Offshore centers introduce substance legislation to stave off EU blacklisting

Jersey, Guernsey, the Isle of Man, Bermuda, the British Virgin Islands, the Bahamas and Cayman have all introduced new legislation late last year requiring that companies that are tax resident in their jurisdictions have enough economic activity locally to justify the profits they make there.

The new laws resulted from pressure by the European Union to blacklist any countries that “facilitate offshore structures or arrangements aimed at attracting profits which do not reflect real economic activity in the jurisdiction”

To avoid an immediate blacklisting and potential punitive measures, Cayman’s government and other jurisdictions made a written commitment in Dec. 2017 to introduce new substance requirements into legislation by the end of 2018.

Cayman’s ministry of financial services said the new requirements “could be fulfilled by activities such as hiring staff and having physical business locations; or outsourcing these activities to a local service provider.”

The International Tax Co-operation (Economic Substance) Law affects banking, insurance, fund management and shipping companies; entities functioning as headquarters or distribution and service centers; and businesses engaged in financing and leasing or holding intellectual property.

If a Cayman entity is conducting relevant business activities in one or more of these categories; and if that entity is not tax resident in another jurisdiction, the law would require the entity to have ‘economic substance’ in the Cayman Islands, the ministry said in a press release.

Resident companies that generate core income in the prescribed fields must pass the economic substance test from July 1, 2019.

They will do so, if they conduct core income-generating activities on island; incur an adequate amount of operating expenditure in Cayman; have a physical presence locally; and have an adequate number of full-time staff. In addition, the company must be directed and managed from Cayman with regular board meetings held and minutes of strategic decisions kept on island.

Equity holding companies are subject to a “reduced” economic substance test under the proposed legislation. They would satisfy the substance test if they have complied with all applicable filing requirements under the Companies Law and if they have “adequate human resources and adequate premises in the islands for holding and managing equity participations in other entities.”

So-called high-risk intellectual property holding companies, on the other hand, are subject to more onerous requirements.

They include companies that hold intellectual property they did not create and acquired either from an entity in the same group or another entity outside of Cayman, and then license the intellectual property to related entities.

They also encompass intellectual property businesses that do not undertake research and development, branding or distribution as part of their local core income-generating activities.
High-risk intellectual property businesses are presumed to have failed the substance test, even if they carry out core income-generating activities on island, unless they can demonstrate that they historically maintained control over the development, exploitation, maintenance, enhancement and protection of the intangible property asset. This would have to be exercised by an adequate number of full-time employees with the necessary qualifications that permanently reside and perform their activities in Cayman.

These types of businesses must provide detailed business plans which demonstrate the commercial rationale for holding the intellectual property assets in the islands; employee information, including level of experience, type of contracts, qualifications and duration of the employment; and evidence that decision making is taking place within the islands.

The new rules effectively force these businesses to demonstrate that they had a high degree of control over the development and exploitation of the intellectual property asset they hold, even if they already have economic substance locally.

Relevant companies must file a report with Cayman’s Tax Information Authority each year. If the authority deems that the company has not passed the substance test, it has the power to issue a penalty of $10,000. If the substance test is failed again in the subsequent year, the penalty increases to $100,000 and the company can be struck off.

Minister for Financial Services Tara Rivers said representatives from more than 15 financial services and commerce associations had participated last year in the government consultation on the new legislation.

The Cayman Islands government is expected to issue guidance notes and regulations after another round of industry consultations in the first half of 2019. However, it is not clear whether these will define what “adequate” economic activity means by setting minimum standards and thresholds for each individual sector.

The lack of minimum substance standards is designed to keep the legislation flexible for the unique circumstances of each type of business, but it also makes it difficult to quantify the economic impact of the substance test.

Premier Alden McLaughlin told fellow members of the Legislative Assembly in December 2018, “Companies that are here in an attempt to circumvent tax obligations elsewhere will have a choice: They can go back to onshore jurisdictions with direct taxation or they can increase their level of substance in Cayman.”

According to Premier McLaughlin, exact data is not available but rough estimates suggest up to 20,000 companies could fall under the law.

The BVI government has estimated that the substance legislation will lead to a 10 percent to 20 percent drop in its financial services business.

The different substance legislations in Cayman, the BVI, Bermuda and the Channel Islands are very similar in their approach because they are based on the work of the OECD Forum on Harmful Tax Practices (FHTP) which seeks to eliminate harmful preferential tax regimes.

These are regimes that apply tax incentives or concessions to taxpayers, who are engaged in operations that are purely tax-driven and involve no substantial activity.

Although none of the tax regimes in the Crown dependencies and British overseas territories are “preferential,” in the sense that a tax rate is reduced in certain circumstances, the OECD expanded the application of substance rules to all “no or nominal tax jurisdictions” under Action 5 of its OECD Base Erosion and Profit Shifting initiative.

The OECD justified the move with the concern expressed by countries who employed harmful preferential tax regimes that they might lose business to low tax countries now that they are forced to change their rules by implementing economic activity standards.

The EU subsequently notified all countries that failed its tax blacklist criterion of “facilitating offshore structures or arrangements aimed at attracting profits which do not reflect real economic activity in the jurisdiction” that they should mirror the rules developed by the FHTP.

This has the effect that the rules developed for harmful concessionary and incentive-based parts of a tax regime are applied to these jurisdictions as a whole. In other words, it treats their entire tax regime as harmful. This leads to significantly higher compliance costs in low- or no-tax jurisdictions.

Netherlands puts low-tax jurisdictions on tax blacklist

The Netherlands has compiled a new list of 21 low-tax jurisdictions, including the Cayman Islands, to fight tax evasion. The list was published on Dec. 28, 2018, in the country’s government gazette.

