In similar fashion to other Overseas Territories and other international financial centres, the Cayman Islands now has comprehensive legislation and regulations requiring legal entities domiciled or registered in the Islands and carrying on certain activities to have demonstrable substance in Cayman.
The International Tax Co-operation (Economic Substance) Act (Act) reflected Cayman's commitment to its obligations as a member of the OECD's global Base Erosion and Profit Shifting (BEPS) Inclusive Framework and corresponding EU requirements for no or nominal tax jurisdictions.
The Act requires that all legal entities domiciled or registered in the Cayman Islands must make an annual notification as to whether or not they were in scope in the prior year and whether or not they were carrying on one or more of a defined list of activities (Relevant Activities) in that period. Entities which are in scope (Relevant Entities) and which were conducting a Relevant Activity are required to meet an economic substance test (ES Test) in respect of those Relevant Activities.
Relevant Entities include all Cayman companies (including foundation companies), LLCs, LLPs and registered foreign companies except:
investment funds or entities through which investment funds directly or indirectly invest or operate;
entities which are tax resident outside the Islands (including, subject to certain conditions, entities which are disregarded entities for US income tax purposes);
entities which are authorised to carry on business locally in the Cayman Islands as a domestic company.
The Relevant Activities are fund management, banking, insurance, finance and leasing, distribution and service centre business, headquarters business, intellectual property business and holding company business. The Guidance issued by the TIA provides detailed information and sector-specific examples regarding the scope of each of these Relevant Activities and, other than investment funds, all entities will need to consider their operational activities carefully in order to determine whether they may be conducting a Relevant Activity.
The ES Test
Relevant Entities that carry on a Relevant Activity must satisfy the ES Test and, where a Relevant Entity carries on more than one Relevant Activity, they must satisfy, and report on their compliance with, the ES Test in respect of each such Relevant Activity. To satisfy the ES Test in relation to a particular Relevant Activity, a Relevant Entity must:
carry on its "core income generating activities" in relation to that Relevant Activity in the Cayman Islands;
be "directed and managed" in an appropriate manner in the Cayman Islands in relation to that Relevant Activity; and
having regard to the level of relevant income derived from the Relevant Activity carried out in Cayman:
have an adequate amount of operating expenditure incurred in Cayman;
have adequate physical presence (including maintaining a place of business or plant, property and equipment) in the Cayman Islands; and
have an adequate number of full-time employees or other personnel with appropriate qualifications in Cayman (note that these may include outsourced personnel provided they are located in Cayman).
A Relevant Entity may satisfy the requirement that its core income generating activities be carried out in Cayman if those activities are conducted by any person and the Relevant Entity is able to monitor and control the carrying out of the core income generating activities by that other person
Core income generating activities
The Act defines "core income generating activities" (CIGA) as activities that are of central importance to a Relevant Entity in terms of generating relevant income (ie income derived from the Relevant Activity) and requires that these be carried on in Cayman. The Act provides examples of core income generating activities for each Relevant Activity. For example:
for fund management business, CIGA include:
taking decisions on the holding and selling of investments;
calculating risks and reserves;
taking decisions on currency and interest fluctuations and hedging positions;
preparing reports or returns, or both, to investors or the Cayman Islands Monetary Authority.
for financing and leasing business, CIGA include:
negotiating or agreeing funding terms;
identifying and acquiring assets to be leased;
setting the terms and duration of financing and leasing;
monitoring and revising financing or leasing agreements and managing risks associated with such financing or leasing agreements.
Directed and managed
To be considered to be "directed and managed" in an appropriate manner in Cayman requires that:
the Relevant Entity's board of directors, as a whole, has the appropriate knowledge and expertise to discharge its duties as a board;
meetings of the board are held in Cayman at adequate frequencies given the level of decision making required;
the minutes of the board of directors record the making of strategic decisions of the Relevant Entity at the board meetings held in Cayman; and
the minutes of all meetings of the board, together with other appropriate records of the Relevant Entity, are kept in Cayman.
A meeting will be considered to be validly held in Cayman for these purposes only if:
the situation of that meeting would be deemed to be in Cayman under the constitutional documents of the Relevant Entity (this is commonly decided by the location of the chairman of the relevant meeting); and
at least that number of directors of the Relevant Entity constituting a quorum are physically present in Cayman for the meeting.
The penalty for failure to satisfy the ES Test for a Relevant Activity in a given financial year is US$12,200. The penalty for failure to satisfy the ES Test for a Relevant Activity in a subsequent financial year can rise to up to US$122,000 and, in addition, the Registrar must make an application to the Grand Court for an order for the Relevant Entity either to take such actions as may be specified or to be struck off.
In addition, there are penalties for any failure to comply with reporting obligations of US$6,100, with an additional fine of US$610 accruing for each day the failure to comply continues. Separately, any failure to provide the TIA with information requested (assuming such information is in the control of the relevant person) can lead to a fine of up to US$12,200 or to imprisonment for a term of two years, or to both.
Bell Rock - Economic Substance Services
As a regulated firm based in the Cayman Islands, we can provide economic substance to support our clients form our offices in Cayman. This often includes dedicated office space, dedicated business number, advice on meeting the ES Test, attending to the annual filings, assistance with hiring employees, provision of professional directors, holding meetings at our offices etc. For further information please feel free to contact us: firstname.lastname@example.org