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The 10 Stages of the Isle of Man Finance industry

By November 21, 2020November 28th, 2020No Comments

The Isle of Man enjoys a thriving finance industry but have you ever wondered how we got here ? This is a drastically simplified history in 10 stages. 

Stage 1 – Vikings

With its strategic location in the dead centre of the irish sea, the Isle of Man arguably began its history as an ‘offshore’ centre as a hide-out for the Vikings raiders who arrived in 798. They settled and used the Island as a base from which to plunder and then trade between England, Ireland and Scotland; the Island prospered.

Stage 2 – Dukes and Earls 

The Viking rule ended following the death of King Magnus in 1265. This was followed by a period where the Island fell variously between the control of the English and the Scots before in 1405, it was granted – in return for the fee of 2 falcons payable to the English King on his coronation, to English Stanley family who were the Earls of Derby. 

It remained under the control of the Stanleys for the next 300 years until in 1736 James Stanley (8th Earl of Derby) died heirless and it was passed to his cousin, James Murray – Duke of Atholl. 

Throughout the period, the Island continued to benefit from its strategic location close to England but outside its direct control. It remained the perfect base for offshore business – legitimate traders as well as smugglers and scoundrels flourished here.   

Stage 3 – Crown Dependency

So successful was the Island as a place for offshore contraband trade, in 1765, the English felt it necessary to pass the Isle of Man Purchase Act 1765  as a means re-requiring (So called ‘Revestment’) the Island for the sum of £70,000 and an annuity payable to the Atholls. 

This enabled the English to exert direct control over the Island via their appointed local Governor who effectively controlled local Manx finances. Later that same year the Smuggling Act 1765 (locally called the Mischief Act) was enacted as a means of the English taking direct control of Manx harbours, customs and merchant shipping. 

Stage 4 – Regaining control.

The Manx didn’t enjoy being controlled by the English and over the next 100 years they pestered the English Government for greater control of their own finances. Over a period of time various representations were made to Westminster and certain concessions were granted. In 1865 Governor Henry Loch successfully negotiated significant control of the Manx finances back to the Manx people.

At this stage in the Island’s history – much of the infrastructure was built as the Manx tourist industry developed and flourished. By the end of century more than 600,000 holidaymakers arrived annually.

Tourism dominated the Island’s economy for the next century or so.

Stage 5 – Our birth as a tax haven. 

The next major change was in 1958 with the passing of the Isle of Man Act which finally removed control of the Islands finances from the UK and this is where our history as a modern offshore centre really begins.

In 1961, a very bold decision was taken to abolish Surtax. At the time Surtax accounted for something like 13% of the Island’s tax take  so this was a rather surprising but ultimately seminal decision in terms of the Island’s development. This was the move that firmly set the Island off down the ‘tax haven’ route. ‘Tax Haven’ is now considered rather a pejorative phrase but the truth is that’s what we were.

In 1972, the UK joined the EU (Common Market) and we gained our special relationship under Protocol 3. Decimalisation followed in 1973 which resulted in increased banking deposits here as exchange control remained in force and we were a ‘scheduled’ territory. 

By 1975 the increased banking deposits resulted in Tynwald introducing a new Isle of Man banking act. Banking continued to boom, further buoyed up by the abolition of exchange controls in 1979 and by the fact that banking licenses were being handed out to all and sundry – some would say with insufficient thought or consideration. 

It is reputed that Falcon Bank managed to obtain a banking licence prior to its formal incorporation and that even following incorporation it had a paid up share capital amounting to just £2.00.

At this stage, there was no supervision and so regulation was somewhat laissez faire (i.e. there wasn’t any).

Of course, in retrospect, a banking disaster was inevitable; and in 1982, it arrived, in the middle of the UK recession, in the shape of the Savings and Investment Bank (SIB). The loss was £42m which in today’s terms is about £190m. Many locals lost their shirts as well as overseas depositors – the Island’s reputation was left in tatters.

At this point, Isle of Man Government reserves stood at just £1m. The Treasury went cap in hand to the Isle of Man Bank to try to borrow £4m to support SIB depositors but their request was dismissed out of hand.

