Cayman Islands Publishes Tax Bill On Economic Substance Requirements To Comply With BEPS Action 5

; posted on
December 11th, 2018

Cayman Islands Publishes Tax Bill On Economic Substance Requirements To Comply With BEPS Action 5

In response to global developments in financial services, the Cayman Islands Government published three bills, including the bill to implement substance requirement, to comply with international standards. The draft legislation which would apply on January 1, 2019, seeks to incorporate the OECD’s proposals under Action 5 of the base erosion and profit shifting (BEPS) project, on countering harmful tax practices, as well as the new EU substance requirements.

Scope of the Bill

The Economic Substance bill covers legal entities engaged in any of the following categories of business:

  • Banking
  • Insurance
  • Fund management
  • Headquarters
  • Distribution and service centers
  • Financing or leasing business
  • Shipping
  • Holding companies
  • Intellectual property

To the extent an entity is not a resident in another jurisdiction, carried on one or more of these business activities, such entity should satisfy the economic substance test to qualify as Cayman tax resident.

Economic Substance Test

Under the draft bill, economic substance means that the Cayman entity must undertake the substantial business activity, appropriate to the line of business that they are conducting, in the Cayman Islands.

The entity will pass the economic substance test if they carry on core income-generating activities in the island; incur an adequate amount of operating expenditure in Cayman; have a physical presence locally; have a sufficient number of full-time staff locally. Moreover, the company must be directed and managed from the Cayman Islands with regular board meetings held and minutes of strategic decisions kept on the island.

The proposed legislation also imposes more rigorous substance test for the high-risk intellectual property. These, include intellectual property businesses that do not undertake research and development, branding or distribution as part of their local core income-generating activities.

High-risk intellectual property businesses are presumed not to satisfy the substance test, even if they carry out core income-generating activities on the island unless they can demonstrate that they historically maintained control over the Development, Exploitation, Maintenance, Enhancement, and Protection (DEMPE) of the intangible property asset. This would have to be exercised by an adequate number of full-time employees with the necessary qualifications that permanently reside and perform their activities in Cayman.

Besides rigorous substance test, there is a ‘reduced’ economic test also laid out in the proposed bill. Equity holding companies are subject to this “reduced” economic substance test. Such entity would satisfy the substance test only if they have complied with all applicable filing requirements under the Companies Law and if they have adequate human resources and adequate premises in the islands for holding and managing equity participation in other entities.

The Cayman Islands government is expected to issue guidance notes for consultation in the near future.

Source: Cayman Islands Government (Press Release)

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