Tag Archives: Economic Substance
HSM explores the requirements for Economic Substance in the Cayman Islands and what it means for this jurisdiction. For a full overview on whether or not your business may be affected by this new Law, download our client guide here.
“I know it when I see it.” With those words Justice Potter Stuart, in the United States Supreme Court, unravelled the most Gordian of knots, with the most Gordian of ease. He was called upon to define that which commentators what was potentially undefinable – what constituted “obscene” in the context of hard-core pornography. Not an easy task for any judge, particularly one in the United States in 1964, but that was his solution. It was beautiful, and simple, and for many, at least for a while, it worked.
The Tax Cooperation (Economic Substance) Law has created a similar dilemma. It requires legal practitioners to advise, and government officials to determine, whether or not an entity is a relevant entity, and if is a relevant entity, whether or not it is carrying out a relevant activity.
What is and what is not a relevant entity can be readily determined on a case-by-case basis, as can a determination as to what constitutes a relevant activity. For those interested, these may include banking business, distribution and service centre business, finance and leasing business, headquarters business, fund management business, holding company business, insurance business, intellectual property business, and shipping business (all defined). It expressly does not include investment fund business.
Any relevant entity carrying on a relevant activity is generally required to satisfy ‘the Economic Substance Test’. That test is satisfied if the relevant entity conducts Cayman Islands core income generating activities in relation to the relevant activity, is directed and managed in an appropriate manner in the islands in relation to that relevant activity; and has an adequate number of full-time employees or other personnel with appropriate qualifications in the Islands.
Whilst the Law is vague as to what constitutes ‘adequate’ and ‘appropriate’, it itself defers to Guidance Notes as to the meaning of those words for the purposes of the Law.
The problem that confronted authors of those Guidance Notes, and must now confront Cayman legal advisors and the Tax Information Authority is uncannily very similar to that which confronted Justice Potter. They may similarly have been expected to define the undefinable. When requiring an entity to demonstrate ‘adequate’ and ‘appropriate’ mean in the context of physical presence, we could regret that lack of specificity in any guidance (though I would think us wrong to do so). Instead we should take a lesson from the US Supreme Court. We will know it when we see it.
Whether the Economic Substance is adequate or appropriate should be obvious, and if it is ever not, the Cayman courts may be asked to sort it out.
Until then, we must know it when we see it. Affected businesses will be advised to employ people, rent premises, spend money and hold meetings here, all to the level they think appropriate to meet the expectations of the legislation. Real estate agents, IT service providers, contractors, restauranteurs and indeed most existing businesses and individuals in the Cayman Islands should probably be delighted. That the core activity is actually being carried out in the Islands should be readily apparent.
Of course, issues will develop. William T. Goldberg described that “I know it when I see it” can be “paraphrased and unpacked as: ‘I know it when I see it, and someone else will know it when they see it, but what they see and what they know may or may not be what I see and what I know, and that’s okay.’”
For now, we should see opportunity, for our islands and our customers, and know it for what it is. That’s okay.
Physical Presence
The idea that a business should have a physical presence in order to claim that it has its seat of operations in a particular jurisdiction is not new. The brass nameplate era, exacerbated by the virtual presence age, has been the subject of chagrin from many western leaders. These criticisms date from well before President Obama found fit to comment on the size of a particular office building in George Town housing some 12,000 companies (and omitted to note the fact of a much smaller building in Delaware (1209 North Orange Street) housing many more companies. Indeed, as Cayman’s companies registry has grown to more than 100,000 companies in the intervening decade, 1209 North Orange Street was recently reported as having some 300,000 companies registered there, three times the number of companies registered at every office building and residential home in the Cayman Islands combined.
Whatever the arguments, the tide has shifted. We can lament the apparent passing of a golden age, and dwell on the hypocrisy of foreign politicians, or look forward with excitement to the opportunities this changing current brings.
All change brings challenge and even fear. That latter sentiment often proves baseless (albeit too often with 20:20 hindsight). Yes, we are going to lose some business, including perhaps to 1209 North Orange Street, but these changes will also affect key competitors, including the BVI and Bermuda. With a level playing field (at least against those jurisdictions) Cayman’s size, depth and range of world class financial services industry professionals, sets us apart.
