Economic substance requirements in the Cayman Islands
The Cayman Islands government has published draft legislation that will require certain Cayman Islands entities carrying on specified activities to have ‘adequate substance’ in the Cayman Islands. Any relevant entity that may be impacted by this legislation will wish to monitor these developments closely.
The Cayman Islands is an early adopter of the Common Reporting Standard, is compliant with FATCA, and is recognised as a jurisdiction committed to tax transparency. Our anti-money laundering and anti-terrorist financing legislative regime meets and in some cases exceeds international standards and our commitment to compliance is unwavering. The Cayman Islands government and financial services industry together have a long history of working closely and cooperatively with key intergovernmental organisations to ensure that our regulatory framework remains sound.
One of these intergovernmental groups, the EU Code of Conduct Group (the Code Group), assessed the tax policies of a range of countries, including the Cayman Islands, in 2017. Following assessment by the Code Group, Cayman was included in a list of jurisdictions which are required to address the Code Group’s concerns about ‘economic substance’. Like their counterparts in BVI, Bermuda, Guernsey, Jersey and Isle of Man, the government of the Cayman Islands has been working closely with the Code Group to ensure that those concerns are adequately addressed. As a result of this engagement, a bill to provide for an economic substance test, called the International Tax Co-operation (Economic Substance) Bill, 2018 (the Bill), has been published in advance of a special sitting of the Legislative Assembly.
The Bill applies only to “relevant entities.” A relevant entity is any of the following (except for investment funds, which are specifically carved out):
(a) a company, other than a domestic company, that is:
(i) incorporated under the Companies Law; or (ii) a limited liability company registered under the Limited Liability Companies Law, unless its business is centrally managed and controlled outside of Cayman and it is tax resident outside of the Islands;
(b) a limited liability partnership that is registered under the Limited Liability Partnership Law, 2017, unless its business is centrally managed and controlled outside of Cayman and it is tax resident outside of the Islands;
(c) a company that is incorporated outside of the Islands, registered under the Companies Law and centrally managed and controlled in Cayman (unless it is tax resident outside the Islands).
A relevant entity is only in scope of the economic substance requirements if it conducts any “relevant activity”. Relevant activities are:
- Banking business
- Distribution and service centre business
- Finance and leasing business
- Fund management business
- Headquarters business
- Holding company business
- Insurance business
- Intellectual property holding business
- Shipping business
Each of the above activities is defined in the Bill, and we expect that further guidance will be issued to assist in determining if a particular entity is carrying on a relevant activity. Appleby is actively involved in the guidance consultation and we will prepare sector-specific briefings once all particulars are published.
The Economic Substance Test
A relevant company conducting relevant activities is required to satisfy a 3-branch economic substance test. It must:
(1) conduct Cayman Islands core income generating activity in relation to that relevant activity (“Cayman Islands core income generating activity” being any activity that is of central importance to a relevant company in terms of generating income that is being carried out in or from within the Islands);
(2) be directed and managed in an appropriate manner in or from within the Islands in relation to that activity;
(3) having regard to the level of relevant income derived from the relevant activity carried out in or from within the Islands –
(i) have adequate operating expenditure incurred in or from within the Islands;
(ii) have adequate physical assets or physical presence (including maintaining a place of business) in the Islands; and
(iii) have adequate employees in the Islands.
Holding companies are required to meet a reduced test for economic substance, while at the other end of the scale high risk intellectual property holding companies will face more onerous requirements. Additional guidance will be prepared which we expect will give clarity to these requirements. There will not be a ‘one size fits all’ approach.
Outsourcing of core income generating activities within the jurisdiction is permitted and counts towards satisfying the substance requirements so long as the relevant company is able to monitor and control the carrying out of that activity by that other person.
Relevant entities will be required to file a notice with the designated authority stating whether or not they are carrying out relevant activities. Those carrying out relevant activities will be required to file a basic return setting out particulars as to income, expenses, assets, management, employees, physical presence and other matters. These filings will be examined by the designated authority to ensure that such entities have adequate economic substance in the Islands. Those lacking adequate substance will be given direction on how to meet the test and may face a fine of up to $10,000. Continued failure to meet the test in the following year may result in higher fines and could lead to the entity being struck off the register.
What Can Appleby do to Help?
All relevant entities will need to undertake an internal review to determine what measures, if any, they might need to take in order to achieve compliance. In most cases, we believe that compliance will be a straightforward matter. We will have a clearer picture once the legislation has been passed and guidance has been circulated for consultation, likely in late-December. At that time, we will be in touch with more information about how we expect this new legislation to impact our client base in the form of sector-specific client briefings.
In the meantime, if you have any questions, please reach out to your usual Appleby contact.