It contains the five jurisdictions – American Samoa, the U.S. Virgin Islands, Guam, Samoa, and Trinidad and Tobago – that are currently blacklisted by the European Union.

In a sign that substance legislation, recently passed by several offshore jurisdictions to avoid an EU-wide blacklisting, will not be enough to appease EU member countries, the Dutch list also contains 16 low-tax jurisdictions. The only criterion for the list appears to be that these jurisdictions have a corporation tax rate of less than 9 percent or no corporation tax at all.

They are Anguilla, the Bahamas, Bahrain, Belize, Bermuda, the British Virgin Islands, Guernsey, the Isle of Man, Jersey, the Cayman Islands, Kuwait, Qatar, Saudi Arabia, the Turks and Caicos Islands, Vanuatu and the United Arab Emirates.

From Jan. 1, 2021, companies registered in blacklisted jurisdictions will be subject to a 20.5 percent withholding tax on interest and royalties received from the Netherlands. In addition, Dutch tax authorities will no longer issue advance tax rulings on transactions with companies headquartered in blacklisted jurisdictions.

In its implementation of EU Anti-Tax Avoidance Directives, the Netherlands will go beyond prescribed minimum standards with stricter controlled foreign company rules and special measures to prevent earnings stripping and hybrid mismatches that attempt to exploit differences between tax systems.

The Cayman Islands government rejected the blacklisting stating the list was based on the sole criterion of those jurisdictions having a lower corporate tax rate than any EU member state.

“This ‘blacklisting’ does not take into account Cayman’s demonstrated adherence to international standards for tax transparency, or participation with the OECD’s BEPS Inclusive Framework, and ignores our engagement with the EU’s Code of Conduct Group over the last two years to address their concerns regarding economic substance,” a government statement said.

The government described the blacklisting as “unjustified” and “lacking in fairness and credibility.”

“It is unfortunate that the Netherlands has chosen to attempt to divert criticism of its own tax practices by attacking the legitimate tax regimes of other jurisdictions,” the statement continued.

The Netherlands itself has come under criticism for operating a tax haven for international corporations, which use the extensive international treaty network of the country with 150 double taxation agreements to shift profits to low-tax jurisdictions.

A recent study by government agency Statistics Netherlands found that the country had received 4.6 trillion euros (US$5.2 trillion) in “foreign direct investment” in 2017.

However, less than a fifth of that money – $836 billion – remained in the Dutch economy, while $4.2 trillion was routed through shell companies to other jurisdictions. Researchers said about a third of the money ended up in “offshore tax havens.”

IMF data, reported by academic Jan Fichtner in the Cayman Financial Review in 2017, shows that in 2015 Cayman entities received $53 billion in foreign direct investment from the Netherlands, and $49 billion were sent in the opposite direction.

FCO: Beneficial ownership register to be made public by 2023

The U.K. has indicated that it will issue an order in council instructing British Overseas Territories to establish fully operational public registers of beneficial ownership by 2023, if they have not done so by the end of 2020.

The U.K. revealed the timeline in discussions with the Overseas territories at the Joint Ministerial Council in Dec. 2018.

The House of Commons passed the Sanctions and Anti-Money Laundering Act in May, including a controversial opposition amendment calling for the U.K. government to force Overseas Territories to make information on the owners of companies and other entities registered there available to the general public.

British lawmakers believe having this type of information accessible on the internet would help in the fight against tax evasion, money laundering and financial crime.

Although most of Britain’s 14 Overseas Territories, including Cayman, have beneficial ownership registers that grant access to British law enforcement and tax authorities, the registers are not public.

The Cayman Islands government has described the action by the U.K. parliament as “a potential constitutional overreach” as it touches on financial services, an area of policy that is devolved to the territory. The government announced that it would therefore mount a legal challenge to such an order if it were ever made.

In addition, the government has held constitutional talks with the Foreign and Commonwealth Office seeking to introduce constitutional safeguards that would confirm that the Cayman Islands government has autonomous capacity in respect of domestic affairs, and that the U.K. will not seek to legislate, directly or indirectly for the Cayman Islands without consultation.

Data Protection Law start date pushed back

Government is delaying the enforcement of the Data Protection Law, originally slated for Jan. 1, 2019, by nine months following representations made by the financial services industry.
The Data Protection Law regulates how businesses and government agencies must handle all personal data in the Cayman Islands and provides a framework of rights and duties designed to give individuals greater control over their personal data.

The law specifically covers how such data is collected, processed, stored or transmitted, particularly when dealing with government bodies, corporate entities, practices and firms.
The new commencement date of Sept. 30, 2019, is aimed to enable all entities impacted by the new law to be ready to meet its requirements.

Attorney General Samuel Bulgin said stakeholders in the financial services industry had sought more time to better prepare themselves for complying with the law. This included the completion of staff training, hiring new staff as needed, auditing existing data and establishing the needed administrative framework.

“Government is hoping that the new starting date will allow all impacted by the law, including data controllers and employers, small and big, in the public and private sectors, sufficient opportunity and time to prepare and be able to comply with the requirements,” Bulgin said.

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Michael Klein
Michael Klein Editor Compass Media Ltd. PO Box 1365, Grand Cayman, KY1-1108, Cayman Islands T: 345-326-1720C: 345-815-0064 E: [email protected] Michael is a financial journalist and copywriter.  In the past he has been responsible for the Risk Management and Corporate Finance sections of a British monthly Corporate Treasury publication.  He has written various financial handbooks, notably on European Banking and Cash Management and the Debt Capital Markets.   In addition he has worked as a copywriter for banks and investment funds and served as corporate communications consultant to US and European blue chip companies.   Michael holds an MA in Political Science and International Law from the University of Bonn in Germany. 

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