Economic substance requirements: major changes to the administration of certain offshore entities

Overview

In recent years the EU has taken action, through its Code of Conduct Group to identify non-cooperative jurisdictions based upon a criteria of tax transparency, fair taxation and compliance with the OECD’s Base Erosion and Profits Shifting (BEPS) requirements. As part of its remit, the EU Code of Conduct Group undertook a review of a number of jurisdictions’ tax policies. The review identified concerns with the lack of statutory ‘substance’ requirements in the British Virgin Islands (BVI), Cayman Islands, Bermuda, Jersey, Guernsey, and the Isle of Man. The lack of substance is perceived to increase the risk of profits being attributed to entities in those jurisdictions which is not commensurate with the activities carried on there.

To alleviate these concerns and avoid their inclusion in the EU’s list of non-cooperative jurisdictions (the EU Blacklist), the Crown Dependencies of Jersey, Guernsey and the Isle of Man, and certain of the Overseas Territories including the Cayman Islands, BVI, Bermuda and Bahamas, have approved new economic substance requirements for entities either tax resident or incorporated in those jurisdictions. The aim being to ensure entities which are in scope of the new rules have genuine economic activity and an actual physical presence on Island.

While each jurisdiction has independently drafted and enacted their own economic substance legislation, the requirements are broadly equivalent across each of the offshore jurisdictions. The substance requirements took effect from 1 January 2019, with some jurisdictions allowing a six-month grace period given to existing entities to satisfy the requirements. The substance rules apply not only to companies but to certain partnerships established in the relevant jurisdictions.

To which entities do the new rules apply?

The legislation applies generally to entities that are “resident” in one of these jurisdictions and carry on a “relevant activity”. To determine whether or not an entity is resident for the purposes of the new requirements, reference must be made to the appropriate law or tax legislation in the applicable jurisdiction. Relevant activities for the purposes of the new rules are:

  • Banking business
  • Distribution and service centre business
  • Finance and leasing business
  • Fund management business
  • Headquarters business
  • Holding company business
  • Insurance business
  • Intellectual property holding business
  • Shipping business

The economic substance that needs to be established and maintained in respect of the relevant activity are:

  • the entity be managed and directed in the offshore jurisdiction;
  • core income generating activities are undertaken in the offshore jurisdiction with respect to the relevant activity;
  • the entity maintains adequate physical presence in the offshore jurisdiction;
  • there are adequate full-time employees in the offshore jurisdiction with suitable qualifications; and
  • there is adequate operating expenditure incurred in the offshore jurisdiction in relation to the relevant activity.

Holding entities generally benefit from reduced substance requirements. Intellectual property entities, however, are presumed to be high risk (due to the geographically mobile nature of the asset class) and hence are subject to a higher substance threshold.

Ongoing reporting obligations and penalties for non-compliance

Entities will have reporting obligations in relation to their compliance with economic substance requirements to local tax authorities.  The ongoing obligations differ greatly. For example, in Jersey, Guernsey, and the Isle of Man, additional information will need to be included within the annual tax returns. Whereas, in the BVI, in scope entities will be required to report certain information to the BVI Registered Agent under the BVI Beneficial Ownership Secure Search (BOSS) regime.

Penalties can be imposed both for a failure to provide required information and for operating a legal entity in breach of the economic substance requirements, including fines and/or striking-off the entity.

What action should be taken now?

Businesses and individuals that have offshore entities within their existing structures should take action now to understand the substance requirements applicable for the offshore jurisdiction(s) in which they operate, and to determine what action, if any, may be required to comply with these measures. AbacusLandmark is well positioned to help with any restructuring in relation to commercial matters, re-domiciliation or changes in tax residency that may be required to ensure full compliance with the new rules and minimal interruption to business.

If you have any questions or would like to discuss in more detail, please contact us at info@abacuslandmark.com 

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