Nick Rogers April 11 2019 Cayman Islands economic substance requirements Ogier | Private Client & Offshore Services - Cayman Islands Nick Rogers Private Client & Offshore Services IntroductionOverviewRelevant entitiesRelevant activitiesEconomic substance testCIGAsDirected and managedKey datesPenalties for insufficient substanceIntroductionFrom 1 January 2019 new legislation came into effect in the Cayman Islands, requiring in-scope entities that carry on particular activities to have demonstrable economic substance in Cayman.The International Tax Cooperation (Economic Substance) Law 2018 was enacted after an extensive process of consultation with:the EU Code of Conduct Group;the Organisation for Economic Cooperation (OECD); andCayman stakeholders.The law is the latest in a series of steps by Cayman to meet its 2017 commitment as an inclusive framework member under the OECD's global Base Erosion and Profit Shifting (BEPS) initiative and corresponding EU requirements encompassing no or nominal tax jurisdictions. Other international financial centres such as the British Virgin Islands, Guernsey, Jersey, the Isle of Man and Bermuda have implemented similar legislation.This article summarises the main elements of the law.OverviewThe law defines which Cayman entities are in scope (relevant entities). Relevant entities must make an annual report as to whether they are carrying on one or more of a defined list of activities (relevant activities). If they are, they must satisfy an economic substance test in Cayman in respect of such relevant activities. Cayman's Tax Information Authority is responsible for determining whether a relevant entity satisfies the economic substance test.Relevant entitiesRelevant entities include most Cayman exempted companies, Cayman limited liability companies and registered foreign companies, except:investment funds or entities through which investment funds directly or indirectly invest or operate;entities which are tax resident outside the Cayman Islands;entities which are authorised to carry on business locally in the Cayman Islands as domestic companies; orCayman exempted limited partnerships and trusts.Relevant activitiesAll relevant entities must make an annual declaration as to whether they have conducted any relevant activities in the preceding financial period. Relevant activities are:fund management;banking;insurance;finance and leasing;distribution and service centre business;headquarters business;IP business;shipping; andholding company business.Economic substance testRelevant entities that carry on relevant activities must satisfy the economic substance test. To satisfy the economic substance test in relation to a relevant activity, a relevant entity must:conduct Cayman Islands core income generating activities (CIGAs);be directed and managed in an appropriate manner in Cayman; andhaving regard to the level of relevant income derived from the relevant activity carried out in Cayman:have an adequate amount of operating expenditure incurred in Cayman;have adequate physical presence (including maintaining a place of business or plant, property and equipment) in Cayman; andhave an adequate number of fulltime employees or other personnel with appropriate qualifications in Cayman.A relevant entity satisfies the economic substance test in relation to a relevant activity if its Cayman Islands' CIGAs in relation to that relevant activity are conducted by any other person and the relevant entity is able to monitor and control the carrying out of the Cayman Islands' CIGAs by that other person.Holding companies that only hold equity participations in other entities and only earn dividends and capital gains are subject to a reduced substance test. Conversely, relevant entities carrying on high-risk IP business are subject to a higher burden of proof in demonstrating that they maintain adequate economic substance in Cayman.The Tax Information Authority has published a form of guidance on satisfying the economic substance test, including as to the meaning of 'adequate' and 'appropriate'. Rather than providing a prescriptive formula, the guidance notes state that what is 'adequate' or 'appropriate' for each relevant entity will be dependent on the particular facts of the relevant entity and its business activity. A relevant entity must ensure that it maintains and retains appropriate records to demonstrate the adequacy and appropriateness of the resources used and expenditures incurred. It is expected that the guidance will be developed and supplemented with sector-specific commentary in due course.CIGAsThe law defines CIGAs as activities that are of central importance to a relevant entity in terms of generating income and that are being carried out in Cayman. For each relevant activity, the law provides particular included activities.For fund management business, CIGAs include:taking decisions on the holding and selling of investments;calculating risks and reserves;taking decisions on currency or interest fluctuations and hedging positions; andpreparing reports or returns to investors and the Cayman Islands Monetary Authority.For financing and leasing business, CIGAs include:negotiating or agreeing funding terms;identifying and acquiring assets to be leased;setting the terms and duration of financing or leasing; andmonitoring and revising financing or leasing agreements and managing risks associated with such financing or leasing agreements.Directed and managedTo be considered directed and managed in an appropriate manner in Cayman will require:that the relevant entity's board of directors, as a whole, have the appropriate knowledge and expertise to discharge its duties as a board;that meetings of the board be held in Cayman at adequate frequencies given the level of decision making required, and that there be a quorum of the board of directors present in Cayman at such meetings;that minutes of such board meetings record the strategic decisions made at these meetings; andretention of all board minutes and appropriate records in Cayman.Key datesThe law and accompanying regulations provide a timetable for compliance, notification and reporting.ComplianceRelevant entities in existence before 1 January 2019 must satisfy the economic substance test in relation to a relevant activity from 1 July 2019.Relevant entities formed on or after 1 January 2019 must satisfy the economic substance test in relation to a relevant activity from the date on which the relevant entity commences the relevant activity.NotificationStarting in 2020, all relevant entities must notify the Tax Information Authority as to whether they conducting a relevant activity and provide certain additional details, including the date of their financial year.ReportingWithin 12 months of the end of their financial year, relevant entities carrying on a relevant activity must submit a report to the Tax Information Authority setting forth prescribed details as to their compliance with the economic substance test.Penalties for insufficient substanceThe penalty for failing to satisfy the economic substance test for a relevant activity in a financial year is $12,200. The penalty for failing to satisfy the economic substance test for a relevant activity in the subsequent financial year is $122,000. Further, an application must be made to the Grand Court for an order requiring the relevant entity to take such action as is specified, or to be struck off.For further information on this topic please contact Nick Rogers at Ogier by telephone (+1 345 949 9876) or email ([email protected]). The Ogier website can be accessed at www.ogier.com.