Economic Substance Returns: Deadlines and Regulations

With the end of the year comes key regulatory reporting deadlines. For Cayman Islands-based entities that need to file a notification under the economic substance regime prior to making their annual return filling, getting an early start is recommended to allow for ample time to prepare paperwork and confirm compliance with advisors.

Economic substance regulations exist in key offshore jurisdictions, including in the Cayman Islands. The goal of such regulations is to ensure fair taxation at a global level, by requiring no and only nominal tax jurisdictions to assess whether an in-scope entity is carrying out core income-generating activities with sufficient substance in the jurisdiction to which tax residence is claimed.

Economic substance requirements in the Cayman Islands

In response to the base erosion and profit-shifting global standards required of member jurisdictions by the Organisation for Economic Cooperation and Development, in 2019 the Cayman Islands enacted what is now known as the International Tax Cooperation (Economic Substance) Act (As Revised) (the “Act”).

The Tax Information Authority is the “Authority” for the purposes of the Act. The Authority’s functions under the Act include administering the Act, determining whether a relevant entity satisfies the ES Test in respect of its relevant activities, monitoring compliance with the Act, and sharing information with other competent authorities. The Authority is a function of the Department for International Tax Cooperation (“DITC”) within the Cayman Islands Government’s Ministry of Financial Services and Home Affairs.

The Act stipulates notification and reporting requirements, among other obligations, for ‘relevant entities’ registered in the Cayman Islands conducting ‘relevant activities’.

A ‘relevant entity’ includes limited liability companies, registered foreign companies, general partnerships, limited partnerships, exempted limited partnerships, limited liability partnerships and foreign limited partnerships. A ‘relevant entity’ excludes investment funds, trust vehicles, domestic companies, local partnerships, and entities that are tax resident outside the Cayman Islands, however.

A ‘relevant activity’ includes the following types of business:

• Banking;
• Corporate headquarters;
• Distribution and service centres;
• Finance and leasing;
• Fund management;
• Holding company;
• Insurance;
• Intellectual property (“IP”); and
• Shipping.

‘Relevant entities’ conducting ‘relevant activities’ are required to satisfy the Act’s economic substance test (“ES Test”) with respect to any part of its relevant income that is not taxable by a jurisdiction outside of the Cayman Islands.

There are modified ES Tests for relevant entities carrying on certain relevant activities, namely, holding company business and intellectual property business. A relevant entity conducting holding company business has a reduced ES Test to meet. Comparatively, a relevant entity carrying on ‘high risk IP business’ (e.g., where an entity holds IP that it did not create, acquired from another entity outside of the Cayman Islands and licences such IP to related entities) must meet a more stringent ES Test.

Further, any entity carrying on high-risk IP business is subject to the rebuttable presumption that it has not met the ES Test for a financial year and therefore, must engage in extensive documentation with the Authority to disprove this assumption.

What constitutes CIGA varies from sector to sector. CIGA denotes activities that are central to a relevant entity in terms of generating relevant income and which, if carried on by a relevant entity in terms of generating relevant income, must be carried on in the Cayman Islands. For example, financing and leasing business, which covers the provision of credit facilities (e.g. financial leasing, intra-group and or third-party lending arrangements) for any kind of consideration to another person, would need to show sufficient evidence of conducting within the Cayman Islands activities such as:

• negotiating or agreeing funding terms;
• identifying and acquiring assets to be leased;
• setting the terms and duration of financing or leasing; and
• monitoring and revising financing or leasing agreements and managing risks associated with such financing or leasing agreements.

Official guidance from the Authority delves further into what CIGA will meet economic substance requirements for each type of relevant activity. For instance, guidance on negotiating or agreeing funding terms notes that CIGA for this activity includes: “negotiating or agreeing the type of funding (e.g., equity / preference shares, debt, convertible debt, bank borrowing etc.), the terms of the agreement, the quantum of funding, the rates of interest payable, the security given (if any), and any covenants”.

