Company formation, United Kingdom

Tax issues for Isle of Man Companies

Isle of Man tax

Corporate income tax

The corporate tax rate in the Isle of Man (IoM) is zero for all companies except in the case of income from banking, Manx land and property and retail businesses with substantial profits on which tax is payable at a rate of 10%. This means that a company resident in the island will generally not need to pay any corporate income tax on profits earned in the island. Profits earned in other countries will not be subject to Isle of Man tax but they may be subject to tax in those other jurisdictions if the IoM company is deemed to have a taxable presence there.

In many countries any income earned in the territory of that jurisdiction will be subject to tax there. So although the Isle of Man Company will not be subject to tax in its home jurisdiction it will be taxed on its profits earned elsewhere under the tax system of the other country.

Some countries only tax profits under their domestic law if the company earning the income has a permanent establishment in that jurisdiction. A permanent establishment would be a fixed base such as an office or factory, or could be a construction site that continues for a particular period of time. In this case a company from outside that jurisdiction that does not have a fixed base there may not be subject to tax on some income that it earns, however the definition of a permanent establishment in the relevant tax law would need to be studied carefully to make sure of this.

The concept of permanent establishment can also be introduced into double taxation agreements, which allocate taxable income between the two contracting states where a resident of one state earns income in the other state. However the Isle of Man has only entered into comprehensive double taxation agreements with a few countries, including the UK.

Currently there is a move to tighten up permanent establishment rules and the UK for example has already introduced a diverted profits tax to ensure that companies cannot artificially avoid become liable to tax by circumventing the definition of a permanent establishment in the UK. This means that it will in future be even more difficult for an Isle of Man company to perform any business in the UK and not pay tax there on its income.

Capital gains

The Isle of Man does not charge any taxation on capital gains. This can be useful both for trading companies and for individuals forming Isle of Man companies to hold investments, but care must be taken not to fall within anti-avoidance legislation of other countries such as the UK. The use of artificial schemes to use an Isle of Man company to avoid UK capital gains tax by UK individuals has been combated by the UK government which has powerful anti-avoidance legislation in place.

Nevertheless in the context of ordinary business activities the absence of tax on capital gains is a useful feature of the Isle of Man tax system and increases the attractiveness of the Isle of Man as a place for investment and doing business.

Value added tax

The Isle of Man is not legally a part of the UK for value added tax (VAT) purposes but under the 1979 Customs and Excise Agreement with the UK it applies the same VAT as the UK and so is effectively part of the UK VAT system. Goods and services supplied between the Isle of Man and the UK are not exports or EU intra-community supplies but are subject to domestic VAT law in the same way as supplies from one part of the UK to another.

This means that an Isle of Man company would make a claim for deduction or refund of VAT input tax on purchased goods and services in the same way as a UK business would claim input tax on domestic supplies. VAT registration on the island works in the same way as UK VAT registration and an Isle of Man company doing business in the UK can register for VAT on the island and operate the VAT in the same way as UK businesses. The VAT in the Isle of Man is administered by the Isle of Man Customs and Excise.

Inheritance tax

There is no estate duty or inheritance tax payable in the Isle of Man, and only a small probate levy is payable. If a person is resident and domiciled in the Isle of Man it is therefore possible to shelter wealth from the inheritance tax in other countries such as the UK. This would ensure that a person’s share in an Isle of Man company would not be taken into account for UK inheritance tax.

A person who is UK domiciled is subject to UK inheritance tax on worldwide assets wherever they are held.  If a person is not domiciled in the UK, however, the inheritance tax can only apply to that person’s assets located in the UK. Assets held in an Isle of Man company would therefore not be subject to any inheritance tax. However a person who has been UK domiciled for some time may have difficulty in establishing that their domicile of choice is now the Isle of Man.

An individual’s country of domicile is the jurisdiction with which the person is most closely associated and the country that is seen as the ultimate home, the place to eventually return to. Each individual has a “domicile of origin” at birth, this being the jurisdiction that is regarded as home by that person’s father at the time of their birth. Up to the age of sixteen a person’s domicile will depend on the domicile of the person they are legally dependent upon.

A person can however later acquire a different jurisdiction as their domicile, referred to as their “domicile of choice”. The domicile of choice is another country where the person has taken the decision to settle down and it has become a permanent home. For the purposes of the UK inheritance tax, the tax authorities would require strong evidence that the person’s domicile has changed from the UK to the Isle of Man.

Deemed domicile in UK law

The UK law has introduced a concept known as “deemed domicile” that can be applied to ensure that inheritance tax applies to a person’s worldwide assets even after that person has acquired a non-UK domicile of choice such as Isle of Man domicile. Where under the general law of the UK a person is not domiciled in the UK, that person will nevertheless be regarded as domiciled in the UK at the time of a transfer of value if the following conditions apply:

  • The person was UK domiciled within the three years immediately before the transfer of value; and
  • The individual was resident in the UK in at least seventeen of the twenty tax years immediately before the tax year when the transfer took place.

