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New Economic Substance Requirements for Key Offshore Centres
 

Date:  11 Apr 2019

New Economic Substance Requirements for Key Offshore Centres



In response to the requirements of the European Union Code of Conduct Group, and in parallel with new global OECD standard on substantial activities requirements for “no or nominal tax jurisdictions”, a number of offshore jurisdictions including Cayman, the British Virgin Islands, Seychelles, Bermuda, Jersey, Guernsey, the Channel Islands, and the Isle of Man have enacted new legislation setting out an economic substance test for tax-resident entities in an attempt to avoid being considered as harmful tax practices and placed on a EU blacklist (i.e. list of non-cooperative jurisdictions). EU wants offshore jurisdictions to implement legislation encouraging brick and mortar institutions, rather than the “shell companies” that comprise a large portion of the jurisdictions’ financial industries.
 
The legislation came into force on January 1, 2019 with a six-month grace period given to existing entities to meet the requirements. Entities which carry on relevant activities in an offshore jurisdiction and are not tax resident in another jurisdiction are subject to the economic substance requirements. 
 
What do relevant activities cover?
Relevant activities include:
  • banking
  • insurance
  • shipping
  • fund management
  • finance and leasing
  • headquartering
  • operation of a holding company
  • holding intellectual property
  • distribution and service centre business
 
What are the economic substance requirements?
Entities are required to:
  • undertake core income generating activities (CIGA) in the offshore jurisdiction;
  • maintain adequate number of employees with appropriate qualifications who are physically present in the offshore jurisdiction;
  • incur adequate operating expenditure in the offshore jurisdiction; and
  • have physical office or premises or equipment located in the offshore jurisdiction.
Holding companies are required to meet a reduced test for economic substance, while at the other end of the scale, intellectual property companies will face more onerous requirements. There will not be a ‘one size fits all’ approach.
 
Penalties for non-compliance
Entities will have reporting obligations in relation to their compliance with economic substance requirements to local tax authorities. Penalties can be imposed both for a failure to provide required information and for operating a legal entity in breach of the economic substance requirements, including fines, imprisonment and/or strike-off.
 
Exchange of information
Breach of the economic substance requirements will trigger spontaneous exchange of information by the tax authorities of offshore jurisdictions with the tax authorities of the jurisdictions in which the parent company, ultimate parent and ultimate beneficiary owner of the relevant entity are located.
 
What to do?
Business groups and individuals that have entities in “no or nominal tax jurisdictions” within their existing investment or operating structures should review their existing holding or operating structures, evaluate the impact of the new economic substance requirements and explore options available.
 
Redomiciling the offshore companies to other low tax jurisdictions such as Hong Kong may be the best option. As Hong Kong taxation is based on territorial concept, companies earning income in overseas and is tax exempted may still enjoying tax exemption. In addition, Hong Kong has concluded Double Taxation Agreements (DTAs) with many trading partners (40 countries until March 2019), being a Hong Kong tax resident will be entitled to benefits under DTAs such as preferential tax rates on dividend, royalties etc. Also Hong Kong is world-renowned for its simple and low tax regime, making it one of the most business-friendly jurisdictions in the world. Under the two-tiered profits tax rates regime, the profits tax rate for the first $2 million of assessable profits is 8.25%, assessable profits above $2 million will be subject to the rate of 16.5%.
 
For more information, please contact Ms. Amie Cheung at amie.cheung@lccpa.com.hk