Offshore e-tailing - Tax Efficient Solutions For A Competitive Edge

Raj K Ganguly, RKG Consulting Limited and
Edmund (Ben) Bendelow, Chairman of Basel Holdings Limited

The purpose of this short article is to demonstrate some of the taxation advantages in locating e-commerce in international financial centres, such as Jersey. One of the rather surprising issues highlighted by the RAL case is that moving servers to Jersey from, for example, the Caribbean to gain access to the superior infrastructure in the Channel Islands is a sufficient business reason not to trigger the general anti-avoidance rules for locating companies in low tax areas.

Retailers are coming under increased pressure to cut costs and thus reduce the delivered price of the product or service in the hands of consumers. Many businesses have taken advantage of tools such as the latest IT systems, specialist customer relationship management software, and the Internet to deliver some cost savings. However, many retailers are simply not aware of the extent of cost savings that are potentially available by re-structuring the business in a manner that moves the ‘tax footprint’ of the organisation to a more benign tax environment.

Such tax savings can be substantial. Indirect taxes such as VAT are levied in the European Union at standard rates that vary between 15% and 25%. By structuring the business in a tax-efficient manner, advantage can be taken of the ‘low-value’ VAT exemption of £18 by delivering products such as CDs, optical and photographic accessories, health products such as vitamin pills, gifts and other such relatively lowpriced items, VAT-free from jurisdictions such as Jersey.

Options available

There are essentially three options available for VAT efficient distribution from locations such as Jersey:

  1. Outsourcing the customer product fulfilment aspect of the operation to an organisation that has the capability of executing this from Jersey, as essentially the operation is a ‘supply of goods’ from a VAT-free location.
  2. Hosting the web servers in the same jurisdiction that the product is shipped from can effectively demonstrate that there is some value added in Jersey in terms of an on-line sales and marketing service, resulting in sales contracts being concluded there.
  3. Incorporating a separate Jersey company that owns the web servers and is responsible for owning and re-packaging the product for delivery to individuals, and for administration services, is a further indication that a substantial degree of management and control exists in Jersey. Without the existence of effective management and control, the tax authorities tend to look upon arrangements as a ‘sham’ with undesirable tax consequences.

It is interesting to examine each of these options in detail against the background of tax rules and other tax developments in this rapidly evolving area.

Outsourcing fulfilment to a third party

Distribution of high-volume but low value items such as those mentioned in the Introduction is basically a supply of goods from Jersey to consumers in the EU. Under Article 8 of the EC Sixth VAT Directive, the place of supply of goods is the place where the goods are at the time when dispatch or transport to the person to whom they are supplied begins. There is no VAT in Jersey, but postal packages from outside the EC can be examined by EU Customs authorities to determine whether import duty, excise duty and VAT are payable. These duties must be paid whether:

EC agreements (known as the Low Value Consignment Relief or LVCRi) allow relief from VAT and duty on certain imported goods, provided:

  1. They have an intrinsic value of £18 or less, although this particular relief does not include alcohol, tobacco products, perfume or toilet waters, which are covered by different exemptions. The intrinsic value is the actual value of the goods excluding postage, packing and other miscellaneous costs.
  2. They are gifts worth £36 or less and comply with certain rules.

Under international postal agreements, the sender must make a Customs declaration on a form which, in most cases, will be attached to the package. The declaration includes a description of the goods, their value and whether they are gifts or commercial items.

Assuming that the goods meet the low-value exemption criteria, perhaps the fundamental question is who has title to the goods up to and including the point of sale? Where and when does the title pass to the onshore purchaser?

This is where the most serious problems are likely to arise, particularly if the UK or other EC originator of the goods still has title to the goods, or the principalagent role has not been precisely defined contractually. The main problem here is the perception by the onshore tax authorities that there is inadequate or insufficient substance in Jersey in terms of product ownership and the process of acceptance of orders and conclusion of contracts.

