How To Prepare For Cayman Islands Economic Substance Returns

Getting an early start to annual Cayman Islands economic substance regime filing allows ample time to prepare paperwork and confirm compliance with advisors.

For Cayman Islands-based entities that need to file annual returns for Economic Substance compliance, getting an early start on year-end deadlines can allow for plenty of time to get the necessary paperwork in order and confirm compliance with key regulations.

Major offshore financial jurisdictions maintain economic substance regulations primarily to assess whether an entity conducts core income-generating activities of sufficient substance having regard to the level of income derived from the entity's relevant activities in their tax jurisdiction, in order to ensure fair taxation at a global level.

What are the rules to determine economic substance in the Cayman Islands?

In 2019 the Cayman Islands Tax Information Authority (the "Authority") enacted what is now known as the International Tax Cooperation (Economic Substance) Act (as revised) ("the Act") in response to the base erosion and profit-shifting ("BEPS") global standards imposed upon member jurisdictions by the Organisation for Economic Cooperation and Development ("OECD").

The Act outlines reporting requirements for certain entities established in the Cayman Islands—namely 'relevant entities' conducting 'relevant activities'. Such relevant entities 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.

Relevant entities engaged in any of the following relevant activities are required to satisfy the ES Test in respect of that relevant activity:

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

The ES Test has three main components, which are satisfied if the relevant entity:

• carries out core income-generating activities ("CIGA") in the Cayman Islands;
• is directed and managed in the Cayman Islands; and
• has adequate physical presence, staff and operating expenditure in the Cayman Islands in relation to that relevant activity.

What constitutes CIGA varies from sector to sector. CIGA means activities that are of central importance 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, fund management businesses would need to show sufficient evidence of conducting within the Cayman Islands activities such as:

• Risk and reserve calculation;
• Investor and regulator returns and reporting;
• Portfolio allocation decisions such as selling or holding investments; and
• Hedging positions on market factors such as interest rates or foreign exchange.

Official guidance from the Authority on fund management delves further into what activity will meet economic substance requirements. For instance, guidance on returns and reporting is as follows: "A fund manager can satisfy this head of CIGA by ensuring that there are systems and processes in place so that the fund manager is able to provide its client investment fund with accurate information on the investment fund's financial position on a timely basis."

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

Additionally, having regard to the level of relevant income derived from the relevant activity carried out in the 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 islands.

The guidance defines 'adequate' in terms of the ES test as "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 be dependent on the particular facts of the relevant entity and its business activity. As such, the directors (or equivalent) of each relevant entity should address their minds to these questions 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 deadlines for Cayman Islands economic substance reporting?

A relevant entity that is carrying on a relevant activity in the Cayman Islands and is required to satisfy the ES Test as defined under the Act must prepare and submit an annual Economic Substance Return with supporting documents for the purpose of the Authority's determination whether the ES Test has been satisfied in relation to that 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 the Department for International Tax Cooperation ("DITC") portal on the DITC website.

In situations where a relevant entity is obligated to meet the ES Test and does not meet annual reporting requirements, a penalty of as much as US$6,098 may be imposed, with an added fine of as much as US$610 per additional day of non-compliance.

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 economic substance during the year being reported, a notice will be issued to the relevant entity with the reasons for the determination and imposing an initial penalty of US$12,195.

Continued failure by a given relevant entity to meet ES test the following year will result in the imposition of a penalty of $121,950, and ongoing failure ultimately may lead to the Authority filing an application to a Cayman Islands registrar to strike off the relevant entity.

How does the Maples Group assist with Economic Substance returns?

The Regulatory Services team at the Maples Group has deep experience and expertise in regulatory deadlines and reporting, including filing of annual Economic Substance Returns. As a secondary user, the Maples Group can file 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. 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.

All supplied information about the client's entity will be included on the Economic Substance return and filed via the DITC portal. The return also requires certain declarations to be made at the time filing to confirm certain information with regards to Economic Substance compliance and satisfaction of the ES Test on behalf of the relevant entity.

Beyond regulatory reporting such as AEOI and 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 ("ManCo") 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 teams, ensuring seamless service under one roof.