On 27 December 2018, the Cayman Islands published The International Tax Co-operation (Economic Substance) Law, 20181 and The International Tax Co-operation (Economic Substance) (Prescribed Dates) Regulations, 2018 (together, the "Initial Law").
The Initial Law was amended first on 22 February 20192 by The International Tax Co-operation (Economic Substance) (Amendment of Schedule) Regulations, 2019 (the "Amendment Regulations") and then again on 30 April 2019 by The International Tax Co-operation (Economic Substance) (Amendment of Schedule) (No. 2) Regulations, 20193 (the "2nd Amendment Regulations" and, together with the Amendment Regulations, the "Regulations", and the Regulations together with the Initial Law, the "Economic Substance Law"). The Economic Substance Law is supplemented by the issuance of related Guidance on Economic Substance for Geographically Mobile Activities4 (the "Guidance"), version 2.0 of which was issued on 30 April 2019.
The Economic Substance Law is responsive to global OECD Base Erosion and Profit Shifting ("BEPS") standards regarding geographically mobile activities. Requirements of this type are rapidly being implemented on a level playing field basis by all OECD-compliant 'no or only nominal tax' jurisdictions.
Global standards in this field continue to develop. Accordingly, it is to be expected that the Economic Substance Law itself and the body of related Guidance will continue to evolve, with further amendments and updates to the Guidance likely in due course in order to address certain important practical aspects of the economic substance requirements.
Those who establish Cayman Islands structures do not generally do so to engage in BEPS activity; they do so because the Cayman Islands is an efficient, stable and trusted neutral hub with key expertise in handling complex transactions.
Accordingly, the Cayman Islands financial services industry and its clients should be able to take these requirements in their stride given the nature of the transactions structured in the Cayman Islands and the global standards that are already applicable in the Cayman Islands.
The Economic Substance Law introduces certain reporting and economic substance requirements for 'relevant entities' conducting 'relevant activities'5.
All 'relevant entities' will initially have to make a simple notification to confirm, amongst other things; whether or not they conduct a 'relevant activity' (this straightforward notification is expected to be made online, via a dedicated portal, the first notification being made around September 2020).
'Relevant entities' conducting 'relevant activities' will then be required to report certain information on their relevant activities on an annual basis to the Cayman Islands Tax Information Authority, the first such annual report being due no later than 12 months after the last day of the relevant entity's financial year commencing on or after 1 January 2019. The report, when submitted, would provide certain information as at the end of the relevant financial year.
For example, if a 'relevant entity' conducting ' relevant activities is subject to the economic substance tests and it has a financial year of 1 January 2019 to 31 December 2019, the first annual report would:
(a) be due on or before 31 December 2020; and
(b) would speak to the relevant entity's economic substance as of 31 December 2019.
For a relevant entity formed on or after 1 January 2019 that will conduct a 'relevant activity', the economic substance requirements apply from the date that the relevant entity commences the relevant activity.
For relevant entities conducting relevant activities that were in existence before 1 January 2019, the economic substance requirements will apply from 1 July 2019.
In addition, all entities having separate legal personality and registered in the Cayman Islands (including where registered as a foreign entity) will need to make a basic notification regarding certain aspects of the Economic Substance Law in connection with their annual return for 2020.
What is a Relevant Entity?
The definition of 'relevant entity' is set out in the Amendment Regulations. It expressly recognises that the following are not within the classification of a 'relevant entity':
(a) an entity that is an 'investment fund';
(b) an entity that is a 'domestic company'; and
(c) an entity that is 'tax resident' outside of the Cayman Islands.
The terms 'investment fund' and 'domestic company' are defined in the Schedule to the Economic Substance Law (as amended by the Regulations). The Guidance provides some practical guidance as to the meaning of 'tax resident'.
Entities without separate legal personality (such as certain forms of partnership or trust) are not within the classification of a relevant entity.
An initial step will be to determine whether an entity may fall within the classification of a 'relevant entity' (and, if so, to then determine if it is conducting or if it intends to conduct a 'relevant activity'). Your usual Maples Group contact will be able to assist you in making these determinations.
What is a Relevant Activity?
The Economic Substance Law applies economic substance requirements to the following categories of geographically mobile relevant activities previously identified by the OECD (and adopted by the EU):
- Fund management;
- Financing and leasing;
- Distribution and service centres;
- Holding company; and
- Intellectual property.
Where a 'relevant entity' conducts a 'relevant activity', the economic substance test will apply.
Where a 'relevant entity' conducts more than one 'relevant activity', the economic substance test will need to be satisfied in respect of each relevant activity conducted.
For details on what it means to be subject to the economic substance requirements of the Economic Substance Law, as well as for information on the potential consequences of breaching these requirements, please contact your usual Maples Group team member.
Implementing a Global Standard
The Economic Substance Law has had significant OECD, EU and industry input and reflects both:
- the Cayman Islands' ongoing adherence to global standards as one of the 129 member countries committed to the OECD's BEPS Inclusive Framework6; and
- commitments made by the Cayman Islands to the EU as part of the EU's listing process7.
How will entities be affected?
However, an initial step will be to determine whether an entity may fall within the classification of a 'relevant entity' and, if so, to determine if it is conducting or if it intends to conduct a 'relevant activity'.
If you have any specific questions in relation to particular entities, industries and / or structures, please speak to your usual Maples Group contact who will be able to guide you as this area of the Cayman Islands law continues to evolve; inevitably much will depend upon the specific entity, industry, structure and transaction(s) involved.
1A copy of the law can be found at: http://www.gov.ky/portal/pls/portal/docs/1/12738510.PDF. The law came into force on 1 January 2019.
2A copy of the Amendment Regulations can be found at: http://www.gov.ky/portal/pls/portal/docs/1/12756530.PDF
3A copy of the 2nd Amendment Regulations can be found at: http://www.tia.gov.ky/pdf/International_Tax_Co-Operation_(Economic_Substance)_(Amendment_of_Schedule)_Regulations_2019.pdf
4A copy of the most recent version of the Guidance can found at: http://www.tia.gov.ky/pdf/Economic_Substance_-_Guidance_-_v2.0.pdf
5See the Amendment Regulations for the definition of 'relevant entity' and see the Schedule to the Initial Law for the definition of 'relevant activities'.
6A full list of the 129 countries that are currently members of the BEPS Inclusive Framework can be found at: https://www.oecd.org/ctp/beps/inclusive-framework-on-beps-composition.pdf
7The EU listing process has seen, as of 31 May, a total of 142 commitments taken at a high political level by 67 jurisdictions across the relevant EU criteria.