other key jurisdictions treat foundations for tax purposes – are they more like trusts or companies and is there a danger of being caught between the 2 concepts and suffering different taxes applicable to both?

Taxing foundations in the same way as trusts may not appeal to those from civil law jurisdictions.

Taxing foundations as companies faces the twin threats in Guernsey from the uncertainties of the corporate tax review and possible changes to the deemed distribution regime. These are short term uncertainties but they do not bode well for the launch of a new product, which could be too closely associated with companies.

Recent proposals to extend the European Union Savings Directive already categorise foundations, trusts and zero rated companies as bêtes noires from a regulatory and compliance perspective. Once there is an EU approved initiative, this tends to set the benchmark for OECD and US led tax and compliance initiatives.

These issues may well have a bearing on the final outcome for the taxation of foundations, in particular any elective regime. However, if we are able to come up with a tax regime which combines flexibility with tax neutrality for the Guernsey foundation we may have a product which can be adapted to suit evolving circumstances.

1. CONCLUSION

These are some of the tax significant features of our existing structures which have served our clients so well over the years. Would it be possible in the context of the tax treatment of a Guernsey foundation to be able to select those characteristics which best meet the client’s requirements and together achieve tax neutrality? Furthermore, if the choice of such characteristics could be finessed on an annual basis, this will give even greater opportunity for the Guernsey foundation to adapt to future circumstances - a genetic pre-disposition towards “perpetual best of breed”, if you will!

Can this be done using terminology and concepts which are consistent with the new Foundations Law without undermining the integrity of the Guernsey foundation as a distinct and separate entity from the trust, company or any other structure? If so, then the Guernsey foundation would indeed enhance Guernsey’s position as a premier international financial centre, offering a range of innovative and flexible structures to meet the demands of a sophisticated and nuanced market.

LailaArstall

2 May 2011

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[1]Carla McNulty-Bauer, Minister of Commerce and Employment Department, Press Release on publication of Consultation Document on Draft Foundations (Guernsey) Law 2011.