The law the legislators like to ignore.

Next week the States are to debate a proposition which has the potential to be up there in the top five worst pieces of legislation the States have adopted see:  Draft Taxation (Companies - Economic Substance). Like one of other pieces in my top 5 - the introduction of 0/10 - it is a response to 'defend ' the finance industry from external  actors.   As the Intro puts it the law provides the means by which commitments of the States of Jersey to address the concerns of the EU Code of Conduct Group (Business taxation) ("COCG") regarding economic substance are met.



I've no problem with them addressing that.  But it is the impact on quite legitimate business that really concerns me.  Like the 0/10  it the law of unintended consequences that the legislators are ignoring. I became aware of it when a few weeks ago an acquaintance who runs a perfectly legitimate non finance business told me he was preparing to wind up his company if this proposition were passsed as it stands.  (There are no amendments and no alternatives on the table as yet so it is all or nothing).


But it is worse than  that because it seems to be  built upon a fundamentally flawed concept too.


The intention , again quoting the  report of the proposition is to  deal with " The jurisdiction should not facilitate offshore structures or arrangements aimed at attracting profits which do not reflect real economic activity in the jurisdiction".  It should be obvious  there are three elements involved here - attracting profits, offshore structures and arrangements, and real economic activity in the jurisdiction.  The proposition only addresses the last item.  Profits are only mentioned twice - in the report, not the body of the proposed law. Offshore is similarly only mentioned once  - in the quote I gave above. 


As I read it, and I am certainly not alone in this, the proposed law applies to all Jersey companies, not just those that need to be addressed in the COCG objective.  Most established companies won't actually have any difficulty in passing the economic substance test, but some most definitely will.  There is a list in section 3 that identifies the relevant activites.  they include most finance activities of course, but also intellectual property holding business.  That's where my acquaintance is  caught.  It would equally cover software developers, playwrights, artists, authors, plant breedrs who retain breeders rights, patent holders etc etc.

There is  a sort of get out clause in the introduction.

A "high risk IP company” is a company which carries on an intellectual property holding business and –(a) the company
– (i) did not create the intellectual property in an intellectual property asset which it holds for the purposes of its business,
(ii) acquiredcthe intellectual property asset–(A) from a connected person, or
(B)in considerationfor funding research and development by another person situated in a country or territory other than Jersey; and
(iii) licences the intellectual property asset to one or more connected persons or otherwise generates income from the asset in consequence of activities (such as facilitating sale agreements) performed by foreign connected persons; or
(b) the company does not carry out research and development, branding or distribution as part of its Jersey core-income generating activities;




The part I would draw your attention to is the first bit of paragraph 5 . 

5 Requirement to meet economic substance test

(1)

Subject to paragraph(8), a resident company must satisfy the economic substance test in relation to any relevant activity carried on by it.

(2)

A resident company meets the economic substance test in relation to a

relevant activity if –

(a)

the company is directed and managed in Jersey in relation to that activity;

(b)

having regard to the level of relevant activity carried on in Jersey

–(i) there are an adequate number of employees in relation to that activity who are physically present in Jersey (whether or not employed by the resident company or by another entity and whether on temporary or long – term contracts),

(ii)

there is adequate expenditure incurred in Jersey, and

(iii)

there are adequate physical assets in Jersey;

(c)

the company conducts Jersey core-income generating activity; and

(d)

in the case of Jersey core-income generating activity carried out for

the relevant company by another entity, it is able to monitor and

control the carrying out of that activity by the other entity.

Anyone who has ever run a start up business, especially in software development or research will be laughing their heads off. Such entities start in one of two ways - the owners working  unpaid hours to develop product, or they get a large dollop of investment  cash  . 90% of the time it is the former.  And if you are developing software you are like playwrights and authors and artists producing intellectual property - something that is licensed rather than sold.  It is a shoe string operation usually there are no employees (directors are office holders that are not necessarily employees - if they are unpaid they cannot be!).   There' s no income initially in development, and of course much of what you need to buy , if anything, is likely to be software tools  not available locally.  Assets are minimal , possibly don't even belong to the business, but are the personal proporty of the owners.  Not much chance of meeting the economic substance test. 


Now if I can go back to the key error.  It arises in  the item quoted above 
i) did not create the intellectual property in an intellectual property asset which it holds for the purposes of its business.   That is always true!  For much the same reason companies cannot go to prison - they are legal structures.  A structure cannot create intellectual property.  You need a sentient being for that - almost always a human, put I guess art created by elephants or dogs might qualify.  It is the reason anyone who works in research or software development will always find their employment conditions  stipulate they assign their employer all rights to intellectual property created. It is troubling that the law seem to be so  ignirant of the realities of  the creation of intellectual property.


The penalties for falling foul of this all encompassing law are steep if you are a minnow start up, potentially £100,000 pounds.  Peanuts to the biggest players who may  make  huge gains from doing exactly what the COCG want to stop, but disasterous for small legitimate businesses.  There is a form of appeal set out in articles 12/13.  First to the Comptroller (the one who raises the penalties and presumably whose department benefits from the fines !) .  After that to a Commission.

4)A Commission of Appeal shall be constituted for the purpose of hearing an appeal under Article12 as it would be constituted  from the Commissioners of Appeal appointed under Article 10(1) of the 1961 Law for the purpose of hearing appeals under the 1961 Law.

That's all well and good, but what is this Law - it isn't named or titled. I am guessing it is the 1961 Income Tax (Jersey) Law.  That Law doesn't give commissioners  powers over fines, only assessments of income tax. Just because it happens to be administered by the same office doesn't give rise to addiitonal powers.  And I doubt thos commssioners are any better qualified than the Comptroller to know what is an appropriate number of employees for an IP busienss, or indeed the necessary local expenditure to be of economic substance.


Hopefully you will have already identified the other open goal in this whole charade.  This proposed law explicitly and only refers to companies.  There is no provision for sole traders, partnerships, trusts or foundations that undertake the exact same activities.  It is quite implausible that the legal advisors to the States (the AG or SG) did not see this.  Of course those other mechanisms are excellent business for some  parts of Jersey' legal fraternity.  What a strange and quite unfathomable coincidence !!