In a nutshell: Cayman Islands' Economic Substance Law
12 May 2020
Why was the law adopted?
The Cayman Islands ("Cayman") joined 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 offshore jurisdictions) put in place a law requiring certain entities which are tax resident in Cayman to demonstrate that they have sufficient 'economic substance' in Cayman to show they are a true tax resident.
The law is The International Tax Co-operation (Economic Substance) Law 2018 (the "ES Law"). There are Regulations and Guidance that accompany the ES Law.
When does it apply?
The ES Law applied from 1 January 2019 to all newly formed entities which were in scope of the ES Law and from 1 July 2019 to entities formed prior to 1 January 2019 which are in scope.
Which entities are subject to the ES Law?
Any company (which could be a company incorporated in Cayman or elsewhere) 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 tax resident in Cayman, receives income and 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 Law.
What do such entities need to show?
Entities subject to the ES Law 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 Law 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 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 annually report and prove 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 Law 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 Law monitored?
Compliance with the ES Law is monitored and enforced by the Cayman Tax Information Authority. Entities subject to the ES Law need to set out details of their compliance in an annual report commencing in 2020 as well as complete a section in the Annual Return on whether they are subject to the ES Law. Failure to comply with the ES Law 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 Law and guidance can be accessed by clicking here.