Over the last decade we have been following the rapidly evolving legislative, regulatory, compliance, and tax environment for our clients[1]. We have seen moves for increased transparency for tax matters and beneficial ownership information[2], as well as a search for “fairness” and a quest to counteract Base Erosion and Profit Shifting (through the OECD “BEPS” project) by companies operating internationally (COIs).
Whilst the legislation implemented is country specific, this is generally the direct result of a program of measures being driven by the G20, the G8, the OECD, the Financial Action Task Force (FATF), and the EU.
In 2019 we are seeing specific laws being introduced in some jurisdiction to put in place “Economic Substance” legislation. In other jurisdictions, such as Mauritius, the local tax and corporate regimes have been adapted to ensure that economic substance is taken into account in a manner coherent with the OECD and EC objectives.
The adoption of BEPs measures has seen a number of changes to the framework of international tax including:
- increased transparency on tax matters with a confidential platform for exchange of tax related information that is available to taxing authorities in over 100 participating jurisdictions,
- improved standards of corporate tax governance, particularly in tax haven and nil tax jurisdictions with the elimination of a number of preferential tax regimes around the world,
- updated OECD guidance on the transfer pricing of intangible assets,
- adoption of measures to eliminate cross border tax reduction outcomes from hybrid mismatches and to counteract potential abuse of tax treaties, and
- the introduction of interest restriction measures, controlled foreign company rules and enhanced reporting of new tax planning ideas through mandatory disclosure regimes.
BEPS Action 5 (Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance) is one of the four BEPS minimum standards applicable to all members of the Inclusive Framework on BEPS and any jurisdictions of relevance.
The OECD considers that low or zero effective tax rates on the relevant income is a necessary starting point for an examination of whether a preferential tax regime is harmful. When a preferential regime benefits income from geographically mobile activities and meets this factor, it is in scope for the Forum on Harmful Tax Practices (“FHTP”). However, the tax rate factor alone does not imply that a preferential regime is harmful; rather it is a gateway criterion that if met means that the FHTP will continue the review process to determine if one or more of the other key factors are implicated.…
Since the start of the BEPS project, the FHTP has reviewed a significant number of preferential regimes. In 2017, commitments were made in respect of more than 80 regimes to be made compliant with the BEPS Action 5 minimum standard.
Jurisdictions have in almost all cases delivered on these commitments. The results to date show that all IP regimes are, with one exception, now either abolished or amended to comply with the nexus approach. These changes mean that it is no longer possible to shift income from IP assets into a preferential regime without having undertaken the underlying research and development activity to create that IP. At the same time, almost all non-IP regimes now contain substantial activities requirements, in order to better ensure the alignment of taxation with the place of value creation.
But as part of the BEPS Project, the FHTP has also reviewed the work done to produce the OECD 1998 Report on Harmful Tax Competition: An Emerging Global Issue (“the 1998 Report” (OECD, 1998)) which set out the framework to identify harmful tax practices, with specific criteria for assessing harmful preferential regimes and for assessing “tax havens” (as they were then called). As a result of this review the FHTP considered that they had not taken a strict enough approach at the time and decided to elevate the “substantial activities factor”. As such, the substantial activities factor has been elevated from being an “other factor” to a “key factor.”
In the context of IP regimes (which include any regime that provides benefits to income from any type of IP asset), this factor mandates that jurisdictions must provide no more benefits than those permitted under the “nexus” approach. In the context of non-IP regimes, the FHTP requires substantial activities whereby:
- Jurisdictions must require core income generating activities to be performed and establish mechanisms to review compliance with this requirement, and
- The FHTP will monitor the jurisdiction’s effective implementation of the substantial activities requirement. In terms of the activities that jurisdictions must require, the FHTP agreed that jurisdictions must require taxpayers to have an adequate number of full-time employees with necessary qualifications and to incur an adequate amount of operating expenditures to undertake the core income-generating activities associated with the income that may benefit from a regime.
Under the threat of yet another black-list the EU required a number of jurisdictions (Anguilla, Bahamas, Bahrain, British Virgin Islands, Cayman Islands, Isle of Man, Jersey, Marshall Islands, Turks and Caicos Islands, United Arab Emirates and Vanuatu) to adopt, in a very short timeframe, economic substance requirements for businesses based there.
Without going into the detail of the specific legislation being introduced in each jurisdiction it should be noted that the British Crown Dependencies and British Overseas Territories have all adopted, or are in the process of adopting very similar legislation, with or without specific guidance on the practical requirements to meet economic substance tests depending on the nature of the business activity.
The legislation generally applies so that the economic substance requirements are applicable to legal entities carrying on the “relevant activities” below:
- banking business
- insurance business
- fund management business
- finance and leasing business
- headquarters business
- shipping business
- holding business (defined as “pure holding companies”)
- intellectual property business
- distribution and service centre business
Trusts are not in scope but corporate trustees are in scope depending on the circumstances.
If the entity does not have adequate substance in that territory it may be possible to confirm that the business is being undertaken elsewhere, which may be subject to different levels of proof being required. It is specifically worth noting that the place of effective management will be included in the BVI BOSS registry. The information concerning non-compliance may be exchanged with the jurisdiction where the “real” economic activity is being undertaken, leading to tax enquiries in that country.
