Government issues economic substance guidance

Government has published a guidance booklet to help companies comply with the territory’s economic substance legislation, which was passed by legislators last year in an attempt to avoid European Union tax blacklisting.

The new rules require Cayman-registered companies to demonstrate they have “adequate” economic activity locally to justify the profits they make. The recently released guidance booklet specifies what entities the law applies to, and it sheds light on what government will consider as “adequate” economic activity.

According to the guidance, the economic substance legislation applies to companies incorporated or registered under the Companies Law, limited liability companies, and limited liability partnerships. The legislation does not apply to domestic companies, investment funds, or entities that are tax resident outside the islands.

By July 1 or sooner, the companies that fall under the law will be required to demonstrate that they have an “adequate” amount of operating expenditure incurred here, an adequate physical presence (including maintaining a place of business or plant, property and equipment), and an adequate number of full-time employees for the “relevant activity” being carried out here.

The booklet defines relevant activity as banking, distribution and service center business, financing and leasing, fund management, headquarters business, holding company business, insurance, intellectual property business, and shipping.

However, the guidance booklet does not exactly state what “adequate” means.

“What is adequate or appropriate for each relevant entity will be dependent on the particular facts of the relevant entity and its business activity,” the guidance states. “A relevant entity will have to ensure that it maintains and retains appropriate records to demonstrate the adequacy and appropriateness of the resources utilized and expenditures incurred.”

The guidance booklet does include explanations for what it considers adequate in some specific sectors.

For example, holding companies must show they have adequate human resources and adequate premises for holding and managing equity participations in other entities.

The guidance booklet also sets a high bar for companies that acquire intellectual property and want to hold those assets here. To do that, they must demonstrate that there was a high degree of control over the development, exploitation, maintenance, enhancement and protection of the intangible asset. They also must prove that such control was exercised by an adequate number of full-time employees with the necessary qualifications that permanently reside and perform their activities here.

The guidance booklet also specifies that Cayman Enterprise City’s special economic zone companies will be held to a higher substance standard.

“The [special economic zone’s] requirement for a business in the SEZ to have at least one employee based in the Islands does not necessarily satisfy the [economic substance test] under the ES Law,” the booklet states. “Recall that the ES Law requires a relevant entity to have an adequate number of full-time employees or other personnel with appropriate qualifications in the Islands having regard to the level of income derived from the relevant activity carried out in the Islands.”

The penalty for not meeting the substance standards is a $10,000 fine, and then a $100,000 fine if the failure is repeated in the next financial year.

The guidance booklet can be found at www.gazettes.gov.ky.

1 COMMENT

  1. Meanwhile companies can be registered in Luxembourg, Andorra, Nevada, Wyoming or just about any other USA state without any economic substance tests at all.
    Just the EU trying to destroy the Cayman Islands so they can take our business. And of course they are too scared to attack the USA.

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