However, we also have an ace up our sleeve – our immigration regime.
Although frustrating to many, and even confounding to some, most aspects of our immigration regime work well. It does something that other territories fail at. It asks if a local person stands ready to fill a role at an appropriate standard and if not, subject to sensible checks as to such things as health and character, the permit is yours. Yes, there is a price to pay and other cost associated with administration, but the government is actively working to streamline processes. What is more, with a relatively nominal express fee paid, a work permit can be available in less than 72 hours. Where the business is international in nature and does not compete locally, the answer is not only yes, but often enthusiastically so.
We are also fundamentally very good at assimilating large numbers of foreign nationals into our community, allowing them to advance towards becoming Caymanian, and even encourage them to purchase (or build) their own homes here.
These are not optimistic statements as to how the Cayman Islands will address the challenge of foreign executives wishing to move here. This is a statement of what has pertained for decades. Anyone contemplating such a move can ask one of the numerous executives who have already, before there was any Economic Substance Test, established their mind management and control firmly on our soil. Their experience has overwhelmingly been positive.
As a new generation of executives arrive, perhaps in significantly increasing number, they will do so under a tried and tested system. The opportunities for the Caymanian people will be many. The real challenge will be ensuring that they participate as fully as they should for many years to come.
This article can also be seen in The Journal – May 2019 issue.
Through the International Tax-Co-operation (Economic Substance) Law, 2018, the concept of an Economic Substance Test has been introduced and certain businesses must satisfy new requirements. The test applies to any “in scope” businesses and requires that any “relevant entity” carrying on a “relevant activity” must pass a 3 pronged test. Download our client guide to determine if your business is within scope or continue reading below.
Economic Substance Test
Certain categories of business operating from within the Cayman Islands must be in a position to demonstrate that, relative to the size and nature of their operations, they have sufficient “economic substance”. Such substance is measured in terms of a demonstrable physical presence, including of the mind, management and control of a relevant organisation.
If you are a relevant entity carrying on a relevant activity – you must:
(a) conduct Cayman Islands core income generating activities in relation to that relevant activity
(b) be directed and managed in an appropriate manner in the Islands in relation to that relevant activity; and
(c) having regard to the level of relevant income derived from the relevant activity carried out in the islands –
a. have an adequate amount of operating expenditure incurred in the islands;
b. have an adequate physical presence (including maintaining a place of business or plant, property and equipment) in the Islands; and
c. have an adequate number of full time employees or other personnel with appropriate qualifications in the Islands.
Definitions
A relevant entity is:
1. A company (other than a domestic company) that is-
a) incorporated under the Companies Law (as Revised) or
b) an LLC registered under the Limited Liability Companies Law (as Revised).
2. A Limited Liability Partnership that is registered under in accordance with the Limited Liability Partnership Law (as Revised)
3. A foreign company registered in the Cayman Islands under part IX of the Companies Law (as Revised)
Investment Funds or entities which are tax resident outside of the Islands are not considered relevant entities.
An “Investment Fund” is defined as an entity whose principal business is the issuing of investment interests to raise funds or pool investor funds with the aim of enabling a holder of such an investment interest to benefit from the profits or gains from the entity’s acquisition, holding, management or disposal of investments and includes any entity through which an investment fund directly or indirectly invests or operates.
A domestic company is a company that is not part of an MNE Group that is:
1. Carrying on business in the islands and which complies with s.4(1) of the Local Companies Control Law (as Revised) i.e. is Caymanian owned and controlled (at least 60% of the board of directors is comprised of Caymanians and at least 60% of the issues shares are held in the names of Caymanians) or holds a valid Trade and Business Licence under the Trade and Business Licensing Law (as Revised), is licensed under the Banks & Trust Companies Law (as Revised) or is otherwise operating under a franchise granted by the Cayman Islands Government.
2. A Company Limited by Guarantee or an “Association not for Profit” under s.80 of the Companies Law (as Revised).
Or a subsidiary of such company.
An MNE Group is a Group with annual revenues of at least US$850m total consolidated group revenue.
“Group” means a collective of two or more enterprises that are tax resident in different jurisdictions and are related through ownership or control such that it is (or would be traded on a public securities exchange) required to prepare Consolidated Financial Statements for financial reporting purposes.
