Draft law requires offshore companies to have local offices and staff

Government has released draft legislation that will impact certain offshore companies that are tax resident in Cayman by demanding that they must have an adequate level of economic substance locally.

The International Tax Co-operation (Economic Substance) Bill 2018 introduces a substance test for banking, insurance, fund management and shipping companies; entities functioning as headquarters or distribution and service centers; and businesses engaged in financing and leasing or holding intellectual property.

“If a Cayman entity is conducting relevant business activities in one or more of these categories; and if that entity is not tax resident in another jurisdiction, the bill would require the entity to have ‘economic substance’ in the Cayman Islands,” the Ministry of Financial Services said in a press release.

The new legislation comes in response to a threatened blacklisting by the European Union, which claims Cayman is violating “fair tax” standards by enabling offshore tax structures that attract profits without any real economic activity.

To avoid an immediate blacklisting and potential punitive measures, Cayman’s government made a written commitment last year to introduce new substance requirements into legislation by the end of 2018.

Under the proposed legislation, companies will pass the economic substance test if they conduct core income generating activities on island; incur an adequate amount of operating expenditure in Cayman; have a physical presence locally; and have an adequate number of full-time staff locally.

Cabinet will define what is adequate in related regulations, according to the legislative proposal.

There are more stringent standards for intellectual property holding companies, which must prove that they historically maintained control on island over intangible property assets, to be recognized as tax resident in Cayman.

The draft bill is scheduled for debate in the Legislative Assembly later this month and is expected to be passed to take effect by Jan. 1, 2019.

Cayman’s bills are based on the OECD’s Forum on Harmful Tax Practices, which falls under the OECD’s Base Erosion and Profit Shifting Inclusive Framework. Cayman became a member of the Inclusive Framework in 2017.

The aim is to prevent companies from using tax structures that divert profits to low tax or zero tax countries even though the companies do not conduct any real economic activity there.

Minister for Financial Services Tara Rivers said it is important to understand why these global developments are occurring, and why it is important for Cayman to participate in them.

“The scope of the Forum on Harmful Tax Practices now includes 120-plus countries, including Cayman,” she said. “This represents an evolution of the global standard in financial services, and Cayman is committed to responding to these standards.”

For more on this story, see Monday’s Cayman Compass.