Company Z is a private company based in the United Kingdom that sells CDs through its network of physical stores, operating for 25 years. It has not yet created a website and wishes, if possible, to combine this activity with digital music delivery to its customers. Company Z has engaged Netbased Ltd, an e-commerce consulting firm, to produce a report on launching a website and the feasibility of introducing digital products.
Netbased confirms that digital delivery is feasible through music encoded in MP3 format, downloadable by individual customers from Company Z’s website, with playback software. The MP3 format (abbreviation for Motion Picture Expert Group-1/Level3, the result of an intergovernmental attempt to create standards for interactive television) has been adopted by the independent music industry. Although despised by major record labels, it is already used by many independent artists.
There is therefore already a substantial amount of music legally available in MP3 format (and much more illegally). Major record labels are expected to introduce an alternative standard, called SDMI, through which they will market their mainstream artists, and which Company Z will also be able to sell from its site once available. Company Z will pay royalties to encoded music suppliers based on the number of units sold.
Netbased also notes that a digital music retailer can operate from an offshore site; however, digital music downloads are very bandwidth-intensive (telecommunications capacity), so the offshore jurisdiction should offer advanced telecommunications facilities.
Netbased believes it would be wise to separate the new business from the existing activity, partly to avoid a negative reaction from record labels that supply Company Z’s stores, and partly to benefit from tax advantages. Creating an offshore company with distinct ownership achieves both objectives, despite the disadvantage that initial losses of the offshore company cannot be offset against British profits.
Company Z’s shareholders constitute a heterogeneous group with varying tax situations, but the majority agree to fund a new offshore company whose profits will not be subject to British tax. Furthermore, under current legislation, VAT would not be payable on digital music deliveries from outside the United Kingdom (see our Tax Law section for more explanation).
This would obviously give the new company a pricing advantage over its local competitors, who would be subject to VAT.
The Netbased report then examines the relative advantages of different offshore jurisdictions and selects Jersey as most suitable, given the strength of its telecommunications and commercial infrastructure, its close ties with the United Kingdom and, on the other hand, its exclusion from the scope of European VAT.
Company Z accepts the Netbased report and develops a program for the digital delivery project in collaboration with CI-net, a Jersey company specializing in e-commerce services. CI-net proposes a turnkey solution comprising the following steps:
An international trading company*, Z Direct Ltd, will be established in Jersey. It will pay a maximum tax of 2% on its net profit, reduced to 0.5% for profits exceeding £10 million.
Z Direct Ltd will operate from a small office on the island of Jersey; a dedicated server will be installed with backup facilities provided by CI-net.
CI-net will create and install a catalog and front-end ordering tools, as well as a secure multi-currency payment processing system.
Bank accounts will be opened in Jersey; online credit card services will be set up with a merchant identifier; customs clearance procedures will be agreed with the new bank.
MP3 file storage, processing and download systems will be created and installed.
Meanwhile, Company Z will begin building an MP3 catalog, a simpler task than it appears. It will use the Internet and its existing contacts in the music industry to identify MP3 sources, conclude licensing agreements and define technical data standards.
Although the cost of this work is substantial, Company Z is satisfied with the results, particularly because it is now well positioned to expand into other types of downloadable products, such as graphics files, videos and publications, without excessive additional costs.
*Note: In accordance with Jersey’s commitment to the “Rollback” provisions of the EU Code of Conduct for Business Taxation, the international trading company regime was abolished for new entrants from January 1, 2006. The benefits already enjoyed by beneficiaries of the international trading company regime will be phased out by December 31, 2011 at the latest.