A relevant entity is in scope if it is carrying on one or more of the below relevant activities:
a) Banking business;
i.e. the business of receiving (other than from a bank or trust company) and holding on current, savings, deposit or other similar account money which is repayable by cheque or order and may be invested by way of advances to customers or otherwise.
b) Distribution and service centre business;
i.e. the business of either or both of the following –
a) purchasing from an entity in the same Group
i) component parts or materials for goods; or
ii) goods ready for sale, and reselling such component parts, materials or goods outside the islands
b) providing services to an entity in the same Group in connection with the business outside of the Islands
but does not include any activity included in any other relevant activity except holding company business. For the avoidance of doubt, b) above only falls within the definition in the specific circumstances where the relevant entity is operating as a service centre for entities in the same Group.
c) Financing and leasing business;
i.e. the business of providing credit facilities for any kind of consideration to another person but does not include financial leasing of land or an interest in land, banking business, fund management business or insurance business.
d) Fund management business;
i.e. the business of managing securities as set out in paragraph 3 of Schedule 2 to the Securities Investment Business law (2019 Revision) carried on by a relevant entity licensed or otherwise authorised to conduct business under that Law for an investment fund.
e) Headquarters business;
i.e. the business of providing any of the following services to an entity in the same Group –
a) the provision of senior management;
b) the assumption or control of material risk for activities carried out by any of those entities in the same Group; or
c) the provision of substantive advice in connection with the assumption or control of risk referred to in paragraph b)
but does not include banking business, financing and leasing business, fund management business, intellectual property business, holding company business or insurance business.
f) Holding company business;
i.e. the business of a ‘pure equity holding company’, which itself is defined to mean ‘a company that only holds equity participations in other entities and only earns dividends and capital gains’.
g) Insurance business;
i.e. the business of accepting risks by effecting or carrying out contracts of insurance, whether directly or indirectly, and includes running-off business including the settlement of claims.
h) Intellectual property business; or
i.e. the business of holding, exploiting or receiving income from intellectual property assets and ‘intellectual property asset’ means an intellectual property right including a copyright, design right, patent and trade mark.
i) Shipping business
Means any of the following activities involving the operation of a ship anywhere in the world other that in the territorial waters of the Islands or between the Islands –
a) the business of transporting, by sea passengers or animals, goods or mail for a charge;
b) the renting or chartering of ships for the purpose describe in paragraph a);
c) the sale of travel tickets and ancillary ticket related services connected with the operation of a ship;
d) the use, maintenance or rental of containers, including trailers and other vehicles or equipment for the transport of containers, used for the transport of anything by sea; or
e) the functioning as a private seafarer recruitment and placement service
but does not include a holding company business or the owning, operating or chartering of a pleasure yacht.
Given the above, the test can be substantially satisfied through the employment of persons within the Islands to carry out the relevant activity or activities. The Cayman Islands may already have persons with the requisite skills and expertise already resident, but where such skills are unavailable, or if available, are not available in sufficient number, then any required persons can be brought into the Islands from overseas. Such persons can bring with their spouses and children (amongst others) following a well-established immigration regime overseen by a Cayman Islands Government Department, “Workforce Opportunity and Residence Cayman” (WORC).
Compliance, Filings and Penalties
Relevant Entities in existence prior to 1 January 2019 must satisfy the economic substance test in relation to a Relevant Activity from 1 July 2019. Relevant Entities formed on or after 1 January 2019 must satisfy the economic substance test in relation to a Relevant Activity from the date on which the Relevant Entity commences the Relevant Activity.
Starting in 2020 all Relevant Entities carrying Relevant Activities are required to satisfy the economic substance test and submit details to the Cayman Islands Tax Information Authority (the “TIA”). Failure to comply can result in an initial fine of CI$10,000 which can increase to CI$100,000 with continued failure to comply and being struck from the Registrar of Companies.
Next Steps
If you are affected by this Law or if you are unsure, contact our team for tailored advice. We can help determine whether a client is “in scope” or “out of scope” in relation to the economic substance test and if affected, provide administrative support as well as provide immigration advice to issues that may arise.
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