It might be worth analysing the steps relating to the order-acceptance and contract-conclusion process in an Internet or mail-order business in order to answer the questions posed above. The website of an on-line retailer displaying the product catalogue, is an invitation to treat. This is very much like a shop window. The passer-by can stop, have a look and, if he or she is interested by the offering, they can enter the shop and make an enquiry about buying a specific product. The shopkeeper would then offer that product to the customer. Provided the price and other details are acceptable to both parties, the contract would be concluded in the shop when the customer accepts the offer and makes the payment.

In an on-line scenario, the customer indicates they want to buy a product when they put it into the ‘shopping cart’ of the website and proceed to ‘checkout’. The website operator then requires certain details from the customer. Once these details, including the credit card information of the customer, have been verified, the website makes an offer to sell. This is done by displaying a final description of the product, price and the terms. Finally, a request is made to the customer to click the ‘Accept’ button if all details are satisfactory. The contract is concluded when the customer clicks the Accept button on the website and the payment is then debited to their credit card.

This process of order acceptance and contract conclusion is deemed to take place where ‘human and technical resources’ (a tax term explained below) are actually located. If this process takes place in the UK or another onshore jurisdiction, the contract will be deemed to have been concluded there, even though the distribution of the product is effected from Jersey. The tax authorities will seek to apply the VAT rates of the UK or other onshore jurisdiction. Although simple, outsourcing just the fulfilment aspect to Jersey is obviously not a satisfactory solution.

Website hosting in Jersey

A more robust solution from the tax point of view would or should involve the order acceptance and contract conclusion process to take place in Jersey. In order to implement this practically the website making the sale should be hosted on a server located in Jersey. Websites are made up of computer software and data, International Financial Centres’ Yearbook which reside on web servers. Web servers are essentially computers, configured with appropriate software, and connected to the Internet.

There is also the question of maintaining the ‘content’ of the website and keeping it up to date in terms of price and product information. This requires human intervention - suitable amendments to the website by changes to software coding carried out by software engineers taking their instructions from local management. For VAT purposes it is essential that there is a permanent presence of both ‘human and technical resources’ in order for sufficient substance to exist in the form of a ‘fixed’ establishment of the vendor. The concept of ‘establishment’ is a theme which is central to the place of supply of services. In this case, the supply of hosting and other value-added services from Jersey, along with the main supply - namely that of goods.

From the VAT point of view there are two kinds of establishment that are important - a ‘business’ establishment and a ‘fixed’ establishment. A company can have only one ‘business’ establishment, for example the seat of its business, its registered office or the location where it was originally founded. However, there can be more than one ‘fixed’ establishment from where services are rendered or where services are received. For example, the location from where hosting services are provided can be one such fixed establishment. The place of company administration, accounting and sales/marketing can be another fixed establishment.

Since the Berkholz case the European Court of Justice (ECJ) regards an establishment as ‘fixed’ only when “both human and technical resources necessary for the provision of particular services are permanently available” there. There have been a number of cases regarding ‘establishment’ including Faaborg Gelting Limien, DFDS, Lease Plan Luxembourg and ARO Lease. It is interesting to look at ARO Lease in detail as certain parallels can be drawn.

ARO Lease BV was a car leasing company based in the Netherlands. ARO did not have an office in Belgium where it had some 800 car leasing contracts in place. ARO’s Belgian customers came into contact with ARO through local self-employed intermediaries, who were paid a commission for their introduction services. The Belgian customers normally chose a car themselves from a Belgian dealership. ARO would purchase the car and then make the vehicle available to its customers via a leasing agreement. The Belgian intermediaries were not involved in the performance of the agreements. The cost of maintaining the car fell on the customers themselves. Repairs and assistance in the event of damage to the car was paid by ARO out of the proceeds of insurance policies taken out by the Dutch company.

