The economic substance requirements are set out in the International Tax Co-operation (Economic Substance) Act (as revised) (the ES Act) and certain regulations issued by the Cabinet of the Cayman Islands pursuant to the ES Act.
Relevant Entities
The requirements of the ES Act apply to the following entities:
Cayman Islands companies incorporated under the Companies Act (as revised) or the Limited Liability Companies Act (as revised);
Cayman Islands limited liability partnerships registered under the Limited Liability Partnership Act, (as revised);
General partnerships and limited partnerships under the Partnerships Act (as revised);
Exempted Limited Partnerships and Foreign Limited Partnerships under the Exempted Limited Partnerships Act (as revised); and
Non-Cayman Islands companies registered as foreign companies under the Companies Act (as revised).
The requirements that apply to a particular entity depend on whether that entity is a 'relevant entity' within the meaning of the ES Act. The following entities are not relevant entities:
investment funds (including vehicles through which an investment fund invests);
an entity that is tax resident outside the Cayman Islands; and
a domestic company or local partnership (as defined in the ES Act).
All entities are required to submit annually an ES Notice (an ESN) to the Registrar of Companies that must be completed and submitted using an online portal. A relevant entity that carries on a 'relevant activity' is required to meet an economic substance test and submit an economic substance report to the Tax Information Authority.
Relevant Activities
Relevant entities are required to satisfy an Economic Substance Test (an ES Test) if they carry on any of the following relevant activities:
banking business;
Distribution and service centre business;
financing and leasing business;
fund management business;
headquarters business;
holding company business;
insurance business;
intellectual property business; and
shipping business.
The scope of each of the above activities is defined in the ES Act. The Guidance in respect of the ES Act issued by the Tax Information Authority of the Cayman Islands contains further explanation of how those definitions should be construed, together with examples of relevant activity. If a relevant entity carries on more than one relevant activity then it is required to meet an ES Test in respect of each activity.
If a relevant entity carries on a relevant activity it is required to satisfy an economic substance test (an ES Test). A reduced ES Test applies to a relevant entity that carries on holding company business.
A relevant entity that carries on a relevant activity other than holding company business will satisfy the ES Test if:
it conducts in the Cayman Islands all core income-generating activities in relation to the relevant activity;
it is directed and managed in an appropriate manner in the Cayman Islands in relation to the relevant activity; and
having regard to the level of relevant income derived from the relevant activity carried out in the Cayman Islands it:
has incurred adequate operating expenditure in the Cayman Islands;
has adequate physical presence (including maintaining a place of business, or plant, property and equipment) in the Cayman Islands; and
has an adequate number of full-time employees or other personnel with appropriate qualifications in the Cayman Islands.
'Relevant income' is defined as 'all of that entity's gross income from its relevant activities and recorded in its books and records under applicable accounting standards'.
A relevant entity that carries on holding company business will satisfy the ES Test if:
it has complied with all applicable filing requirements under the Companies Law (as revised); and
it has adequate human resources and adequate premises in the Cayman Islands for holding and managing equity participations in other entities.
Directed and Managed
If a relevant entity is required to satisfy an ES Test in respect of a relevant activity other than holding company business then that relevant entity must be directed and managed in an appropriate manner in the Cayman Islands in relation to that activity.
The Guidance provides that a relevant entity satisfies this part of the ES Test if:
its board of directors has the appropriate knowledge and expertise to discharge its duties;
meetings are held in the Cayman Islands at adequate frequencies given the level of decision-making required with respect to the activity;
such directors' meetings are always quorate;
the minutes of those meetings record the strategic decisions that the entity takes; and
all such directors' meeting minutes and other appropriate records are kept in the Cayman Islands.
The number of board meetings held in the Cayman Islands is required to be included in the economic substance report filed by a relevant entity that carries on a relevant activity.
Core income-generating activities (CIGA) are defined in the International Tax Co-operation (Economic Substance) Act (as revised) (ES Act) as activities that are of central importance to a relevant entity in terms of generating income from the relevant activities carried on by that entity that must be carried on in the Cayman Islands. Other than in respect of holding company business, a relevant entity that carries on a relevant activity must conduct CIGA to satisfy the ES Test.