The reputational damage, coupled with the recession which hit the ever shrinking tourist industry hard, resulted in a fall in Manx GDP of 28% between 1982 and 1984. Unemployment was also rising fast and feelings discontent led to anti finance industry groups like Fo Halloo making their feelings known in no uncertain terms.

All of this might have resulted in a rather dreary end to the story but of course it didn’t. The SIB debacle actually prompted a remarkable regeneration of the industry. 

The Income Tax (Exempt Companies) Act 1984 introduced a 0% tax rate for companies owned by non residents with non Isle of Man income prompted the development of the Islands CSP industry.

In conjunction with other legislation, such as the 1981 Insurance Act, this marked the beginning of a truly remarkable period of prosperity and growth.

I think the Island owes a debt of gratitude to those responsible for the seminal decisions taken. It’s impossible to name all those involved, but they included people like Edgar Mann, John Crellin, Charles Cain, Mark Solly, Sir Miles Walker, Dursley Stott and others, including perhaps more controversial characters like Chris Kingston who also played an important part in putting the Island on the map.

Stage 6 – Regulation begins

The Financial Supervision Commission (FSC) was set up in 1983, the Shipping Register & Income tax exemption in 1984, KYC requirements came in 1985, followed by Captives in 1986.

By 1991 the Depositor Compensation Scheme was in place, Government Income was rising and GDP was on an upward trend. Government reserves reached £110 million; all looked rosy, and it was. However, changes on the international scene were soon to bring new external pressures to bear.

In 1996 just as the Manx Government enacted the Isle of Man Limited Liability Companies Act, a US style entity with a view to attracting more business from the United States. The US Government enacted a raft of anti-tax avoidance legislation which effectively killed US business in the Isle of Man and the other offshore islands stone dead. This was an early sign of things to come – the onshore jurisdictions were beginning to wake up to the vast amounts of money moving into the offshore economy and they didn’t like it.

Stage 7 – Scrutiny and more regulation

Following this the UK and then the OECD also began to look more closely at the Isle of Man, the Channel Islands and other tax havens. At the time, the protocol where one country wouldn’t assist another to collect its taxes was very much in place so much of the thrust of this unwelcome attention was disguised as being to combat money laundering (i.e. proceeds from drugs, weapons and other organised crime) whereas in reality the agenda was much more about lost tax revenue. Big countries were starting to look with jealousy at the success of the tax havens and trying to find ways of tracing funds that had been legally earned but surreptitiously stashed offshore by their citizens.

The Andrew Edwards Report was commissioned by Jack Straw in 1998 to look into the regulation in the Channel Islands and the Isle of Man. Its conclusion found the Islands to be in the ‘top draw’ of financial centres from a regulatory perspective and drew heat from the argument for a short while. But the threat had been recognised and it resulted in tighter regulations. Suitcases full of money were no longer welcomed by Isle of Man banks, ‘all crimes’ money laundering laws were introduced in 1998 and the licensing of Corporate Service Providers and then trustees followed shortly after in 2000 and 2005 respectively.

The age of regulation had arrived with a bang – FSC headcount rose from seven in 1983 to 23 in 1998 and 63 by 2007.

In 2000, the OECD issued a report on harmful tax practices and started to focus on so-called non-cooperative tax havens who would not commit to fiscal transparency but by now the Isle of Man was already well regulated and succeeded in remaining on the white list. It achieved this by beginning an intensive program of agreeing bilateral Tax Information Exchange Agreements with other countries commencing with the USA on 3 October 2002.

Stage 8 – Phony war 

For a while, all seemed well again. 

The Island enacted ‘all crimes’ money laundering legislation (Criminal Justice (Money Laundering Offences) Act 1998) which essentially outlawed professionals overtly assisting tax evaders and the Island’s tax and fiduciary industry had matured somewhat as a result clients with undeclared money became the exception rather than the rule. 

As well as the usual staple of non-dom planning, creative offshore professionals were making their money from selling legitimate (if not somewhat aggressive) tax structures such as Employee Benefit Trusts, Stamp Duty avoidance schemes, and Property Development Partnerships. Simultaneously both the Fund and the Life Insurance industries were booming.

