Understanding Economic Substance

By Alun Griffths, Forward Group Limited

The Council of the EU adopted a resolution on a Code of Conduct for business taxation, the aim of which was counteracting the effects of zero tax and preferential tax regimes around the world. In 2017, the Code of Conduct Group (Code Group) investigated the tax policies of both EU member states and third countries, assessing:

  • Tax transparency;
  • Fair taxation; and
  • Implementation of anti–BEPS measures (the OECD’s project on Base Erosion and Profit Shifting).

Following assessment by the Code Group, each non-EU relevant jurisdiction (which includes Bermuda, the British Virgin Islands, the Cayman Islands, Guernsey, Isle of Man, and Jersey amongst others) was required to address the Code Group’s concerns about “economic substance”.

The governments in each of these jurisdictions have been working closely with the Code Group to ensure that those concerns are adequately addressed. As a result of this engagement, new laws and regulations have been adopted in each jurisdiction (substance regulations).

Who Is Affected?

The scope of the substance regulations varies from jurisdiction to jurisdiction. As a first step, member firms should take an inventory of all their entities in any of the affected jurisdictions and make note of the type of company, LLC, or partnership, and how they are taxed.

Relevant Activity?

An in-scope entity will only be required to meet the economic substance test if it carries on a relevant activity. The relevant activities in each jurisdiction are:

  • Banking;
  • Insurance;
  • Fund management;
  • Financing and leasing;
  • Headquarters;
  • Shipping;
  • Distribution and service centres;
  • Holding entity; and
  • Intellectual property.

Requirements?

An entity (other than a holding entity, and entities that conduct intellectual property business, for which there are different criteria) conducting a relevant activity will satisfy the economic substance requirements if:

  • It is managed and directed in the jurisdiction;
  • Core income generating activities (CIGA) are undertaken in the jurisdiction in relation to the relevant activity;
  • It maintains adequate physical premises in the jurisdiction;
  • There are adequate employees in the jurisdiction with suitable qualifications;
  • There is adequate expenditure incurred in the jurisdiction in relation to the relevant activity; and
  • It files a confidential economic substance report each year with the applicable authority in its jurisdiction which will assist the authority in assessing compliance.

The substance regulations also set out the circumstances where the above activities may be outsourced to regulated service providers.


Alun Griffiths

Alun Griffiths

GGI member firm
Forward Group Limited
Advisory, Corporate Finance, Fiduciary and Estate Planning
Jersey
T: +44 1534 721420
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Forward Group Limited is a regulated trust and company services business located in Jersey. Jersey is a top-tier, low-tax jurisdiction. Forward provides regulated corporate and trust services to a broad spectrum of clients, included listed companies and high-net-worth individuals.

Alun Griffiths is the founding member of GS Chartered Accountants and Forward Group in Jersey. He is a Chartered Accountant and Tax Advisor with specialist offshore tax structuring experience spanning over 25 years.


Published: International Taxation Newsletter, No. 12, Spring 2020 l Photo: Oligo - stock.adobe.com

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