By using this test based on residence in the UK, this provision makes it more difficult for a person to acquire a domicile of choice in the Isle of Man or another jurisdiction just for the purpose of avoiding UK inheritance tax on a particular transaction. The UK could remain the deemed domicile of a person for up to three years after leaving the country and changing domicile.

Setting up a domicile of choice

To establish a domicile of choice in the Isle of Man a person should cut off economic and other ties with the UK and establish economic links with the Isle of Man such as establishing a home there and having other economic interests. The person should make it clear that the intention is for the Isle of Man to be the permanent home.

Appropriate advice should be obtained by anyone considering acquiring a domicile in the Isle of Man with a view to setting up a company to shelter assets from UK inheritance tax. The deemed domicile rules in the UK should be taken into account. Reference should also be made to existing anti-avoidance measures and potential future developments.

Individual income tax

Income tax rates in the Isle of Man range from 10% to 20% and are therefore lower than tax rates in the UK. Also Isle of Man residents obtain more exemptions and deductions, including a tax deduction for mortgage interest paid. Non-residents earning income in the Isle of Man pay tax at a flat rate of 20%. Individuals forming a company in the Isle of Man and becoming resident as individuals are therefore in a very favorable tax position for income and capital taxes. There is also a maximum “tax cap” that limits the amount of income tax that any individual pays to GBP 120,000 – a high cap on tax payable but attractive to some wealthy individual taxpayers.

Individuals must prepare a tax return form for the tax year to 5 April and submit the form by 6 October following the year end. The tax must be paid by 6 January in the following year, or if an assessment is issued 30 days after the date of issue if later. Tax for the following year must be paid on account and this tax must also be paid by 6 January. The payment on account is normally 105% of the previous year’s liability.

An employer must deduct tax from payments of wages under the Income Tax Instalment Payments scheme and remit the tax to the Isle of Man Income Tax Division. National insurance contributions (social security contributions) are payable by both the employer and the employee.

Exchange of tax information

In line with the international standard on transparency in tax matters the Isle of Man has in recent years signed a number of agreements with other countries providing for the exchange of tax information. This means that the Isle of Man can exchange information with many other jurisdictions about the tax affairs of individuals or companies in either jurisdiction.

Generally the provisions for exchange of tax information worldwide are being strengthened and it is becoming increasingly easy for tax administrations to gain information about the worldwide tax affairs of individuals or companies resident or holding funds in their jurisdiction. The arrangements for the exchange of tax information are contained in double tax treaties or in agreements for the exchange of tax information.

Some international agreements for the exchange of information also exist and the Organization for Economic Cooperation and Development (OECD) is currently encouraging more countries to sign up to international agreements and international standards on transparency and exchange of information. The Isle of Man has committed itself to reaching the international standard on automatic exchange of information by 2016.

Anti avoidance legislation

Anyone looking at possibilities for using a company based in a jurisdiction that charges zero corporation tax on that company must be aware of the possibility that various kinds of anti-avoidance legislation may be used by jurisdictions in which the company earns income. Some countries for example may charge higher rates of withholding tax on payments to companies in the Isle of Man while other countries will include payments to companies in low tax jurisdictions in their transfer pricing rules and apply rules to ensure that all payments to an Isle of Man company are at arm’s length.

General anti avoidance rules

It is also worth noting that many jurisdictions are introducing general anti avoidance rules (GAAR) under which transactions considered to be artificial in nature can be disregarded for tax purposes. This means that where purely artificial transactions are set up with the main purposes of securing a tax advantage taxation could be imposed on the real transaction or any tax advantage could be disregarded. The UK for example has passed a general anti abuse rule targeting transactions considered to be abusive.

Controlled Foreign Companies rules

Controlled foreign companies (CFC) legislation has been introduced by most major economies such as the UK to prevent profits being accumulated in a non-resident company that is controlled by persons who are resident in that state. Under the CFC rules certain income arising in the controlled foreign company is apportioned among the non-resident shareholders and is deemed to be part of their taxable income.

CFC rules in the UK and other jurisdictions would operate to prevent persons resident in the UK or similar jurisdictions from setting up companies in the Isle of Man to accumulate income without this income being subject to tax. Under the general tax rules of the UK the income of an Isle of Man company owned by UK resident shareholders would not be taxable until paid back to the UK as dividend income, but under the CFC legislation the income would be apportioned and taxed on the UK shareholders in the period when it arises.

Another point to consider is that the whole subject of CFC rules is currently being considered by the OECD as part of its action plan on base erosion and profit shifting (BEPS). Recommendations are to be made to governments with a view to strengthening these rules to combat tax base erosion. These rules are therefore likely to be strengthened further by all major economies in the future.

Do you need general information about Isle of Man? Read our introductionary article here.

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