Legislative changes proposed by the government in response to EU demands and other regulatory pressures will bring what appear to be significant changes for offshore companies that are tax resident in Cayman.
Under the new rules, companies must have physical offices, an adequate number of staff and management presence locally to be recognized as tax resident in Cayman.
The new substance requirements ostensibly add costs and introduce onerous reporting requirements to companies operating in a limited set of industries and activities, such as banking, insurance and investment.
However, Cayman Finance, the association representing financial services in Cayman, believes clients will have no problems adapting to the new rules and will take the changes “in their stride.”
Financial services representatives in the Channel Islands and Bermuda, which are also forced to introduce substance requirements for certain tax resident business, appear equally laid-back about the potential threat to existing and future business.
Andy Sloan, deputy chief executive of strategy at promotional agency Guernsey Finance, said in October that substance rules were of the kind that “what doesn’t kill you, makes you stronger.”
He said in the long term, the requirements could bolster the offshore industry by giving jurisdictions like Guernsey “a clean bill of health,” the Guernsey Press reported.
Christian Luthi, chairman of offshore law firm Conyers Dill & Pearman, is equally confident Bermuda can adapt to the new rules. “Many Bermuda entities already meet the requirements,” Mr. Luthi told the Bermuda Gazette in December. “Indeed, for certain of our key industries, such as insurance and banking, the EU has expressly recognized the substantive nature of those industries in Bermuda.”
Mr. Luthi said industry stakeholders and Bermuda’s government had ensured compliance with EU and global requirements while protecting Bermuda’s interests and competitiveness.
Much like Cayman Finance and the Cayman Islands government, the Conyers Dill & Pearman chairman emphasized the global nature of the rules, which are expected to soon become an OECD standard.
Cayman Finance characterized the changes as the adoption of a new global standard that will be applied in more than 120 member countries of the OECD Base Erosion and Profit Shifting (BEPS) Inclusive Framework, including the United States.
“It is worth noting that all of Cayman’s main competitor jurisdictions are in a similar position as BEPS Inclusive Framework members,” the association said.
In an effort to create a “unified jurisdictional message,” Cayman Finance encouraged its members to use its general statement on the new rules and hold back on issuing client advisories until government releases guidance with the exact details on the substance requirements.
‘Sacrificing’ intellectual property business
Statements by financial services representatives in the British Virgin Islands show why this message may not necessarily be unified, as not all offshore companies are going to be impacted equally.
At a BVI Finance event in November, Harneys partner Peter Tarn described the substance requirements as “the most existential threat that the industry has faced since probably 1999,” the BVI Beacon reported.
Compared to transparency initiatives and other regulatory hurdles put up during the past 20 years, “this is frankly the most difficult to deal with,” he said.
In its negotiations with the EU, the BVI and other overseas territories and Crown dependencies facing substance requirements had decided to “sacrifice” intellectual property-holding companies, Mr. Tarn said, because the EU was “obsessed” with them and they did not represent a critical part of the industry in the Virgin Islands or in other jurisdictions, the BVI Beacon reported.
However, in return, important parts of the offshore business were kept outside of the relevant criteria for substance requirements. In addition, the substance tests apply only to tax resident businesses, and many businesses were simply not within the scope of the legislative changes.
The Cayman Islands Ministry of Financial Services issued a notice arguing similarly that “not all exempted companies are covered in the proposed legislation.” Only those companies conducting business in one of the specified categories will have to determine an adequate level of substance, the ministry said.
The assumption is that not as many companies in the areas and activities covered by the substance legislations are effectively tax resident in the jurisdictions as is commonly believed.
A client advisory by offshore law firm Walkers adds that the profit shifting that the new rules are trying to prevent does not exist in Cayman.
“We do not consider that structures seeking to exploit BEPS are at all prevalent in Cayman, where tax neutrality and the absence of a network of double-taxation treaties would render such structures largely meaningless, but Cayman is committed as a jurisdiction to assisting the international community in the preservation of standards of fiscal propriety wherever possible,” Walkers said.
Meanwhile, offshore jurisdictions that are part of larger economies are trying to benefit from the application of the new standards.
Bloomberg claimed in November that many U.S. multinationals were “packing up,” or choosing to open subsidiaries “in low tax, rather than no-tax, countries that are seen as more legitimate than the formerly popular island destinations of the Cayman Islands and the Bahamas.”
According to the report, the companies “are fleeing” from EU-imposed regulations that require them to justify the business purpose for their offshore operations.
The article may have simply been a marketing effort by the Asian law firms quoted in the piece.
However, it is far from clear whether Cayman-registered companies who must demonstrate economic substance would decide to do so locally.
If the same substance rules applied in more than 120 jurisdictions, the availability of qualified labor, the cost of doing business and many other factors would have to be considered, in addition to the effective tax rate.