The directed and managed component of the ES Test is designed to ensure that a relevant entity’s board of directors has the appropriate knowledge and expertise to discharge its duties in relation to conducting the relevant activity and there is an adequate frequency of board meetings held and attended in the Cayman Islands.

Additionally, with regard to the level of relevant income derived from the relevant activity carried out in the Cayman Islands, the relevant entity is required to have an adequate amount of operating expenditure incurred, an adequate physical presence and an adequate number of full-time employees or other personnel with appropriate qualifications in the Cayman Islands.

The guidance defines ‘adequate’ in terms of the ES Test “as much as or as good as necessary for the relevant requirement or purpose”, and that what is adequate or appropriate for each relevant entity will depend on the particular facts of the relevant entity and its business activity. As such, the directors (or equivalent) of each relevant entity should consider whether the relevant entity can satisfy the ES Test, as applicable and make their determination in good faith. A relevant entity must ensure that it maintains and retains appropriate records to demonstrate the adequacy and appropriateness of the resources utilised and expenditures incurred.

What are the key reporting requirements and deadlines for economic substance in the Cayman Islands?

All Cayman Islands entities (including foreign entities registered in the Cayman Islands) are required to determine as to whether or not they are a “relevant entity” and whether or not they conduct a “relevant activity”. Having conducted the required initial analysis, all entities are required to make a simple notification confirming whether they are a “relevant entity” and whether they conduct a “relevant activity”, such notification to be made online, by the entity’s registered officer service provider, via the General Registry’s Corporate Administration Platform (“CAP”). The notification is required to be completed prior to the filing of the annual return with the relevant Registrar. Typically, this is in January of each year.

A relevant entity that is carrying on a relevant activity in the Cayman Islands is required to prepare and submit an annual economic substance return (“ES Return”), with applicable supporting documents, with the Authority for the purpose of the Authority’s determination of whether the entity has satisfied the requirements of the ES Test in relation to its relevant activity. The ES Return must be made within 12 months after the last day of the end of the relevant entity’s fiscal year (commonly 31 December) via DITC’s portal on the DITC website.

The Authority maintains the right to decide whether a relevant entity has fulfilled the ES Test for the year being reported under the Act. If it is determined that the entity has failed to demonstrate adequate economic substance during the year being reported, the Authority shall issue a penalty notice to the relevant entity, notifying the relevant entity of such determination, giving the reasons, details regarding any penalty, directing any action to be taken to satisfy the ES Test and advising of the relevant entity’s right to appeal. Failure of the ES Test can attract a first-time penalty of up to US$12,195. Continued failure by a given relevant entity to meet the requirements of the ES Test in a subsequent financial period will result in the imposition of a penalty of up to US$121,950, while ongoing failure ultimately may lead to the Authority filing an application to the Cayman Islands registrar to strike off the relevant entity.

How can the Maples Group assist with ES returns?

The Maples Group has leading expertise and experience advising on all aspects of the economic substance regime, the Act and the associated regulatory obligations and reporting deadlines.

As a secondary user, the Maples Group can file ES Returns on behalf of relevant entities that have notified the Authority that they are engaging in relevant activities necessitating economic substance reporting. The team supplies clients with a template to obtain the required information including key operating information, ownership, and financial data. Relevant entities with relevant activities outside of a holding company will also be required to provide information about CIGA, assets, physical presence, employees, outsourcing, expenditure, and management within the jurisdiction.

As certain declarations must be made at the time of filing, at least one person must be identified as being authorised to confirm certain information with regards to economic substance compliance and satisfaction of the ES Test on behalf of the relevant entity. All supplied information about the client’s entity will be included on the ES Return and filed via the DITC portal.

Beyond regulatory reporting such as ES Returns, Automatic Exchange of Information (“AEOI”), country-by-country reporting (“CbCR”), the Maples Group offers extensive services to support fund management and operations. The Group offers a full suite of fund administration solutions, including anti-money laundering, management company support for EU fund structures such as AFIM and UCITS, Depository Lite and EMIR obligations. Complementing our array of fund services are fiduciary and legal advisory teams, ensuring seamless service under one roof.