The Income Tax (Substance Requirements) Order 2021 was approved by Tynwald on 16 June 2021. This Order extends the scope of the economic substance rules in Part 6A of the Income Tax Act 1970 to cover partnerships, including limited partnerships both with and without legal personality, and limited liability companies (LLCs). The expanded rules will apply to accounting periods commencing on or after 1 July 2021.
The Order also introduces requirements in respect of annual tax returns made by partnerships, including the introduction of civil penalties for late filings, and a registration requirement for certain foreign or general partnerships that carry out business activity in the Isle of Man.
WHAT ENTITIES ARE IN SCOPE?
In addition to tax resident companies, the expanded rules will apply to:
- general partnerships formed on the Isle of Man that carry out business activity in the Isle of Man;
- limited partnerships registered in accordance with Part II of the Partnership Act 1909;
- partnerships formed outside the Isle of Man that carry out business activity in the Isle of Man; and
- LLCs formed under the Limited Liability Companies Act 1996,
in each case if they are resident in the Isle of Man and the derive revenue from any relevant sector.
All such entities are referred to in the expanded rules as "relevant partnerships".
HOW IS RESIDENCE DETERMINED?
The residence of a partnership for the purposes of the expanded rules will be determined by its place of effective management.
We expect a partnership's place of effective management to be treated as the place where key management and commercial decisions that are necessary for the conduct of its business as a whole are in substance made, and we would expect a partnership to have one place of effective management at any one time, even if management decisions are made in more than one place. We anticipate that the Assessor of Income Tax will revise the existing economic substance guidance, or issue revised guidance, in due course to provide further detail about a partnership's place of effective management.
In a manner broadly similar to the existing rules governing the residence of an Isle of Man-incorporated company, a limited partnership or an LLC will be resident in the Isle of Man unless its place of effective management is outside the Isle of Man in a country or territory where (a) it is required to satisfy a test that is substantially the same as the economic substance test or (b) the highest rate that may be charged to tax on any part of its profits is 15% or higher.
WHAT ARE RELEVANT SECTORS?
Only those "relevant partnerships" that are resident in the Isle of Man and that derive revenue from a relevant sector will be in scope of the expanded economic substance rules. The relevant sectors for this purpose are the same as those that have applied to resident companies since the economic substance rules were introduced.
ARE ANY PARTNERSHIPS OUT OF SCOPE?
The following entities are not required to comply with the expanded rules:
- collective investment schemes within the meaning of the Collective Investment Schemes Act 2008, other than "self-managed schemes";
- relevant partnerships all of the partners of which are individuals who are subject to personal income tax in the Isle of Man; and
- relevant partnerships that are not part of a multinational group and that carry out all of their activities on the Isle of Man. A multinational group for this purpose means any group that includes (i) two or more enterprises, the tax residence for which is in different jurisdictions, or (b) an enterprise that is resident for tax purposes in one jurisdiction and is subject to tax with respect to the business carried out through a permanent establishment in another jurisdiction.
THE ECONOMIC SUBSTANCE TEST
An in-scope relevant partnership must satisfy the economic substance test. In summary, this means it must (a) have its place of effective management on the Isle of Man (discussed further below), (b) have an adequate number of qualified employees or individual partners in the Isle of Man, (c) have adequate operating expenditure proportionate to the level of activity carried on in the Isle of Man, (d) have an adequate physical presence in the Isle of Man and (e) conduct its "core income-generating activity" in the Isle of Man.
A relevant partnership will have its place of effective management on the Isle of Man if (a) its governing body meets in the Isle of Man at an adequate frequency given the level of decision-making required, and during those meetings a majority of the relevant persons are physically present in the Isle of Man, (b) strategic decisions of the relevant partnership are set at meetings of its governing body and minutes of the meetings reflect those decisions, (c) the members of the governing body, as a whole, have the necessary knowledge and expertise to discharge their duties and (d) the minutes of all meetings of the governing body, and the records relating to the relevant partnership, are kept in the Isle of Man.
A relevant partnership's governing body is the person or body of persons responsible for the general supervision of the relevant partnership's affairs. The expanded rules set out further detail on what this means for different types of relevant partnership.
WHAT ARE THE PENALTIES FOR NON-COMPLIANCE?
There are financial and other penalties for a relevant partnership that fails to meet the economic substance test. They are broadly similar to those that have applied to resident companies since the economic substance rules were introduced.
If a relevant partnership fails to meet the test in a single financial period, the fine is up to GBP 10,000. If the relevant partnership fails to meet the test in consecutive financial periods, the fine increases to up to GBP 50,000 in the second consecutive period, up to GBP 100,000 in the third consecutive period and up to GBP 150,000 for each additional period. Higher financial penalties apply to high-risk IP entities. Other sanctions include requiring the relevant partnership to be struck off the register, where possible, and exchange of information with overseas tax authorities.
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.