LEGAL GUIDE: International Tax Co-Operation (Economic Substance) Law, 2018 (ESL)
The International Tax Co-Operation (Economic Substance) Law, 2018 (ESL) was enacted in the Cayman Islands on 21 December 2018. Its purpose is to fulfil the Cayman Islands’ commitment to ensuring the highest standards of tax governance and to ensure that the Cayman Islands is not included in Annex 1 to the EU list of non-cooperative jurisdictions for tax purposes (List) when it is reviewed in early 2019. All of the other key tax neutral jurisdictions (such as Bermuda, the British Virgin Islands, Guernsey, Jersey, Isle of Man) have recently passed similar legislation.
The EU’s Code of Conduct Group is responsible for preparing the List, the latest version of which was adopted by the ECOFIN Council on 5 December 2017. The Code of Conduct Group also produces a document (State of Play) setting out the state of play of the cooperation with the EU with respect to commitments taken to implement tax good governance principles.
The Cayman Islands tax regime is currently included in the State of Play as one that facilitates offshore structures which attract profits without real economic activity. The Cayman Islands, mindful of the need to ensure tax good governance, made a commitment to address the EU’s concerns relating to economic substance by the end of 2018.
2. Who does it apply to?
Companies, limited liability companies and limited partnerships incorporated in the Cayman Islands (unless they are centrally managed and controlled outside of and are tax resident outside of the Cayman Islands) which carry on relevant activities.
Companies incorporated outside of the Cayman Islands but registered under the Companies Law (2018 Revision) and whose business is centrally managed and controlled in the Cayman Islands, (unless they are tax resident outside of the Cayman Islands) which carry on relevant activities.
Essentially ESL provides that certain companies, limited liability companies and limited partnerships (“relevant entities”) which are tax resident in the Cayman Islands must, if they carry out a “relevant activity” (listed below) satisfy the economic substance test.
NB Domestic companies and investment funds are specifically excluded from ESL.
3. Relevant Activities
The “relevant activities” are defined in ESL as: banking * , distribution and service centre, finance and leasing, fund management, headquarters, holding company, insurance, intellectual property or shipping business but does not include investment fund business. These are defined in more detail in ESL and certain “Cayman Islands core income-generating activities” are specified in respect of each “relevant activity”.
It is worth noting here that “holding company business” is narrowly defined as “the business of a pure equity holding company”. Asset holding entities, such as those entities that only hold commercial or residential property, aircraft or yachts and carry out no other Relevant Activities therefore seem to fall outside the scope of the ESL.
* (Banking Business is defined in section 2 of the Banks and Trust Companies Law (2018 Revision) as 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).
4. Pure Equity Holding Company
A relevant entity whose only business is that of a pure equity holding company (i.e. just holding equity participations in other entities and only earns dividends and capital gains) is subject to a reduced economic substance test which will be satisfied if it (a) complies with all applicable filing requirements under the Companies Law (2018 Revision); and (b) has adequate human resources and premises in the Cayman Islands for holding and managing equity participations in other entities.
5. What do you have to do if ESL applies to your company, LLC or limited partnership?
A relevant entity which carries out relevant activities (other than holding company business) is required to satisfy the economic substance test in relation to those activities.
6. Economic substance test
The economic substance test is satisfied for relevant activities (other than holding company business) if the relevant entity:
1. conducts core income generating activities in relation to that relevant activity in the Cayman Islands;
2. is directed and managed in the Cayman Islands in relation to the relevant activity;
3. having regard to the level of income derived from the relevant activity in the Cayman Islands:
a. has adequate operating expenditure incurred in the Cayman Islands;
b. has an adequate physical presence in the Cayman Islands;
c. has an adequate number of full-time employees or other personnel with appropriate qualifications in the
A relevant entity is directed and managed in the Cayman Islands in relation to a relevant activity if:
1. its board of directors, as a whole, has the appropriate knowledge and expertise to discharge its duties;
2. meetings of the board of directors are held in the Cayman Islands at adequate frequencies given the level of
decision making required;
3. during a meeting of the board of directors a quorum is present in the Cayman Islands;
4. the minutes of all board meetings record strategic decisions made; and
5. the minutes of all board meetings and appropriate records of the relevant entity are kept in the Cayman Islands.
The Cayman Islands core income generating activities may be conducted by a third party provided the relevant entity is able to monitor and control the activities.
