The Income Tax division of the Treasury issued a consultation document last month that aims to force trading companies in the Isle of Man to distribute 60 per cent of their profits to shareholders.

Any companies not doing this will be classified as 'non-distributing' and will, if the shareholder is a Manx resident, be subject to tax of 18 per cent on that proportion of its profit, which equates to 10.8 per cent of the entire profit made.

Treasury is aiming to pass the legislation this month as part of the Income Tax Amendment Bill 2005 and it has been seen in many circles as a roundabout way of mitigating the loss that will result from the zero corporation tax measures due in 2006.

Phillip Dearden, tax director with PKF, said that the government faced a public relations problem, as many company directors and advisers still believe that corporation tax will be totally abolished in 2006.

'Many people have been believing that companies will not pay tax. This proposal will make it so that corporate profits are still taxed albeit they will be distributed to shareholders and then taxed. I can understand why they would do it but they have a big PR problem, because there are clients and advisers out there who will be quite surprised. I imagine they will be phoning their MHKs and saying "what is this, this isn't what we were told."

Mr Dearden added that the consultation document had a number of errors and oversights that would make the tax very difficult to implement.

'I have just prepared an enormous long list of practical difficulties with the proposals. It is a very complicated piece of legislation, it will involve tax, accounting and company law and is going to be very very messy. One of my biggest bugbears has been lack of consultation. That document was issued in the middle of January with a deadline of the middle of February and they have already drafted the legislation.'

He says that one of the areas that needs clarification is the tax liability due to non-Manx resident shareholders. The document states that they are exempt from any tax, but Mr Dearden says that separation of profits within a company is not done that easily.

'If an Isle of Man company is owned totally by non-residents they will be outside the scope of this bill. If you have a company owned by a Manx person and a foreign person, it could be quite messy.'

Greg Jones, tax director at KPMG, said: 'The difficulty we are facing is that we need to have the new regime in place, but actually putting in the infrastructure to make it work properly and to make sure there is no tax leakage was always going to be difficult. The Treasury have asked for help and we can't sound negative when we put our submissions in. We have to give a balanced view and not try to pick holes in the proposals.'

He echoed Mr Dearden's view that the general public might be misguided regarding the future of corporation tax.

'I have always made the point to the tax office, that there needs to be an ongoing educational process, so that expectations can be managed. The problem is that zero corporation tax is seen as a tax break for local residents. That was never meant to be the case, at some stage there needs to be a carefully worded statement to local residents, that this really isn't intended to give them a tax break, it is for the greater good of the Island as a whole.'

Malcolm Couch, government assessor of income tax, said the legislation is designed to protect cashflow to the Treasury and to avoid the situation where people can avoid income tax at 18 per cent by leaving money in a company. He believes that a comprehensive consultation process with industry has already taken place.

'The charge will be levied at 18 per cent of 60 per cent of profits, already we have fairly wide consultation with industry and the general view is that we didn't want 100 per cent of profits to be included. We want people to tell us where we need to relax the rules as part of the consultation process.'

He added: 'From our perspective we want to make sure that companies pay out dividends and are not "money-boxing", the tax system is evolving and changing and it does cause issues for the general population, but it is all necessary. Once we get the tax strategy sorted, it will be more stable. We want to be very careful in our consultation and education programme to make sure this is understood.'