The Belgian tax authorities took the view that the mere presence in Belgium of a fleet of cars owned by ARO meant that ARO had a fixed establishment in Belgium, from which the service of car leasing was being provided. Therefore Belgian VAT ought to have been charged in respect of these leasing services. The tax authorities in the Netherlands applied Article 9(1) of the EC Sixth Directive on the basis of the general rule therein which states that the place of supply of services is where the supplier has established his business. The Dutch tax authorities took the view that there was no fixed establishment in Belgium as there were no staff or technical facilities there to conclude leasing contracts. According, they argued, the place of taxation should be at ARO’s office in the Netherlands.

The ECJ applied the general ‘business’ establishment rule citing its application in the earlier case of Berkholz. It argued that if the Belgian ‘fixed’ establishment argument were to prevail, then there should be a sufficient degree of permanence and a structure adequate, in terms of human and technical resources, to supply the services in question on an independent basis. The ECJ’s view was that when a leasing company does not possess in a Member State either its own staff or a structure which has a sufficient degree of permanence to provide a framework in which agreements may be drawn up or management decisions taken, and thus to enable the services in question to be supplied on an independent basis, it cannot be regarded as having a fixed establishment in that State.

The conclusion from this case would be that the economic substance argument would not survive simply by outsourcing the fulfilment function to Jersey. The entire order acceptance, contract ratification and conclusion processes should also take place in Jersey.

Operating via a separate Jersey company

Further substance is added if a separately owned Jersey company actually buys the product for fulfilment from Jersey. The business must be controlled and managed from Jersey by professional directors who know and understand the business. The sales contracts must be concluded in Jersey. The Jersey company can also own the web servers, or it could sub-contract out the IT part of the process to independent third parties. It is critical that genuine substance exists in Jersey. The Jersey company cannot simply be a ‘figurehead’ with instructions coming from directors resident on the mainland. Otherwise, the entire arrangement will be considered a sham or Abuse of Rights by the tax authorities. This is exactly what happened in the recent (October 2002) UK VAT Tribunal case of RAL (Channel Islands) Limited (formerly known as the Rank Organisation). This case serves as a useful case study as how not to do it.

Gaming machines in 127 amusement arcades in the UK were leased to a newly formed Channel Islands subsidiary called RAL (Channel Islands) Limited (CI). CI was granted licences by a group company in the UK to use the arcades. Another UK subsidiary contracted with CI to provide staff at the arcades. The objective of the scheme was that the place of supply of gaming machine services would be in Guernsey . Therefore, VAT output tax would not be due on these services. However, it was hoped that CI could recover VAT input tax charged to it on the supplies it received from the UK under the EC Thirteenth Directive.

The VAT Tribunal decided as follows:

  1. The repayment claims for input tax made by CI under the 13th Directive were to be refused.
  2. CI was liable to be registered for VAT in the UK.
  3. CI was liable to charge output tax on the gaming machine services which were deemed to have been supplied in the UK. (Input tax could be set-off against output tax).

The rationale for the decisions revolved around the place of supply issue. It was accepted that CI had a ‘business’ establishment in Guernsey both under section 9 of the UK VAT Act 1994 and article 9.1 of the EC Sixth Directive. The question was whether CI had ‘fixed’ establishments at the 127 arcades in the UK where the machines were situated and whether the services were supplied there rather than at the Guernsey office. The Tribunal found that the amusement arcades in the UK were fixed establishments from which gaming services were supplied by CI. Treating the place of supply as Guernsey where CI had established its business would not produce a rational result based on the following findings, best illustrated via an actual quote from the Tribunal.

“We were invited to make findings of fact in certain areas. This we do as appropriate. Other findings are contained in our conclusions. The amusement arcades are of sufficient size to constitute fixed establishments. We are satisfied that real functions are performed at the CI office in Guernsey . However, the four Appellant companies do not in fact function independently of each other and many key decisions, in particular as to the acquisition and disposal of units, are taken by the directors of their common parent Holdings. CI, RAL and Machines could not function without the human resources provided by Services. Except for inputs provided under contracts by RAL, Machines, Services and Securicor, CI has no real involvement in the day-today management control of the provision of gaming services, its involvement being directed rather to monitoring the services and the cash flow after the event. All marketing is in the UK and all supplies are enjoyed by customers in the UK. There is no reason to believe that any change in the arrangements is apparent to customers, the facilities enjoyed by customers being unchanged. The arrangements involve some additional costs. We found the justification for the transfer of all staff to Services to be wholly unconvincing except in the context of the avoidance scheme.”

