In a nutshell: Cayman Islands' economic substance law
05 May 2021
The Cayman Islands ("Cayman") is part of a global effort to establish an international standard for tax residence of entities doing business in a jurisdiction to avoid the Harmful Tax Practice of Base Erosion and Profit Shifting. Cayman (like many other international financial centres) has put in place legislation requiring certain entities which are incorporated or registered in Cayman to demonstrate that they have sufficient 'economic substance' in Cayman to show that they should not be taxed elsewhere.
The International Tax Co-operation (Economic Substance) Act (2021 Revision) (the "ES Act") has applied from 1 January 2019 to all newly formed entities which are in scope of the ES Act and from 1 July 2019 to entities formed prior to 1 January 2019 which are in scope. There are Regulations and guidance that accompany the ES Act.
Which entities are subject to the ES Act?
Any company (incorporated or registered as an overseas company in Cayman) which is not a "domestic company" (e.g. carrying on business only in Cayman or a Not for Profit) or Limited Liability Partnership which is registered in Cayman, and which carries on any of the following 'Relevant Activities':
- banking business;
- insurance business;
- fund management business;
- finance and leasing business (which, among other activities, includes the provision of finance to third parties or affiliates);
- headquarters business;
- shipping business;
- holding company business (i.e. only pure equity holdings not holdings of another kind of property e.g. real estate or private vessels or aircraft);
- intellectual property holding business; or
- distribution and service centre business (which, among other activities, includes the provision of services to affiliates).
Definitions of each Relevant Activity are provided in the ES Act.
What do such entities need to show?
Entities subject to the ES Act must, in respect of their Relevant Activities:
- be directed and managed in Cayman;
- conduct Core Income Generating Activities in Cayman; and
- have adequate employees, expenditure and physical assets in Cayman.
When is a company 'directed and managed' in Cayman?
A company will be directed and managed in Cayman in an appropriate manner if:
- the board's members have adequate knowledge and expertise;
- it meets in Cayman with adequate frequency, having regard to the amount of decision making required (it is not expected that all or a majority of board meetings will be held in Cayman);
- a quorum is physically present at each board meeting in Cayman;
- strategic decisions of the company are made in those meetings with minutes recorded; and
- minutes and other records of the company should be kept at the office in Cayman.
What are 'Core Income Generating Activities'?
Examples of Core Income Generating Activities ("CIGA") are provided in the ES Act for each of the Relevant Activities. The CIGA are considered to be the key essential and valuable activities that generate the income of the company and these activities must be carried out in Cayman. However, non CIGA activity such as back office functions, expert professional advice or specialist services can be obtained elsewhere. A company can outsource its CIGA in Cayman so long as it continues to monitor and control the outsourced activities.
How can I tell if an entity has adequate employees, expenditure and physical assets?
This needs to be assessed on a case by case basis depending on the activities of the entity and how its CIGA arises. Directors should consider these factors, make a determination in good faith and ensure there are records to demonstrate the basis and operation of that determination.
Are there any exceptions?
Entities which are tax resident outside of Cayman do not have to have, or report on, economic substance but do have to file an annual notification and form proving their tax residence.
Entities which carry on the following activities are subject to a slightly different regime:
- Holding company business: entities are only holding companies if they are a pure equity holding business, in which case they need only show they have complied with the Cayman Companies Act (2021 Revision) and have premises and human resources adequate for the purpose of holding equities in other companies.
- Intellectual property holding business: entities which hold, exploit or derive income from intellectual property in a manner defined as "high risk" are automatically deemed non-compliant with the substance requirements unless they provide additional evidence of compliance. The details of these companies are also automatically exchanged with the relevant foreign tax authorities.
How is compliance with the ES Act monitored?
Compliance with the ES Act is monitored and enforced by the Cayman Tax Information Authority. Entities subject to the ES Act need to set out details of their compliance in an annual report as well as complete a section in the Annual Return on whether they are subject to the ES Act. Failure to comply with the ES Act will result in fines of up to US$100,000 and, potentially, in a non-compliant company being struck off. The details of non-compliant companies will also be disclosed to the relevant foreign tax authorities.
What do I do now and where can I find out more?
Please refer to Bedell Cristin's detailed economic substance briefings and 'top tips', available on our website, and contact any of our specialists if you would like more information or advice. Cayman's ES Act and guidance can be accessed here.
Location: Cayman Islands
Related Service: Economic Substance
Partner | Cayman Islands
Partner | Cayman Islands | BVI