The Cayman Islands enacted The International Tax Co-Operation (Economic Substance) Law on 1 January 2019 (the “Law”). The Law requires entities engaged in certain relevant activities to have demonstrable “economic substance” within the Cayman Islands, in accordance with the standards established by the OECD and the EU to combat base erosion and profit shifting (BEPS).
WHO DOES THE LAW APPLY TO?
Currently, the Law applies to Cayman entities that are defined as “relevant entities” conducting “relevant activities”. Relevant entities will include most Cayman Islands exempted companies, limited partnerships and Cayman LLCs except investment funds or entities through which investment funds directly or indirectly invest or operate. Relevant entities also include registered foreign companies, unless those registered foreign companies are tax resident outside the Cayman Islands.
Relevant entities are only in scope of the Law if they are carrying on “relevant activities”. Relevant activities cover a wide range of matters, including fund management, banking, insurance, finance and leasing, distribution and service center business, headquarters business, intellectual property business, shipping, and holding company business.
WHAT DOES THE LAW REQUIRE? – THE ECONOMIC SUBSTANCE TEST
A relevant entity conducting relevant activities will need to satisfy the three-criteria “economic substance” test. It must:
- conduct “Cayman Islands core income generating activities” in relation to that relevant activity. A “core income generating activity” is an activity that is of central importance to a relevant company in terms of generating income that is being carried out in or from within the Islands;
- be “directed and managed” in an appropriate manner in or from within the Islands in relation to that activity;
- having regard to the level of relevant income derived from the relevant activity carried out in Cayman –
- have an adequate amount of operating expenditure incurred in Cayman;
- have adequate physical presence (including maintaining a place of business or plant, property and equipment) in Cayman; and
- have an adequate number of full-time employees or other personnel with appropriate qualifications in Cayman.
Holding companies are required to meet a reduced test for economic substance, whilst any high-risk intellectual property holding structures will face more onerous requirements.
Outsourcing of “core income generating activities” within the jurisdiction is permitted and can count towards satisfying the substance requirements provided the entity can monitor and control the carrying out of that activity by any delegate.
The Guidance Notes provide more detailed information on satisfying the economic substance test, including the meaning of “adequate” and “appropriate”.
Relevant entities are required to file a notice with the Cayman Islands Tax Information Authority (TIA) confirming whether they are conducting relevant activities. Entities conducting relevant activities are required to file a basic TIA return with information regarding income, expenses, assets, management, employees, physical presence and other data. The TIA will examine the filings to determine whether entities have complied with the Law. Noncompliance with the Law may result in a penalty of $10,000 in year one and $100,000 in year two. Continued failure to meet substance requirements may result in a possible court-ordered dissolution of the Cayman Islands entity.