“There was no evidence of any monitoring of the staff costs attributable of the different group companies and it seems to us that the subcontracting of staff functions makes it more difficult for CI to monitor and control costs borne indirectly by it, in particular staff costs. Such control as there is appears to be exercised from Milton Keynes. The purpose of Project CICo was to avoid VAT. Such other benefits as there may be from the establishment of a Channel Islands company are speculative and arise from a desire to exploit its existence as opposed to being purposes in themselves.”

The fundamental difference between the RAL case and our scenario of fulfilment from Jersey is that in our situation goods are being supplied from a VAT-free jurisdiction, together with an element of services. In the case of RAL, although services were being provided contractually by a Channel Islands company to UK customers, the Tribunal was able to successfully apply International Financial Centres’ Yearbook the argument that essentially the main ingredients of the service still continued to be performed in the UK by group companies. This was because there were two serious flaws in the manner RAL was re-structured. The essential ingredients of the service continued to be provided in the UK. Additionally, these services were provided by group companies under the same management and control rather than by independent organisations.

Commercial reasons for restructuring

It is worth noting that the Tribunal in the RAL case examined the thinking behind the restructuring. Although the restructuring was originally suggested by RAL’s advisers as a VAT saving arrangement, there were other aspects to the group’s thinking, which bore on its decision to adopt the arrangements. The group was interested in obtaining a casino licence in Jersey. While CIL was strictly based in Guernsey, it was nevertheless felt that this presence in the Channel Islands was an advantage when it came to obtaining such a licence. The group was also interested in obtaining an Internet gaming licence in Jersey, so that it could relocate its Internet gaming servers (which were then located in Costa Rica) more conveniently in Jersey. CIL’s Channel Island resident directors were in fact actually resident in Jersey and were able to devote time to these matters. The RAL group wanted to expand its Internet gaming business via a company called Cyberslotz, which although not currently part of the RAL group, did have common investors. There was a proposal to integrate Cyberslotz into the RAL group and the Channel Islands were an essential point of facilitation in this regard. It is significant to note that the Tribunal commented that to the extent these proposals existed, the incorporation of the Channel Islands subsidiary was not a 'sham'.


The parallel that can be drawn from the case studies discussed above is that fulfilment of goods from Jersey by third party suppliers on an outsourced basis falls seriously short of the substance argument. The RAL case illustrates that the location of web servers in Jersey as part of the operational process is a valid commercial rationale for relocation. Most importantly, the title to the goods should belong to a separately owned Jersey company, controlled and managed from Jersey by suitable resident directors.

Needless to say, professional advice should be taken on a specific case-to-case basis well before implementing any scheme. Significant opportunities for tax-efficient distribution from Jersey do exist, but only with proper planning.

The information in this article is provided on a general non-specific basis. From August 1, 2004 any schemes which may be construed as avoiding or mitigating UK tax are subject to the registration and disclosure provisions of The Tax Avoidance Schemes (Information Regulations 2004.

©2004 RKG Consulting Ltd -

Raj K Ganguly, Managing Director, RKG Consulting Limited
37 Panton Street, Haymarket, London, SW1Y 4EA, UK
Tel: +44 20 7839 0389
Fax: +44 20 7839 2506
Email: [email protected]

Edmund (Ben) Bendelow, Chairman of Basel Holdings Limited
PO Box 484, 3 Old Street, St Helier, Jersey, JE4 5SS, Channel Islands
Tel: +44 1534 500 900
Fax: +44 1534 500 901
Email: [email protected]