Category Investments

Guidance on economic substance rules proving challenging

12 June 2019 Maitland
Colin Bird, Partner with Maitland in Isle of Man

Colin Bird, Partner with Maitland in Isle of Man

Discrepancies should be ironed out over time under the scrutiny of the EU Code of Conduct Group

The so-called Economic Substance Requirements of the European Union Code of Conduct Group were translated into legislation in certain non-EU jurisdictions from 1 January 2019.

Jurisdictions affected are Guernsey, Jersey, the Isle of Man, British Virgin Islands (BVI), Cayman, Bermuda, Vanuatu and others. Many high-net-worth individuals and businesses are needing to review their offshore structures in the light of the development, to ensure they are compliant.
The economic substance requirements arose from the EU’s concern that certain jurisdictions’ tax systems facilitate artificial offshore structures without real economic activity - in other words, structures that attract profits which are not supported by sufficient economic activity or presence in the relevant jurisdiction.

Guernsey, Jersey and the Isle of Man were the first to release draft “Economic Substance Requirement” legislation and worked closely together to ensure a uniform approach to implementation, which was effective from 1 January 2019. The BVI, Cayman, Bermuda and Bahamas followed shortly after, each with their own legislative approach. In the case of the Carribean jurisdictions the legislation is generally applicable to any structures formed this year and structures formed prior to 1 January have until 30 June 2019 to have everything in place to meet the requirements.

According to Colin Bird, Partner with Maitland and based in the Isle of Man, most jurisdictions have in the past few weeks issued guidance notes to help interpret the substance legislation but the guidance “remains incomplete in many cases, remaining a challenge for both authorities and practitioners to know how to implement it.”

Multiplying the challenge, Mr Bird says that there are significant differences in the legislation among the jurisictions involved, perhaps because each jurisdiction is focussing on its own particular offering and/or advantages, for example, the Cayman Islands appear to have a focus on investment funds.

“The temptation is to go ‘jurisdiction-shopping’ but we advise clients not to make hasty decisions, as we expect that discrepancies between jurisdictions in the guidance will be ironed out, probably starting with the meeting of the EU Code of Conduct Group in late June.

“As a first step, we are helping our clients to analyse and understand where their entities are tax resident and whether their activities are affected by the legislation. The practical aim is to ensure that a company is not ‘caught’ in the reporting net of more than one jurisdiction. In the long run the most cost-effective route may be to consolidate one’s offshore structure to a single credible offshore jurisdiction,” he says.

Commenting on the substance requirements in general, Mr Bird said that they form part of a worldwide trend towards tax transparency. In this, there was a balance to be struck between the need for regulation and the rights of individuals to privacy.

“There remain anomalies in the approach, notably in the omission of EU jurisdictions. For example, the economic substance requirements apply to the Channel Islands, and Isle of Man, however not to the jurisdictions of Malta, Cyprus or Liechenstein,” he says.

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