Brighter Law

What Are the Economic Substance Requirements?

In this article, we outline the Economic Substance requirements and what they mean for certain offshore jurisdictions.


What is Economic Substance?

The European Union (“EU”) Code of Conduct Group for Business Taxation, the Companies and Limited Partnerships (Economic Substance) Ordinance 2018 and accompanying Regulations (the “Substance Legislation”) came into force on 1 January 2019 in British Overseas Territories.

This occurred following concerns raised regarding the absence of a legal substance requirement for doing business in and through certain jurisdictions. The Economic Substance legislation is designed to substantiate the use of these jurisdictions by ensuring that companies (and certain other entities) incorporated in international financial centres have sufficient ‘substance’, either in the jurisdiction in which they are incorporated or another jurisdiction where they are tax resident.


Who does this apply to?

The Economic Substance legislation exists across financial centres in the British Overseas Territories and Crown Dependencies. The economic substance requirements apply to resident entities carrying out “relevant activities” in these jurisdictions.

There are nine “relevant activities” captured by the Substance Legislation:

(i) banking business
(ii) distribution and service centre business
(iii) finance and leasing business
(iv) fund management business
(v) headquarters business
(vi) holding entity business
(vii) insurance business
(viii) intellectual property holding business
(ix) shipping business

Each jurisdiction within these territories has defined the type of entities to which economic substance requirements apply, but by way of an example, in the Turks and Caicos Islands (TCI), a resident TCI entity is defined as:

a) a TCI company incorporated under the Companies Ordinance
b) a TCI limited partnership registered under the Limited Partnership Ordinance; or
c) a foreign company registered in the TCI under the Companies Ordinance.


What are the Economic Substance requirements?

A resident entity carrying out a “relevant activity” must be directed and managed in the jurisdiction, conduct its core income-generating activities there, and have an occupied physical office or premises there. It must also meet standards of adequacy.

A resident entity must demonstrate, proportionate to the level of the relevant activity carried out, that they have:

a) an adequate number of appropriately experienced and, if appropriate, qualified full-time employees in the territory, including those employed by third parties.
b) an adequate level of operating expenditure incurred in the territory.
c) adequate physical assets or presence in the territory.

“Adequate” is defined as being contingent on the nature, scale and complexity of the business that the relevant entity is carrying on. An entity must maintain and retain records to demonstrate the adequacy and appropriateness of the resources utilized and expenditure involved in order to determine “adequacy”.

Once an entity has met all these criteria and had substance established, it must file an economic substance report to the relevant authority or Exchange of Information Unit (EOIU) outlining prescribed information relating to the entity. Each entity must certify if it has passed the economic substance test.

All entities must also submit information to the EOIU on an annual basis to enable the EOIU to determine whether the entity is carrying on relevant activities and, if so, whether it has met the requirements.


What are the penalties for non-compliance?

Penalties and sanctions may be imposed upon resident entities who fail to meet the economic substance requirements. Penalties will vary across different jurisdictions, but these penalties may include financial penalties, spontaneous exchange of relevant information with the relevant EU Member States and (eventually) removal from the Register of Companies, and/or liquidation or dissolution.


DISCLAIMER: The contents of this article are made available for information purposes only. Nothing within this article should be relied upon as constituting legal or other professional advice. Neither G&P Group nor any of its companies, subsidiaries or affiliates accept any responsibility whatsoever for any loss occasioned to any person no matter howsoever caused or arising as a result, or in consequence, of action taken or refrained from in reliance on any of the contents of this article.

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