Economic Substance Compliance – Offshore Jurisdictions
In addressing the concerns of the EU Code of Conduct Group for Business Taxation and OECD guidance around the economic substance of entities in low or no tax jurisdictions, these jurisdictions (which include Bermuda, Cayman Islands, British Virgin Islands, Jersey, Guernsey and the Isle of Man) have recently introduced legislation requiring “in-scope” entities to demonstrate adequate local economic substance.
Hong Kong is a regional hub for local and foreign investors to structure their inbound or outbound investments, often making use of vehicles incorporated in these offshore jurisdictions. This article considers the relevant new regulations and whether and to what extent our local or foreign investors are affected. The discussions below reflect the general situations for these offshore jurisdictions. There may be minor variations on implementation details amongst the jurisdictions.
In-scope entities and relevant activities
In general, the offshore jurisdiction (“home country”) has introduced legislation that applies to all home country entities carrying on relevant activities unless they are resident for tax purposes in another jurisdiction.
Relevant activities include:
• Banking business
• Insurance business
• Shipping business
• Fund management business
• Financing & leasing business
• Headquarters business
• Distribution & service centre business
• Holding business
• Intellectual property business
The home country legislation may further define some of the activities as being subject to home country licensing (e.g. fund management by licensed persons in the home country). Certain activities may not therefore be in-scope where home country licensing is not required but may nonetheless be subject to annual reporting to confirm / declare their tax residence.
Each home country entity not tax resident in another jurisdiction and carries on the relevant activities in the home country must comply with the economic substance requirements.
An in-scope entity (other than a pure holding company) is required to be in compliance with the economic substance requirements if:
• The relevant activity is directed and managed in the home country;
• There are an adequate number of suitably qualified employees physically present in the home country;
• There is adequate expenditure incurred in the home country;
• There are physical offices or premises as appropriate for the home country core income-producing activities;
• For intellectual property business requiring the use of specific equipment, the equipment is located in the home country.
An in-scoped pure holding company (defined as an entity which primary function is to hold equity interest in other companies and does not carry on any commercial activity) is considered to have adequate substance if it:
• Complies with the statutory obligations under the companies’ law of the home country;
• Has adequate employees and premises for holding and, where relevant, managing those equity investments.
Existing in-scope entities will need to comply with economic substance requirements by 30 June 2019 and meet the reporting obligation within one year of 30 June 2019.
New companies that are incorporated on or after 1 January 2019 should comply with the economic substance requirements immediately. They will have one year from the date of incorporation to meet reporting obligations.
All home country entities are required to provide information to the home country tax authority on annual basis with details of:
• Any relevant activities carried on during the reporting period and how they satisfy the economic substance tests; or
• If they are not tax resident in the home country, information of the jurisdiction where they are tax resident.