If the substance requirements are not met, or if the company is not seen to be managed elsewhere then there may be sanctions and penalties imposed, with the company eventually being struck off.
The deadlines for application and implementation of the law will vary locally. For the BVI and Caymans the legislation is effective from 1 January, 2019 for newly incorporated entities.
The legislation in the BVI will generally apply to relevant entities existing before 1 January 2019 with effect from 30 June 2019. The period of assessment is over periods of time of not more than 12 months. Default reporting periods apply but an entity subject to the Act should consider whether it wishes to align its economic substance reporting period with its own financial year (or any other date). For relevant BVI entities formed in 2019, the first reporting period will start from the date of incorporation, formation or registration and, by default, run for 12 months. By default, the first reporting period for entities existing before 1 January 2019 is for 12 months from 30 June 2019.
What should you do now?
Do not panic. You should methodically review the situation and decide whether any action is required or not. We estimate that in more than 90% of private client cases no action may be necessary now. However you might also use this opportunity to review the suitability of the structure to ensure that it is robust taking into account the expected longer term aims of the OECD BEPS project and the EU aims of a common consolidated tax base, and minimum levels of corporate taxation, and the (unjustified in our view) push towards publicly available information on beneficial ownership of entities [3].
- First you should consider the relevant legislation in the place of registration of the business entity. Some legislation is still not finalized as we publish this article.
- Then you will need to review whether or not the entity is a relevant entity. This will also depend on the relevant period under consideration, and will probably require the production and analysis of accounts for the relevant period.
- Then you will need to consider the local substance requirements for that activity, and review whether or not the entity already meets those requirements.
- If the entity is not effectively managed in that jurisdiction where should it be considered to be managed? This will depend on many factors, such as the location of directors, physical offices, and where decisions are being taken in respect of the core activities. You will need to consider what proof can be obtained in respect of this alternative jurisdiction (eg tax assessments), and whether or not there are other tax effects in that jurisdiction resulting from this classification.
- Creating a new business in a different jurisdiction, and transferring the business there;
- Re-domiciling the existing company to another country;
- Making the existing company tax resident in another jurisdiction
You will find below links to the webpages of the Rosemont offices in jurisdictions where there is an attractive business environment; Malta, Hong Kong, Singapore, Mauritius, Monaco and Andorra where you will find an overview of what it would take to establish economic substance for your existing businesses in those countries.
Please contact your existing client relationship manager or the local office contact should you wish further information on this.
[1] See for example Rosemont’s news articles back in 2013 and 2014 https://rosemont.com.mt/en/article/news/tax-transparency-update-detailed-international-update-november-2013 and https://rosemont-int.com/en/article/news/base-erosion-and-profit-shifting-beps-deliverables-update and https://rosemont.com.mt/zh/article/-3/european-parliament-endorses-proposed-anti-avoidance-directive
[2] In May 2015 the Fourth Anti-Money Laundering Directive (directive no. 2015/849/EU, the “Directive”) was passed strengthening the EU Anti-Money Laundering (“AML”) legal framework. Under the Directive is that each EU Member State is obliged to implement a central register with the data collected by the legal entities subject to the AML legislation and related to the beneficial owner information of companies and other legal entities (including trusts).
The EU’s 5th Anti-Money Laundering Directive to be implemented by the end of 2020 introduces the requirement for Registers of Trusts, where member States will have to grant public access to information held on each Member State’s register of trusts, subject to a “legitimate interest” test, the conditions for which must be defined in law by each individual Member State.
The EU’s 5th Anti-Money Laundering Directive to be implemented by the end of 2020 introduces the requirement for Registers of Trusts, where member States will have to grant public access to information held on each Member State’s register of trusts, subject to a “legitimate interest” test, the conditions for which must be defined in law by each individual Member State.
- Member States must put in place mechanisms to ensure that information on beneficial ownership in the registers of companies and trusts is “adequate, accurate and current”; and
- Member States will have to ensure interconnection between each Member States’ registers of companies and trusts via an EU “Central Platform”.
[3] The positive effects of tax neutral, or low tax jurisdictions, on the world economy should not be forgotten. Low tax jurisdictions have contributed significantly to the increased fluidity of international trade, and the mobility of human and other resources. International stakeholders still seek to use legitimate tax neutral vehicles to structure transnational trade and investment. Increased regulatory burdens will raise the costs and time needed to complete transactions, without an obvious net benefit to the world as a whole.
The choice of appropriate jurisdiction for an activity will depend on many business, and non-business factors. One of these factors will be the requirement for privacy for the beneficial owners, who will now also need to take into account the EU push for mandatory, standardized, public EU wide registers on businesses, beneficial owners, and land owners. In addition the UK is “pushing” for the British Crown Dependencies and British Overseas Territories to adopt public beneficial ownership registers for legal entities by end 2023.
The choice of appropriate jurisdiction for an activity will depend on many business, and non-business factors. One of these factors will be the requirement for privacy for the beneficial owners, who will now also need to take into account the EU push for mandatory, standardized, public EU wide registers on businesses, beneficial owners, and land owners. In addition the UK is “pushing” for the British Crown Dependencies and British Overseas Territories to adopt public beneficial ownership registers for legal entities by end 2023.