7. Information Provision
ESL requires each relevant entity carrying out one or more relevant activities to (1) notify the Tax Information Authority of the Cayman Islands (TIA) each year of: (i) whether or not it is carrying on a relevant activity; (ii) 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 the Cayman Islands and if so provide appropriate evidence to support that tax residence; and (iii) the date of the end of its financial year; (2) provide an annual report to the TIA including: (a) the type of relevant activity; (b) the amount and type of relevant income; (c) the amount and type of expenses and assets; (d) the location of the place of business or plant, property or equipment in the Cayman Islands; (e) the number of full-time employees or other personnel with appropriate qualifications who are responsible for carrying on the relevant activity; (f) the Cayman Islands core income generating activities; (g) a declaration as to whether or not the relevant entity satisfies the economic substance test; (h) in the case of a relevant activity that is an intellectual property business, a declaration as to whether or not it is a high risk intellectual property business and, if it is, whether or not the relevant entity will provide the information to rebut the presumption that it does not satisfy the economic substance test; (i) details of any Multinational Enterprise Group (MNE Group) in respect of which the relevant entity is a Constituent Entity for the purposes of the Tax Information Authority (International Tax Compliance) (Country-By-Country Reporting) Regulations, 2017; (j) in the case of a relevant entity that is carrying on a high risk intellectual property business – (i) detailed business plans which demonstrate the commercial rational for holding the intellectual property assets in the Cayman Islands, (ii) employee information, including level of experience, type of contracts, qualifications and duration of employment; and (iii) evidence that decision making is taking place within the Cayman Islands.
The TIA can require a relevant entity to provide information to assist it in making its determination as to whether the entity satisfies the economic substance test.
8. Intellectual Property Business
ESL provides that there is a presumption that any relevant entity which carries on high risk intellectual property business does not satisfy the economic substance test even if it conducts core income generating activities relevant to the business and the intellectual property assets in the Cayman Islands unless the relevant entity can:
a) demonstrate that there was, and historically has been, a high degree of control over the development, exploitation, maintenance, enhancement and protection of the intangible asset, exercised by an adequate number of full-time employees with the necessary qualifications that permanently reside and perform their activities within the Cayman Islands; and
b) provide sufficient information to the TIA to rebut this presumption.
A “high risk Intellectual property business” is an intellectual property business carried on by (1) an entity that: (a) did not create the intellectual property in the intellectual property asset it holds; (b) acquired the intellectual property asset (i) from an entity in the same group; or (ii) in consideration for funding research and development by another person situated in a country or territory other than the Cayman Islands; (c) licences the intellectual property asset to one or more entities in the same group or otherwise generates income from the asset in consequence of activities (such as facilitating sale agreements) performed by entities in the same group; or (2) an entity that does not carry out research and development, branding or distribution as part of its Cayman Islands core income generating activities.
9. When do you have to comply by?
ESL came into force on 1 January 2019 and applies to relevant entities which carry on a relevant activity during any financial year from the “date prescribed” i.e.: the relevant entity is required to satisfy the economic substance test in relation to a relevant activity by either (i) 1st July 2019 for relevant entities in existence before 1 January 2019 or (ii) for those relevant entities which came into existence on or after 1 January 2019, the date of commencement of a relevant activity.
The TIA may determine whether a relevant entity satisfies the economic substance test during any financial year of the relevant entity ending on or after the date prescribed.
10. How is it enforced?
The TIA is responsible for determining whether an entity passes the economic substance test and may share information on an entity that fails the test with various competent authorities in relevant jurisdictions. The TIA may impose fines or refer a matter to the relevant registrar who may make an application to the Grand Court. The Grand Court may make such order as it sees fit.
11. Offences and Penalties
On a first determination of failing to satisfy the economic substance test the TIA will impose a penalty of CI$10,000. On a second determination the TIA will impose a penalty of CI$100,000.
Under ESL a person who fails to provide or make available required information to the TIA or who interferes with required information commits an offence and is liable on summary conviction to a fine of CI$10,000 and/or 2 years imprisonment.
A person who knowingly or wilfully provides false information to the TIA commits an offence and is liable on summary conviction to a fine of CI$10,000 and/or 5 years imprisonment.
Where the TIA gives notice to a relevant entity that it has failed the economic substance test it also reports that to the relevant registrar who may apply to the Grand Court for an order: requiring the entity to take action to satisfy the economic substance test; or an order that the entity is a defunct company or LLC; or (if it is a limited partnership) that it is struck off.
12. Regulations and Guidance Notes
ESL also provides for regulations to be issued further defining the scope of relevant entities that are required to pass the economic substance test and the scope of relevant activities.
ESL provides for guidance to be issued on satisfying the economic substance test and on the meaning of “adequate” and “appropriate”.
We will provide further guidance once any regulations or guidance notes are issued.
13. What you need to do now
1. Consider whether your Cayman Islands company, LLC or limited partnership is a Relevant Entity or carries out any
2. If your Cayman Islands company, LLC or limited partnership is a Relevant Entity and carries out any Relevant
Activities, consider whether such entity is tax resident outside the Cayman Islands and obtain evidence of this.
3. If your Cayman Islands company, LLC or limited partnership carries out any Relevant Activities and is not tax
resident outside the Cayman Islands, consider what is required for such entity to establish economic substance in
the Cayman Islands.
4. Start contingency planning for satisfying and, or demonstrating your Cayman Islands company’s, LLC’s or limited
partnership’s satisfaction of the economic substance test or restructure.
14. How can Forbes Hare help you?
1. We can advise you on applicability of and compliance with ESL and each of the above points.
2. We can provide Cayman Islands based directors, secretaries and other officers to help you establish economic
substance in the Cayman Islands.
This article is intended to be for the general information of the clients and professional contacts of Forbes Hare. It is not intended to be comprehensive and should not be relied on as a substitute for independent legal advice in any circumstances.