In a strategy most notably pioneered by Charterhouse in Ramsey, payroll companies started to spring up too. Loopholes in UK tax laws exploited by leading Counsel allowed these companies to offer UK based workers a more or less tax free salary, even though they were UK nationals, living and working in the UK. Needless to say they were very popular with their clients and as a result their owners became very rich. David Dean, Charterhouse’s founder was a regular member of the Times Rich List during this period but of course, as Jimmy Carr later found out they are understandably less popular the UK tax authorities and may have been instrumental in tipping the UK Government’s view of the tax havens from a tolerable nuisance to an outright menace.

The early noughties was a good time to be a law firm in the Isle of Man. An increasingly sophisticated and often institutional clientele wanted complex Fund structures rather than simple holding companies. Protected Cell Companies having been introduced by the Companies Act 2004 were in demand and a spate of successful and high profile stock exchange listings all meant expensive legal work was in demand.

The main law firms Cains, and Dickinson Cruickshank (now Appleby) grew significantly and started to dramatically expand their own corporate services and trust activities. They jointly lobbied the Government to enact a new legislation for a New Manx Vehicle (NMV) which could compete on equal terms with the IBCs being turned out in the thousand by the British Virgin Islands. The result was the Isle of Man Companies Act 2006; a modern companies Act closely following the BVI template. Company number 1v was formed by Middleton Katz Chartered Secretaries on 1 November 2006.

Stage 9 – Credit Crunch

Then came 2008, first the credit crunch resulted in a real estate crash which hit the Island’s CSP and the fund industry badly. 

On 9 October 2009,  Kaupthing Singer & Friedlander Isle of Man Bank was placed into administration. Ultimately the depositors received all their money back but the outcome was far from clear at the time and the reputation of the Island again suffered a serious blow. 

But worse – much worse, was to come; In 2009, the UK Government prompted by its own fiscal squeeze decided to unilaterally renegotiate the IOM / UK VAT agreement – not just once but twice. The initial 2009 VAT loss was £114m annually and this was soon followed by another £30m in 2011 & £50m in 2012.

The VAT blackhole in the annual budget which totalled nearly £190m (out of total Government spend of £533m) looked catastrophic. Thankfully, the Government had substantial reserves (in excess of £1bn) saved from the good times and to this day is still facing the challenge of balancing the budget before they run out.

Fortunately, with impeccably fortunate timing, the offshore eGaming sector came the rescue, global players like Microgaming and Pokerstars made their home on the Island and eGaming grew from 8% of the national income in 2012 to 21.1% in 2018

Stage 10 – Transparency leads to consolidation & contraction

Along with the other tax havens, the reality is that transparency was forced upon us. The coffee was now burning and the smell was getting stronger. 

If you remember that the Island came from a place, as far back as the Vikings, where the Island’s success as an offshore centre was substantially based on being able to do deals away from prying eyes – It’s hard to overstate how important (and painful) being dragged into the light felt for the finance sector.

As mentioned above, the steps towards transparency started with the Report on Harmful Tax Practices published in 2000. The report anticipated a ‘black list’ of countries considered to have harmful tax practices.

Escaping from the list was necessary and it required the Isle of Man Government to remove  preferential tax treatment for non residents and much frenzied activity to demonstrate cooperation by negotiating Tax Information Exchange Agreements (TEIAs) with any country that would engage with us. We now have 41 in place or awaiting ratification.

The next initiative came like a bolt from the blue. In 2010 FATCA arrived. Almost unimaginably in the context of what had been done before, this US imposed law required financial institutions to automatically transfer information about their US clients to Uncle Sam annually via national tax authorities. 

That felt radical….privacy – overnight – the central plank of the success of tax havens of the past was being swept away and replaced by reporting obligations. 

Following the lead from the US, the international community realised that they could effectively legislate for us so they did. The OECD copied FATCA resulting in the introduction of the Common Reporting Standard (CRS) in 2017. 

CRS is essentially the same as FATCA except that it requires the automatic reporting by financial institutions of their overseas clients in relation to over 100 juridictions and not just the US.

Around the same time, the invention of social media channels facilitated campaigners such as Richard Murphy at the Tax Justice Network to popularise a view of tax havens and tax avoidance as a moral issue.