The ES Act provides examples of CIGA but the nature of CIGA for any entity will depend on how that entity conducts its business and the Guidance confirms that the CIGA examples are not exhaustive or mandatory. The examples of CIGA set out in the ES Act for each relevant activity are as follows.
For banking business:
raising funds, managing risk including credit, currency and interest risk;
taking hedging positions;
providing loans, credit or other financial services to customers; and
managing capital and preparing reports or returns, or both, to investors or the Cayman Islands Monetary Authority, or both.
For distribution and service centre business:
transporting and storing goods, components and materials;
managing stocks;
taking orders; and
providing consulting or other administrative services.
For financing and leasing business:
negotiating or agreeing funding terms;
identifying and acquiring assets to be leased;
setting the terms and duration of financing or leasing; and
monitoring and revising financing or leasing agreements and managing risks associated with such financing or leasing agreements.
For fund management business:
taking decisions on the holding and selling of investments;
calculating risk and reserves;
taking decisions on currency or interest fluctuations and hedging positions; and
preparing reports or returns, or both, to investors or the Cayman Islands Monetary Authority, or both.
For headquarters business:
taking relevant management decisions;
incurring expenditures on behalf of group entities; and
coordinating group activities.
For insurance business:
predicting or calculating risk or oversight of prediction or calculation of risk;
insuring or re-insuring against risk; and
preparing reports or returns, or both, to investors or the Cayman Islands Monetary Authority, or both.
For intellectual property business:
where the intellectual property asset is a:
patent or asset similar to a patent, research and development; or
non-trade intangible (including trademark), branding, marketing and distribution;
In exceptional cases, except if the relevant entity is a high-risk intellectual property business, other CIGA relevant to the business and the intellectual property assets, which may include:
taking strategic decisions and managing (as well as bearing) the principal risks related to development and subsequent exploitation of the intangible asset generating income;
taking the strategic decisions and managing (as well as bearing) the principal risks relating to acquisition by third parties and subsequent exploitation and protection of the intangible asset; and
carrying on the underlying trading activities through which the intangible assets are exploited leading to the generation of income from third parties.
For shipping business:
managing crew (including hiring, paying and overseeing crew members);
overhauling and maintaining ships;
overseeing and tracking deliveries; and
determining what goods to order and when to deliver them, and organising and overseeing voyages.
Physical Premises
For a relevant entity to satisfy an ES Test in respect of a relevant activity other than holding company business, that relevant entity must have an adequate physical presence (including maintaining a place of business or plant, property and equipment) in the Cayman Islands having regard to the level of relevant income derived from the relevant activity.
For a relevant entity to satisfy an ES Test in respect of a holding company business, that relevant entity must have adequate premises in the Cayman Islands for holding and managing equity participations in other entities.
Employees & Staff
For a relevant entity to satisfy an ES Test in respect of a relevant activity other than holding company business, that relevant entity must have an adequate number of full-time employees or other personnel with appropriate qualifications in the Cayman Islands having regard to the level of relevant income derived from the relevant activity.
For a relevant entity to satisfy an ES Test in respect of a holding company business, that relevant entity must have adequate human resources in the Cayman Islands for holding and managing equity participations in other entities.
The Guidance in respect of the ES Act issued by the Tax Information Authority of the Cayman Islands clarifies that 'adequate' means 'as much or as good as necessary for the relevant requirement or purpose'. What is adequate for each relevant entity will depend on its activity as well as the particular facts of its business.
Expenditure
For a relevant entity to satisfy an ES Test in respect of a relevant activity other than holding company business, that relevant entity must have an adequate amount of operating expenditure incurred in the Cayman Islands having regard to the level of relevant income derived from the relevant activity.
The Guidance in respect of the ES Act issued by the Tax Information Authority of the Cayman Islands clarifies that 'adequate' means 'as much or as good as necessary for the relevant requirement or purpose'. What is adequate for each relevant entity will depend on its activity as well as the particular facts of its business.
Outsourcing
The ES Act expressly provides that a relevant entity may outsource its CIGA with respect to a relevant activity to any person in the Cayman Islands provided that the entity is able to monitor and control that person carrying out such CIGA so as to ensure the CIGA is in fact being carried out in the Cayman Islands. Other activities that are not CIGA, such as payroll or HR, may be outsourced to service providers outside the Cayman Islands with no restrictions of any kind under the ES Act.
