The International Tax Co-operation (Economic Substance) Law, 2018 (the “Economic Substance Law”) came into force on 1 January 2019 in the Cayman Islands (“Cayman”). The Economic Substance Law was enacted in response to the work of the Organisation for Economic Co-operation and Development (“OECD”) and the European Union (“EU”) on fair taxation. The OECD Forum on Harmful Tax Practices sets the international standard that requires geographically mobile activities to have substance regardless of whether the activities are conducted in a “no or nominal tax” jurisdiction or in a preferential tax regime of a jurisdiction that has corporate income tax.
Summary of the Economic Substance Law
The Economic Substance Law requires a “relevant entity” that is carrying on “relevant activities” to satisfy the Economic Substance Test in relation to each relevant activity. Such a relevant entity will also have notification and reporting obligations under the Economic Substance Law.
“Relevant entity” means the following entities, except an “investment fund” or an entity that is “tax resident” outside Cayman:
- A company, other than a domestic company, that is:
- Incorporated under the Companies Law (2018 Revision); or
- A limited liability company registered under the Limited Liability Companies Law (2018 Revision);
“Relevant activities” includes each of the following, except investment fund business:
- banking business;
- distribution and service centre business;
- financing and leasing business;
- fund management business;
- headquarters business;
- holding company business;
- insurance business;
- intellectual property business; or
- shipping business.
The Economic Substance Test (“ES Test”) requires that a relevant entity:
- conducts Cayman core income generating activities (“Cayman CIGA”) in relation to that relevant activity;
- is directed and managed in an appropriate manner in Cayman in relation to that relevant activity; and
- having regard to the level of relevant income derived from the relevant activity carried out in Cayman:
- has an adequate amount of operating expenditure incurred in Cayman;
- has an adequate physical presence (including maintaining a place of business or plant, property and equipment) in Cayman; and
- has an adequate number of full-time employees or other personnel with appropriate qualifications in Cayman.
A relevant entity may satisfy the ES Test by outsourcing the conduct of its Cayman CIGA to another person provided that the relevant entity is able to monitor and control the carrying out of the Cayman CIGA. Cayman CIGA means activities that are of central importance to a relevant entity in terms of generating income and that are being carried out in Cayman.
Holding companies that only hold equity participations in other entities and only earn dividends and capital gains are subject to a reduced ES Test. Conversely, relevant entities carrying on high risk intellectual property business are subject to a higher burden of proof in demonstrating they maintain adequate economic substance in Cayman.
The Tax Information Authority (the “Authority”) has published a Guidance on satisfying the ES test, including the meaning of “adequate” and “appropriate” which will be dependent on the particular facts of the relevant entity and its business activity. A relevant entity will have to ensure that it maintains and retains appropriate records to demonstrate the adequacy and appropriateness of the resources utilised and expenditures incurred.
- Relevant entity in existence prior to 1 January 2019 must satisfy the ES Test in relation to a relevant activity from 1 July 2019;
- Relevant entity formed on or after 1 January 2019 must satisfy the ES Test in relation to a relevant activity from the date on which the relevant entity commences the relevant activity.
Starting in 2020, a relevant entity shall notify the Authority annually of:
- whether or not it is carrying on a relevant activity;
- if the relevant entity is carrying on a relevant activity, whether or not all or any part of the relevant entity’s gross income in relation to the relevant activity is subject to tax in a jurisdiction outside of Cayman and, if so, shall provide appropriate evidence to support that tax residence as may be required by the Authority; and
- the date of the end of its financial year.
Within 12 months after the end of each financial year, a relevant entity carrying on a relevant activity must submit to the Authority a report setting forth prescribed details as to their compliance with the ES Test.
Failure to Satisfy ES Test
The penalty for failure to satisfy the ES Test for a relevant activity in a financial year is USD12,200 or USD122,000 if it is not satisfied in the subsequent financial year after the initial notice of failure. In addition, application must be made to the Grand Court for an order requiring the relevant entity to take such action as is specified, or to be struck off.
The Guidance issued by the Authority may be subject to changes based on the EU’s review and subsequent comments. There are still questions about how to interpret some of the requirements and we anticipate that more detailed guidance will be further issued in Cayman shortly.
If you have any questions regarding the above, please feel free to contact your Sertus Client Services Representative or contact us at firstname.lastname@example.org.