Gibraltar’s long-awaited new corporation tax system has been in the pipeline for many years following a challenge to its legitimacy by the European Commission (EC), an argument based on Gibraltar's fiscal autonomy from the UK. The judgement, which is expected to go in Gibraltar’s favour however, will bring some closure on the issue and bring about a highly competitive low tax system in Gibraltar.

In London for Gibraltar Day last month, Gibraltar’s Chief Minister, Peter Caruana, said he fully intended that the legislation needed for the new tax system would be put into place by July 1, 2009. He added that his government is committed to the development, consultation, drafting and passing of the legislation necessary to implement the new regime in time for the 2010/11 tax year – starting on July 1, 2010.

Caruana slammed recent Opposition comments on the slow progress of the corporation tax reforms, stating that such a significant change needs to be a delicate process and enforcing it early could be detrimental to Gibraltar’s economy. He stressed the importance of giving companies time to adapt to the new corporation tax regime, which would harmonize the ‘onshore’ and ‘offshore’ regimes and bring about a single system, with a corporate tax rate of 10% to 12%. He said that stretching out the process was crucial to ensuring that the government could provide the clarity and confidence that current and potential investors needed from the government. He underlined that the process would not go ahead until a judgement was reached.

The dispute between Gibraltar and the EC over the jurisdiction’s corporate tax system dates back to July 2002 when Caruana said that he would implement a new tax system setting a zero rate of corporation tax for all companies. The proposal would have removed corporation tax, replacing it with new taxes targeted at company personnel and property occupation - which would have been capped at 15% of profits.

This tax system (which was originally to have been put in place in 2003), would have brought about:

• A “Company Payroll Tax” (similar to what exists in Bermuda and elsewhere) in respect of employees in Gibraltar and charged as a sum per annum per employee. This would have been a tax on the company and payable by the company only.
• A new Business Property Occupation Tax in respect of property occupied in Gibraltar by companies for business purposes.
• An annual company registration fee of GBP300 (if the company had income) or GBP150 (if the company had no income) inclusive of annual return fees.

The European Council of Finance Ministers confirmed that the reforms did not constitute harmful tax measures in March 2003. However when the European Commission looked into the reforms in April 2004 they objected on the grounds that the tax new rules would give companies domiciled in Gibraltar an unfair advantage over their counterparts in the UK, under a principle known as 'regional selectivity'. The Commission also took issue with the fact that since the taxes were based on payroll and the occupation of business premises, ‘offshore’ companies registered in Gibraltar would incur little or no tax liability. The EC therefore rejected the reforms, effectively suggesting that for taxation purposes, Gibraltar should be considered part of the United Kingdom.

Chief Minister, Peter Caruana slammed the EC for suggesting that the jurisdiction is fiscally part of the UK, pointing to its 1969 constitution, which gives the territory fiscal autonomy. For its part, the UK government is said to be “100% on-side” regarding the ‘regional selectivity’ debate.

As part of the negotiations with Brussels in respect of its tax system, Gibraltar has been forced to phase out elements of its existing offshore regime. Gibraltar dissolved its ‘qualifying’ company scheme in January, 2005, in a move which cost the government an estimated GBP1.5m in annual tax revenues. These companies paid corporate tax at a rate agreed by the company and the government at a rate set anywhere between 0% and 35% (but generally was set between 5% and 10%). As a transitional measure, the 80 or so qualifying companies registered in Gibraltar were switched to the ‘exempt’ company regime (which paid annual fees and no corporate tax). However, later that month, it was announced that Gibraltar had been given until 2010 (2007 for new companies) to phase out its exempt company tax regime after the European Commission ruled that the scheme violated EU state aid rules.

There is a broad consensus among Gibraltar’s political parties that the proposed new low tax regime is needed to ensure that the jurisdiction remains attractive to international companies, and in his 2007 budget speech, Caruana reinforced his commitment to implementing the reform. He said:

"The Tax Exempt Company has been the backbone of the development and growth of both our finance centre and the online gambling industry, and thus of a very significant part of our economy. It continues to underpin thousands of jobs in Gibraltar and large amounts of government revenue."

"In order to comply with EU law we must phase out the tax exempt company in 2010. However, in order to sustain our successful economic model we must retain a commitment to a very competitive corporate tax model."

“Since it is no longer legally acceptable to have one tax model for ‘local’ companies and a different one for ‘foreign’ companies it is necessary to have a low tax system for all companies because without a low tax system for overseas companies they will leave, and our economy will suffer hugely. Thousands of jobs would be lost, as well as significant government revenue.”

“I have therefore already said, and I reaffirm now, that the Gibraltar government is irrevocably committed to the principle of ‘low tax’ for our economic operators. By mid-2010 the government will have introduced an across-the-board flat, low corporate tax rate. This will most probably be set at 10%, but in any event not higher than 12%. This will be similar to arrangements that already exist in Ireland, Cyprus, Malta and other EU Countries.”

In order to signal the government’s commitment to a low tax system Caruana has gradually reduced corporation tax for ‘onshore’ companies in Gibraltar, and he took the first step when he reduced the rate for the year of assessment 2007/08 from 35% to 33%. Then in June 2008 he revealed a surprise cut of 6% bringing Gibraltar’s local corporation tax to 27%. The Chief Minister has pledged that he will enforce a further cut in June 2009 ahead of the proposed introduction of the flat low tax rate in 2010, although he did not specify the size of the cut.

A successful judgement will be the catalyst in proceedings enabling Gibraltar to enforce a low tax system – a system providing a beneficial environment for businesses looking to set up offshore. Gibraltar currently operates no capital gains tax, sales tax or VAT. Currently the main tax applied to companies is corporation tax. If the judgement goes in Gibraltar’s favour companies will only be liable to pay a 10-12% corporation tax, certain withholding taxes, property taxes and stamp duties.