For the purposes of satisfying the ES Test the activities of the service provider (the person taking on the outsourced activity) will be taken into account and further, the resources of that service provider will be taken into account to satisfy the people and premises part of the ES Test as well. This means that the service provider’s employees can be considered to be employees of the relevant entity but only while they are providing services for that relevant entity and this must be evidenced by the relevant entity (via timesheets or the like). In addition, the Authority requires service providers to verify the information on outsourcing within 30 days of the date on which the relevant entity submits its economic substance report.
Reporting
All entities are required to submit annually an ES Notice (an ESN) to the Registrar of Companies that must be completed and submitted using an online portal. In the ESN the entity must state whether it is carrying on any 'relevant activity'. If an entity is not carrying on a relevant activity then it must also confirm if it is an investment fund. If an entity is carrying on a relevant activity then the entity must also identify the type of relevant activity and confirm whether it is a 'relevant entity'. Certain additional information will be required depending on the answers the relevant entity selects in the online form. Subject to any extensions that may be granted, the deadline for submitting an ESN is 31 March each year.
If a relevant entity is carrying on a relevant activity it is required to prepare and submit an economic substance report in respect of the relevant activity using an online portal. The ES Act requires the report to contain the information that is listed in section 7(4) of the ES Act and in the Schedule to the International Tax Co-operation (Economic Substance) Regulations 2020. Subject to any extensions that may be granted, the report is required to be filed with the Authority within 12 months of the end of the relevant financial year of the relevant entity.
The information that must be included in the ES return is set out in section 7(4) of the ES Act and Schedule 2 of the ES Regulations (2020). That information includes:
the type of relevant activity;
the amount and type of relevant income;
the amount and type of expenses and assets in respect of the relevant activity;
the number of full-time employees or other personnel with appropriate qualifications who are responsible for carrying on the relevant entity's relevant activity;
the name and address of any person other than the relevant entity who is conducting CIGA for that relevant entity (ie, outsourced CIGA);
that CIGA that has been conducted;
for intellectual property business a declaration as to whether it is high-risk intellectual property business;
details of any MNE Group (as defined in the Tax Information Authority (International Tax Compliance) (Country-By- Country Reporting) Regulations, 2017) for which the relevant entity is a constituent entity;
the jurisdiction of tax residence of the relevant entity's immediate parent, ultimate parent and ultimate beneficial owner; and
a copy of the relevant entity's financial statements or books of account for the relevant financial year.
The Authority has the power to determine if a relevant entity has satisfied the applicable ES Test. The Guidance explains that the assessment will be undertaken using a principles-based approach. Specific requirements as to, for example, employee numbers for a particular level of relevant income are not prescribed, as all businesses will be treated as unique and the requirements for any entity will depend on how that entity conducts its business.
In assessing an entity's satisfaction of the ES Test the Authority will consider a variety of factors, including:
the fluctuation of activities from year to year and the impact that fluctuation may have on what constitutes an adequate level of employees or personnel;
the ability of directors to perform CIGA in addition to their fiduciary duties and the potential to eliminate the need for full-time employees or outsourced work; and
the Authority will on request, take into consideration normal business practices for a relevant activity that are permitted in other jurisdictions subject to the Forum on Harmful Tax Practices' substantial activities requirements.
Penalties
Failure to submit an ES report when required shall result in a penalty of CI$5,000 plus an additional penalty of CI$500 per day that the report is not filed.
Any relevant entity that fails to satisfy the ES Test for a financial year shall be subject to a penalty of CI$10,000. If a relevant entity fails again to satisfy the ES Test in the financial year that follows the financial year in which the Authority gave notice of the initial failure then the ES Act provides for a penalty of CI$100,000.
How can Bell Rock Help?
From our offices in Cayman, and as a regulated firm, we routinely assist with the provision of a range of ES services and solutions on an outsourced basis:
Senior and Professional Directors
Management Personnel
Employees & Support Staff
Compliance & Regulatory Services
Accounting & Financial Accounts Prep
Physical Office and Business Class Services
Board Meeting Services for hosting meetings
Company Secretarial
Registered Office Address
Preparation of Annual Economic Substance Filings
Contact us for more information: ES@bellrockgroup.com or info@bellrockgroup.com