Following the recent introduction of standards by OECD regarding compliance with substance requirements, there are several aspects companies need to consider for registering and operating companies in offshore jurisdictions.
The Organisation for Economic Co-operation and Development (OECD) under its Base Erosion and Profit Shifting (BEPS) action plan, introduced standards to combat tax avoidance through profit shifting. Its aim is to prevent jurisdictions with no or only nominal tax from attracting profits from mobile activities that do not reflect real economic activity in that jurisdiction. Such mobile activities include:
· Headquartering
· Distribution and service centre
· Banking
· Finance and leasing
· Fund management
· Insurance
· Shipping
· Holding companies
· Intellectual property holding
In response to these standards, several low-tax jurisdictions – including Bahamas, Bermuda, BVI, Cayman Islands, Guernsey, Isle of Man, Jersey, Mauritius, Seychelles - have introduced legislation to comply with the economic substance requirements for such activities, effective as of 1 January 2019.
Even though each jurisdiction enacts its own legislation and there might be slight variances in the requirements amongst them, the criteria for economic substance are broadly equivalent for entities:
· Need to be directed and managed in the jurisdiction
· Ability to demonstrate that the Core Income Generating Activities (CIGA) are undertaken in the jurisdiction1
· There is an adequate number of employees in the jurisdiction with the suitable qualifications
· There is an adequate amount of operating expenditure to undertake certain CIGA
1 Where activities include the holding of IP rights, the substance requirements are adapted based on the Nexus approach
Failure to prove compliance with the above substance requirements may result in financial penalties, strike-off for entities from the jurisdictions’ registrar of companies and potentially exchange of information with foreign tax offices for this non-compliance.
Corporations therefore need to fully understand the substance requirements in the jurisdictions in which they operate and keep monitoring the developments around this subject. Careful consideration is required over local resourcing, proving core income generating activities in the jurisdiction and board decision making. Where these requirements are difficult to meet or are not commercially viable, multinationals may alternatively need to consider liquidations, re-domiciliation of entities or group restructuring.
Author: George Panayiotou - Head of Finance at Ultimate Fintech
