In response to the OECD’s Forum on Harmful Tax Practices, under Action 5 of the OECD’s Base Erosion and Profit Shifting (BEPS) Project, the Cayman Islands government has passed a new law requiring certain Cayman Islands entities to demonstrate ‘economic substance’ in relation to the activities carried on in the Cayman Islands.
On 1st January 2019, the International Tax Co-Operation (Economic Substance Law), 2018 (the “ES Law”) came into effect.
Please see below questions aimed at outlining some of the main features of the ES Law.
Does the ES Law apply to me?
If you are an exempted company, a limited liability company, a foreign company or a limited liability partnership incorporated or established in the Cayman Islands that is not:
- centrally managed and controlled in a jurisdiction outside the Islands; and
- tax resident outside the Islands. you are considered a relevant entity for the purposes of the ES Law.
What are my obligations?
All relevant entities must notify the Tax Information Authority (the “Authority”) annually as to:-
- whether or not they are carrying on a relevant activity;
- if the relevant entity is carrying on relevant activity, whether or not all of 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 Islands and if so, shall provide evidence to support that tax residence; and
- the date of its financial year. If the entity is carrying on a relevant activity, it is required to report certain particulars to the Authority within 12 months of its financial year end, in order for the Authority to assess whether it has satisfied the economic substance test (“ES Test”).
Such information will include amount and type of income, expenses and assets, number of employees, location of the place of business and whether or not all or any part of the relevant 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 as may be required by the Authority.
The Authority will advise shortly on the deadlines for compliance as well as the form and manner in which notification and reporting should be made.
What are relevant activities?
Relevant activities include:-
- 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; or
- shipping business, but does not include investment fund business (i.e. the business of operating as an investment fund).
What is the ES Test?
The ES Law requires a relevant entity that is carrying on relevant activities to satisfy the economic substance test in relation to each relevant activity.
A relevant entity satisfies the ES Test if it:
- conducts Cayman Islands core income generating activities in relation to that relevant activity (i.e. activities that are of central importance to a relevant entity in terms of generating income and that are being carried out in and from within the Islands);
- s directed and managed in an appropriate manner in and from within the Islands (i.e. frequent board meetings held in the Island with a quorum present in the Islands and minutes of meeting recording strategic decisions).
- has adequate employees, expenditure, physical assets (including a place of business) in the Islands relative to the income derived from the relevant activity. General guidance notes on satisfying the ES Test, including sector specific guidance are being developed and should be released shortly.
What if my only activity is that of a pure equity holding company?
There is a reduced ES Test for holding companies that only hold equity participation in other entities and only earn dividends and capital gains. These companies will satisfy the ES Test by confirming that:
- they have complied with all the applicable filing requirements under the Companies Law; and
- have adequate human resources and premises in the Islands for holding and managing their equity participation.
What if I fail to comply or satisfy the ES Test?
The Authority will impose a penalty of $10,000 or $100,000 if the relevant entity does not satisfy the ES Test in subsequent years after an initial notice has been issued.