As we gear up for the final quarter of 2024, this is an excellent time to review Cayman based entities with a financial year end of 31 December 2024 and consider the position of these entities with respect to the Cayman Economic Substance regime.
Economic Substance Regime
The International Tax Co-operation (Economic Substance) Act (as revised) and the Economic Substance for Geographically Mobile Activities Guidance (as revised) (together, the "Economic Substance Regime") apply to Cayman-based entities which are considered a 'Relevant Entity' carrying on a 'Relevant Activity' in the relevant period. The list of 'Relevant Activities' pursuant to the Economic Substance Regime includes banking, insurance, fund management, financing and leasing, headquarters, shipping, intellectual property, distribution and service centres and holding companies.
Economic Substance Requirements
Generally speaking, the Economic Substance Regime requires a Relevant Entity that carries on a Relevant Activity to satisfy the economic substance test ("ES Test"). Bearing in mind that all "entities" including those that do not conduct Relevant Activities will be required to submit an economic substance notification ("ESN") to the Cayman Tax Information Authority ("TIA") to confirm, amongst other things, whether or not they conduct one or more Relevant Activities and, if so, whether or not they are a Relevant Entity.
A Relevant Entity includes a company incorporated under the Companies Act, a limited liability company registered under the Limited Liability Companies Act, a limited liability partnership registered in accordance with the Limited Liability Partnership Act, a company incorporated outside of the Cayman Islands and registered under the Companies Act, a partnership defined in section 3 of the Partnership Act, an exempted limited partnership as defined in section 2 of the Exempted Limited Partnership Act, and a foreign limited partnership registered under section 42 of the Exempted Limited Partnership Act but excludes:
- a local partnership1;
- an entity that is an "investment fund2";
- an entity that is a "domestic company3"; and
- an entity that is "tax resident" outside the Cayman Islands.
Trusts are not currently considered to be Relevant Entities.
Any Relevant Entity carrying on a Relevant Activity must ensure that they comply with the ES Test by ensuring the entity is conducting the following:
- managed and directed in the Cayman Islands;
- core income generating activities are undertaken in the Cayman Islands with respect to the Relevant Activity;
- maintains adequate physical presence in the Cayman Islands;
- there are adequate full time employees in the Cayman Islands with suitable qualifications; and
- there is adequate operating expenditure incurred in the Cayman Islands in relation to each Relevant Activity.
Local entities and entities conducting holding company business which carry on a Relevant Activity only need to comply with minimum economic substance requirements.
Economic Substance Filings
Under the Economic Substance Regime, a Relevant Entity must file an annual ESN outlining whether the Relevant Entity is conducting a relevant activity for the purposes of the Economic Substance Regime. If the Relevant Entity declares in the ESN that it is conducting a Relevant Activity, the Relevant Entity will then have to file an economic substance return ("ESR"). In the ESR, entities will confirm details of the substance which is evidenced by the financial statements, and ultimately make a declaration as to whether they have complied with the Economic Substance Regime
If the Relevant Entity declares in the ESN that the entity is tax resident in another jurisdiction outside the Cayman Islands, the entity must file a tax resident outside the jurisdiction form ("TRO") along with evidence or confirmation of such tax residence. The ESR and the TRO requires the entity to submit information to the TIA in relation to the previous financial year evidencing the entity's compliance with the Economic Substance Regime.
On-going Monitoring and Enforcement
The TIA undertakes regular compliance checks in respect of entities which have not filed their ESR or TRO filings, and in recent instances has issued compliance notices and penalties to entities that are not in compliance with the Economic Substance Regime.
When reviewing an entity's economic substance filings, the TIA can request information and supporting documents from entities in instances where the entity has declared information in their filings filed, and may attend an entity's registered office to conduct an audit of its records to assess compliance. It is important, therefore, that entities maintain adequate records in order to substantiate their economic substance filings (or their determination that they are not in scope). It can be stated that the Economic Substance Regime will continue to grow and mature and this will bring with it the likelihood of further increased penalties from the TIA for failure to comply with the regime, especially in respect of entities which have repeatedly failed to comply.
Is Your Entity in Compliance?
The TIA has noted on numerous occasions that there continue to be a number of mis-filings which result in incorrect interpretation of or compliance with the Economic Substance Regime and that risk enforcement action being taken. Entities also preparing their Annual Return, which must be filed with the Cayman Registrar of Companies along with the payment of their Annual Government Fees by 31 January 2025, should be mindful of the information declared for the relevant financial year, as a cross–reference review may be undertaken with the Annual Return to the economic substance filing to monitor whether they align. As the end of the fiscal year approaches it is advisable for entities to carefully consider and assess their position under the Economic Substance Regime and whether any filings or remediations are required on the entity's economic substance filings to align with the entity's business activities.
Footnotes
1 "Local partnership" means a partnership that is not part of an MNE Group and that is only carrying on business in the Cayman Islands with persons resident in the Cayman Islands and that is licensed under the Trade and Business Licensing Act; operating under a government franchise; or complies with section 3(a) of the Trade and Business Licensing Act.
2 "Investment Fund" means an entity whose principal business is the issuing of investment interests to raise funds or pool investor funds with the aim of enabling a holder of such an investment interest to benefit from the profits or gains from the entity's acquisition, holding, management or disposal of investments and includes an entity through which an investment fund directly or indirectly invests or operates (but not an entity that is itself the ultimate investment held), but does not include a person licensed under the Banks and Trust Companies Act or the Insurance Act, or a person registered under the Building Societies Act or the Friendly Societies Act. "Investment Interests" means a share, trust unit, partnership interest or other right that carries an entitlement to participate in the profits or gains of the entity.
3 A "domestic company" is one that is not part of an MNE Group and that is only carrying on business in the Islands and which complies with section 4(1) of the Local Companies (Control) Act or section 3(a) of the Trade and Business Licensing Act; or a company referred to in section 80 (not-for-profit) of the Companies Act.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
