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HOW TO UNDERSTAND AND RESPOND TO THE NEW ECONOMIC SUBSTANCE REGULATIONS

Eric Anliker, General Counsel at Estera, details the nuances of the economic substance legislation that came into effect in the Crown Dependencies and Overseas Territories at the beginning of 2019

Economic Substance legislation came into effect in the Crown Dependencies and Overseas Territories on 1 January 2019.

The legislation is designed to protect the reputation of offshore jurisdictions by ensuring that income streams from certain activities are based on actual local activity to substantiate the use of low tax jurisdictions.

Substance legislation doesn’t apply to all entities in each jurisdiction – rather, it applies to certain ’relevant entities’ carrying out certain ‘relevant activities’. Affected entities are required to be managed and directed, to have adequate employees, expenditure and physical presence and to conduct their ‘core income generating activities’ in the local jurisdiction.

There are two key stages to establishing how an entity might be impacted by substance regulations in any given jurisdiction. Firstly, is the entity in scope of the new law – i.e. is the entity a relevant entity carrying out a relevant activity? And, secondly, if it is in scope, does it meet the substance requirements?

Each jurisdiction has its own subtle variances and has defined – within its own legislation – the legal type of entities that will be affected by the new economic substance rules.

In Guernsey, The Income Tax (Substance Requirements) (Guernsey) (Amendment) Ordinance, 2018 applies to a company that is tax resident in Guernsey, namely that it is controlled in Guernsey or it is incorporated in Guernsey.

In Jersey, The Taxation (Companies - Economic Substance) (Jersey) Law 2019 applies to all companies that are tax-resident in Jersey.

If an entity matches the legal type specified in the law it also needs to be carrying out certain relevant activities to be affected by the requirements for economic substance. This means that core income generating activities need to be carried out in the jurisdiction to demonstrate substance.

Once it has been determined that an entity is a relevant entity and is carrying out a relevant activity as described by local regulations, it has to satisfy the applicable substance test.

The substance requirements differ depending on the type of relevant activity an entity performs.

Generally speaking, although there are exceptions, an entity that is carrying out a relevant activity will meet the substance requirements if:

    • It is managed and directed in the jurisdiction
    • Core Income Generating Activities are conducted in the jurisdiction
    • It has an occupied physical office or premises
    • There are an adequate number of employees with suitable qualifications in the jurisdiction
    • There is adequate operating expenditure in relation to the relevant activity in the jurisdiction


Once substance is established, the entity must file an economic substance report each year with the applicable authority in its jurisdiction.

Penalties for failure to comply with the new substance regulations vary from one jurisdiction to another – but range from increasing fines, removal from the register through to imprisonment.

Estera has a significant presence in jurisdictions affected by changes to substance legislation. Alongside this, we have comprehensive experience in gathering and reporting company data in those jurisdictions. As a result, we are uniquely placed to help our clients understand and respond to the new legislation.

The importance of compliance with the new substance regulations can’t be understated given the potential liability for extensive penalties. Our experts can help you navigate the complexities of the new legislation and ensure that you are meeting the requirements. 

 

A version of this article has appeared in December's edition of Business Brief, CI


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