Bermuda's international business sector is about to face fresh challenges from several overseas jurisdictions. In the first of a series, Roger Crombie looks at moves afoot in the Isle of Man to reduce corporate tax rates to zero to head off the European Union's Savings Directive.

The Isle of Man is heading towards a zero rate of income tax for all its businesses. The move comes in response to the European Union's Code of Conduct on Business Taxation.

The code is part of a package of EU tax initiatives being introduced to persuade members to accept what has become known as the Savings Directive. The directive is an exchange of information agreement that would see all EU members (and, presumably, associates such as Bermuda) provide data on savings accounts held by nonnationals to other members of the EU. Several EU countries, including Luxembourg, have so far resisted the directive.

Jersey has also announced that it will introduce a zero tax rate for all its businesses, to take effect from 2006 if the directive is finally approved. Dissenters to the directive have said they will not approve it unless non-EU countries such as Switzerland and the US go along with it.

Ian Kelly, assessor at the Isle of Man's Treasury, has confirmed that the Isle of Man would introduce automatic exchange of information only if all EU jurisdictions, Switzerland and the US agree to do so. Switzerland has refused point blank to do so and it is widely believed that the US will resist entering into such an agreement with a Republican in the White House, so the Isle of Man may be on safe ground for some time.

The Isle of Man currently taxes its businesses at 15 percent, with insurance companies paying ten percent. The EU code requires all companies to be treated at the same rate, regardless of their business purpose or ownership. The Isle of Man could therefore have chosen to increase all its corporate taxes to, say, 15 percent, or, equally, drop them to zero.

The move to zero would cost the Isle of Man ?22 million annually, based on present receipts. Mr.......... Kelly has said that increasing rates to 15 percent would probably have been very costly to the Isle in the long term. "Exempt insurance companies are very important to the economy and we can't afford to lose them, especially as there will most likely be a reduction in back office operations based on the island in the next few years," he said.

Mr. Kelly pointed out that the Isle of Man has offered the one alternative acceptable to a limitless exchange of information, under the Savings Directive, which is a withholding tax on bank savings deposit income. The end of banking privacy in the Isle of Man, Mr. Kelly said, is "Orwellian" and "not up for discussion".

Meanwhile, the EU directive, which has been on the table for more than three years, is proving a bone of contention across the Union and is awash in regional politics.

This summer, German Finance Minister Hans Eichel attacked the measure. James Mason, a spokesman for the usually taciturn Swiss Bankers' Association, has argued that Mr. Eichel is facing an election, "so all (his) comments could be election rhetoric." Mr. Mason added: "The EU is stamping its feet (over the directive) like a spoilt child and is under a time pressure of its own making (on the issue)."

The Swiss are particularly angry at being made the stumbling block for the introduction of the directive. Luxembourg, Belgium and Austria "have effectively outsourced the problem to the Swiss," Mr. Mason charged. The three countries were granted seven years to introduce the exchange of information envisaged by the directive, by agreeing to introduce a withholding tax on income earned on savings accounts by foreign residents

The EU is attempting to force the Swiss to abandon banking secrecy, which the Swiss have indicated they would not do. A referendum on the subject in Switzerland recently upheld the notion of banking secrecy, giving the Swiss Government no room to negotiate with the Europeans, even if they wanted to.

The UK's Gordon Brown, Chancellor of the Exchequer has also indicated his opposition to the EU Savings Directive. Mr. Brown's comments cannot be relied upon, however, following a dramatic U-turn on the subject by Prime Minister Tony Blair.

At first, Mr. Blair said the directive would be introduced "over my dead body", although he quickly changed his mind without an explanation and decided to approve the measure while still alive. Critics charge that Mr. Blair has his eye on the EU presidency; his opposition to a measure greatly favoured by Brussels bureaucrats, it is argued, would count against him in his bid for the job.

Where Bermuda would stand in all this is not clear. As a British Overseas Territory, it is hard to imagine that the island would be allowed to be exempt from any pan-European regulations.

Were the Progressive Labour Party to win a second term but not almost immediately move to Independence (as is its stated policy), it might therefore face a choice between introducing a withholding tax on bank deposits held by non-Bermudians (resident or otherwise) or abandoning what remains of bank secrecy on the Island.

Neither outcome would be attractive to the Government or the banking sector, who would have to do the hard work of supplying the data.

Meanwhile, the Isle of Man has cleverly turned a sacred EU policy on its head. When the Union introduced its code, it envisaged that all its member States would move to tax their businesses at the previous highest rate.

The Isle of Man's decision to reduce all corporate taxes to zero would fly in the face of Brussels, which believes that high levels of taxation are necessary to allow the welfare state to function efficiently in all areas of human endeavour.

The issue looks likely to drag on for some years.

Tomorrow: The Bahamas moves onshore in a bid to improve its share of the international business sector.