All three of the British Crown Dependencies – Guernsey, the Isle of Man and Jersey – have tabled legislation that will introduce new substance requirements for tax-resident firms engaged in certain industries. It will be effective for accounting periods commencing on or after 1 January 2019.
In 2016 the European Union’s Code of Conduct Group was instructed by the European Council to undertake a screening process by which jurisdictions, including the Crown Dependencies, were assessed against three standards in respect of tax transparency, fair taxation and compliance with the OECD’s Base Erosion and Profit Shifting (BEPS) project.
No issues were raised in respect of the Crown Dependencies’ standards of tax transparency and BEPS compliance. However, during the screening process the Code of Conduct Group expressed concern that the Crown Dependencies did not have a “legal substance requirement for entities doing business in or through the jurisdiction”. This it said increased “the risk that profits registered in a jurisdiction are not commensurate with economic activities and substantial economic presence”.
These concerns were articulated in a letter to each of the Crown Dependencies in November 2017. In response, each of the Crown Dependencies made a commitment to address these concerns by the end of December 2018.
The proposed legislation has been designed to address concerns that companies could be used to artificially attract profits that are not commensurate with economic activities and substantial economic presence in the Crown Dependencies. With this in mind the proposed legislation requires certain companies to demonstrate they have local substance by:
- Being directed and managed in the jurisdiction
- Conducting Core Income Generating Activities (CIGA) in the jurisdiction
- Having adequate people, premises and expenditure in the jurisdiction.
The directed and managed test is designed to ensure that there are an adequate number of board meetings held and attended in the jurisdiction, which will be dependent on the relevant activities of the company. It is generally expected that the majority of board meetings will be held in the jurisdiction and that, even for companies with a minimal level of activity, there will be at least one meeting.
The test also looks to ensure that the associated minutes and records are kept in the jurisdiction and that the board is a decision-taking body with the necessary knowledge and experience. In the case where there are corporate directors, the requirements will apply to the individual officers of the corporate director who are actually performing the duties.
The proposed legislation provides a list of the core activities that a company operating in each sector could carry on although it is not necessary for the company to perform all of the CIGA listed in order to demonstrate substance. Some companies may undertake or outsource all or part of an activity outside the jurisdiction. However, the income subject to tax in the jurisdiction must be commensurate to the CIGA undertaken in the jurisdiction.
If some or all of the CIGA is outsourced, the company must be able to demonstrate that it has adequate supervision of the outsourced activities and, to meet the substance requirements, that those activities are undertaken in the jurisdiction. The company remains responsible for ensuring accurate information is reported on its return and this will include precise details of the resources employed by its service providers, for example based on the use of timesheets.
The proposed legislation refers to the term “adequate” but this is not defined. What is adequate for each company will be dependent on the particular facts of the company and its business activity. A company will have to ensure it maintains and retains appropriate records to demonstrate the adequacy of the resources utilised and expenditure incurred.
These substance requirements apply to the following categories of geographically mobile financial and other service activities, identified by the OECD’s Forum on Harmful Tax Practices – banking, insurance, shipping, fund management (excluding companies that are collective investment vehicles), financing and leasing, headquarters, distribution and service centres, holding company and intellectual property (IP).
All tax resident companies will be required to provide more information in their tax returns to ensure these activities can be identified. Tax returns will also be redesigned to collect the information needed to monitor compliance with the substance requirements.
Where a company receives income from IP, it will have to consider if it is a “high risk IP company”. It is presumed in the legislation that a high risk IP company has failed the substance requirement and the competent authority will therefore exchange all of the information provided by the company with the relevant EU Member State competent authority where the immediate parent company, ultimate parent company and/or ultimate beneficial owner is resident.
To rebut this presumption, a high risk IP company will have to produce materials that explain how the development, enhancement, maintenance, protection and exploitation (DEMPE) functions have been under its control, and that this has involved people who are highly skilled and perform their core activities in the jurisdiction.
The proposed legislation includes sanctions for failure to meet the substance requirements. These are progressive and include financial penalties and, ultimately, the company being struck off the Companies Register.
The draft legislation comprises the Guernsey Income Tax (Substance Requirements) (Implementation) Regulations 2018, the Isle of Man Taxation Companies Economic Substance Law and the Jersey Taxation (Companies – Economic Substance) (Jersey) Law.
The tax administrations from the Crown Dependencies will issue comprehensive guidance notes in due course. The guidance notes cannot, however, cover every scenario and will not replace the need to take independent professional advice. Sovereign will be able to provide such advice through our offices in Guernsey and the Isle of Man.