The new Economic Substance requirements for the Cayman Islands went into effect on January 1, 2019.
The International Tax Co-operation (Economic Substance) Law 45 of 2018 (the Law) falls under the OECD’s Base Erosion and Profit Shifting (BEPS) Inclusive Framework and requires entities formed on the first of January in 2019 or later, and pre-existing entities (in existence prior to January 1, 2019) that carry on particular activities, to have demonstrable economic substance in the Cayman Islands. That is to say, relevant entities must demonstrate they have sufficient economic activity in the country to justify the profits they’re making.
The Law arises after the Cayman Islands committed to reform their tax structures in order to comply with the European Union Code of Conduct Group of Business Taxation criteria.
What entities does the law affect?
The Law covers relevant entities engaged in any of the relevant activities (listed below). The relevant entities are the following:
- a company, other than a domestic company, that is:
- incorporated under the Companies Law (2018 Revision); or
- a limited liability company registered under the Limited Liability Companies Law (2018 Revision);
- a limited liability partnership that is registered in accordance with the Limited Liability Partnership Law, 2017;
- a company that is incorporated outside of the Islands and registered under the Companies Law (2018 Revision); but does not include:
- an investment fund; or
- an entity that is tax resident outside the Islands.
The relevant activities
There are nine types of relevant activities:
- banking business
- distribution and service center business
- financing and leasing business
- fund management business
- headquarters business
- holding company business
- insurance business
- intellectual property business
- shipping business
The Law does not classify investment fund business as a relevant activity.
Starting in 2020, relevant entities must notify the Tax Information Authority (the Authority) annually of the following:
- whether or not it is carrying on a relevant activity;
- if the relevant entity is carrying on a relevant activity—whether or not all or any part of the relevant entity’s gross income in relation to the relevant activity is subject to tax in a jurisdiction outside of the islands—and, if so, shall provide appropriate evidence to support that tax residence as may be required by the authority; and
- the date of the end of its financial year.
However, relevant entities in existence prior to January 1, 2019, must first satisfy the Economic Substance Test (the Test) in relation to relevant activities performed from July 1, 2019. Relevant entities formed on or after January 1, 2019, must satisfy the economic substance test in relation to relevant activities performed from the date on which the relevant activity commenced.
The Test requires that a relevant entity
- conducts Cayman Islands core income generating activities (“Cayman Islands CIGA”) in relation to that relevant activity;
- is directed and managed in an appropriate manner in the Islands in relation to that relevant activity; and
- having regard to the level of relevant income derived from the relevant activity carried out in the Islands -
- has an adequate amount of operating expenditure incurred in the Islands;
- has an adequate physical presence (including maintaining a place of business or plant, property and equipment) in the Islands; and
- has an adequate number of full-time employees or other personnel with appropriate qualifications in the Islands.
The relevant entities must submit a report to the Authority within 12 months of the end of their financial year offering the prescribed details about their compliance with the economic substance test.
The Authority will impose a penalty of $10,000 on relevant entities that fail to satisfy the Test and/or $100,000 if the Test is not satisfied in the following financial year (after receiving an initial notice of failure).
Relevant entities must carry out an internal review to define what measures, if any, are necessary to comply with the Law.
To help companies comply with the requirements, the Cayman Islands published the Economic Substance For Geographically Mobile Activities Guidance.
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