In 2017, the Crown Dependencies gave commitments to the EU to introduce rules on Economic Substance.
The legislation, which came into effect on 01 January 2019, is designed to protect the reputation of offshore jurisdictions by ensuring that income streams from certain activities are based on actual local activity to substantiate the use of low-tax jurisdictions.
Does substance apply to my company?
Substance legislation doesn't apply to all entities; it applies to certain 'relevant entities' carrying out income-generating activities within certain 'relevant sectors'.
The "relevant sectors" are:
– Banking
– Insurance
– Fund management – not including collective investment vehicles
– Finance and leasing
– Pure equity holding companies – must hold a controlling interest in underlying investment
– Shipping – commercial shipping business; it excludes pleasure crafts
– Headquartering – where strategy/coordination type services are provided to other group entities
– IP companies and high-risk IP companies
– Distribution and service centre business – where goods are purchased from a group company and re-sold for a percentage of profit, or where management services are provided to group companies.
Upon an entity being determined a relevant entity and carrying out a relevant activity, it must satisfy the adequate substance test.
What is adequate substance?
A relevant sector entity will need to consider whether it has 'adequate substance' in its tax jurisdiction. A relevant sector entity (except for a pure equity holding company) will be considered to have adequate substance in the Isle of Man if it:
- is directed and managed in the Island;
- has an adequate number of (qualified) employees proportionate to the level of activity carried on in the Island;
- has adequate expenditure proportionate to the level of activity carried on in the Island;
- has an adequate physical presence in the Island; and
- conducts core income-generating activity ('CIGA') in the Island
Demonstrating effective management and control
A relevant sector entity will be considered to be directed and managed effectively in the Isle of Man where:
- its board of directors, as a whole, has the appropriate knowledge and expertise to discharge its duties as a board of directors;
- board meetings are held in the Isle of Man and at frequencies considered adequate to the level of decision making required;
- there is a quorum of directors present in the Isle of Man for said meetings;
- the minutes of said meetings record the strategic decision-making of the relevant sector entity at the meeting; and
- the minutes of all meetings and appropriate records of the relevant sector entity are kept in the Isle of Man.
Guidance suggests that there be at least one meeting of the board of directors per year, even for companies with a minimal level of activity.
Filings and penalties
Once substance is established, the entity must file an economic substance report each year, which, in the case of the Isle of Man, forms part of the annual tax return.
Penalties for failure to comply with the new substance regulations vary from one jurisdiction to another – but range from increasing fines, removal from the register through to imprisonment.
The Isle of Man legislation includes specific powers to request additional information in relation to any substance information provided on or with the income tax return. This also includes specific sanctions to address circumstances where companies have acted so as to avoid or seek to avoid the application of the economic substance requirements.
If an entity in a relevant sector does not meet the economic substance requirement in an accounting period, it will be subject to sanctions which include exchange of information, increasing financial penalties ranging between £10,000 to £100,000, removal from the register through to imprisonment.
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.