In April 2016 – the Panama Papers hit the news, a leak of 11.5m documents from Mossack Fonseca, the world’s largest corporate service provider, shone a very bright and unwelcome light on the offshore world. Mossack’s operations were largely based in Panama and BVI so the leaked documents didn’t focus on the Isle of Man to any great extent but it was big news so it added significantly to the media pressure and anti offshore centre sentiment.

In October 2017, there was a further high profile leak, this time from law firm Appleby who had a large office on the Island, dubbed the Paradise Papers, the Isle of Man found itself squarely in the eye of the storm.  Unlike the Panama papers, in reality, there was little evidence of wrongdoing in the leaked documents, as by this time, the Island’s business was mainly focused on legitimate planning rather than evasion. However, predictably, the global media and BBC Panorama sensationalised the leak, somewhat unfairly, and the Island suffered a significant reputational body blow. 

Transparency was working, 

In January 2008, there were 32,505 Isle of Man companies on the register by June 2020 this had dropped by more than 20% to 25,107 and between December 2008 and June 2020 bank deposits dropped 37.5% from £57.29bn to £35.80bn.  

Further anti tax haven initiatives quickly followed; 

On 1 July 2017, the Isle of Man beneficial ownership database went live providing the Isle of Man Government and also HMRC in the UK and possibly other national agencies details of the beneficial ownership of every Isle of Man incorporated entity.

In 2019 as part of the BEPS initiative, the OECD effectively legislated for us again. This time economic substance requirements were introduced, resulting in Isle of Man companies operating in certain ‘Relevant Sectors’ being required to have real economic substance in the Isle of Man.

The age of transparency and big data has truly arrived, hiding money in the Isle of Man or similar places such as our neighbours in Jersey and Guernsey is no longer an option. Crypto-currencies and onshore jurisdictions like the US and the UK or, Malta or Cyprus offer much better hiding places for criminals and tax evaders and also tend to have less risk averse financial institutions due to comparatively less strictly enforced compliance standards.    

What’s next for the Isle of Man ?

My best guess is that the traditional sectors of Banking, Trust and Company, Insurance and Funds will continue to consolidate and shrink as continuing pressure in the form of transparency legislation, anti tax avoidance rules, local regulation and international adverse media attention reduce their usefulness and attractiveness to international clients.  

Our banking sector in particular seems to have been left behind. Compared with nimble challenger banks in the UK, our banks appear woefully sluggish and complacent. 

Only the brave would bet against continued increase in compliance and regulation as it has since the demise of the Savings and Investment bank in 1982

There is significant pressure from the UK and elsewhere for us to make the beneficial ownership database public….in the long-run that seems likely; maybe sooner than we think.

There are rumblings about a possible reintroduction of company tax or perhaps some form of capital gains tax or even a transaction tax. Time will tell.

However, there are some bright spots and looking to history, the Island exhibits an astonishing ability to reinvent itself and flourish.

Currently eGaming still seems to be flourishing; and eSports is in its infancy with some exciting potential for the future.

FinTech is certainly on the Government radar and the Island has an innovative blockchain incubator working hard to grow a viable sector here on the Island. However, we look at the challenger banks in the UK and elsewhere with some envy and the Government needs to take care that the Fintech sector does not have the life sucked out of it by the burden of our compliance requirements and the relative inflexibility of our regulator.

Virtual currency business had a promising start on the Island and there remains significant interest in the Island but like the other Fintech sectors the correct regulatory balance needs to be reached.

The Isle of Man is a special place, we have a resilient and creative economically active population, the Island is beautiful and our quality of life is enviable. I have no doubt that the Island’s future is bright.

Acknowledgements:

Much of the information in this article was researched from three sources – they are excellent and highly recommended:

(i) New History of the Isle of Man Vol. 5: The Modern Period, 1830-1999: ISBN-10: 0853237166 | ISBN-13: 978-0853237167 By John Belchem

(ii) No Man is an Island: 50 Years of Finance in the Isle of Man – Roger Rawcliffe: ISBN-10: 0955404320: ISBN-13: 978-0955404320

(iii) Government and Law in the Isle of Man – Mark Solly – ISBN-13 978-0951849934

 


Contact Martin Katz by telephone on +44 1624 777900 or email – martin@katzand.co if you require assistance with this or other matters relating to the Isle of Man.