Corporate structures incorporated in so-called "tax heavens" or "offshores" are used for various reasons; including, tax optimization and the diversification of ownership structures among various jurisdictions. Conventionally, your interaction with the operators of this structure would be limited to paying annual servicing fees, conducting audits, and receiving standard paperwork from the government. Times are changing as you will now be chased by your operators who are raising issues related to the economic substance of your company. It is evident that something important is taking place and now is the time to make powerful moves.
Business entities in British Virgin Islands and Cayman Islands will be forced to implement the Economic Substance legislation. Therefore, they will be required to provide annual reports regarding their total generated turnover, expenditure incurred within relevant jurisdiction, total number of employees engaged in the activity, names of the persons responsible for the direction and management of the activity, etc. Furthermore, BVI and Cayman Islands established entities may also be subject to robust and harsh fines and penalties; and under such circumstances, it is difficult to avoid “flying into an unbeatable and uncontrollable rage!”
The prescribed, devastating change to the BVI and Cayman Islands legislation is due to the fact that the EU is still dissatisfied with the Economic Substance legislation enacted by the BVI and Cayman Islands (as well as with other states, such as Barbados and Bermuda); particularly, regarding collective investment funds.
WHAT IS THE ECONOMIC SUBSTANCE LEGISLATION AND HOW IS IT ENACTED AND CLASSIFIED?
This “hurricane” is due to the amendments that took place in December of 1997, where the Council of European Union and the representatives of the governments of the member states, adopted a resolution on a Code of Conduct for business taxation; with the objective to curb harmful tax competition. Pursuant to the Code of Conduct, tax measures "which provide for a significantly lower effective level of taxation, including zero taxation, than those levels which generally apply in the Member State in question are to be regarded as potentially harmful and therefore covered by this code" (this referred to as “gateway” criterion).
Nonetheless, the Code of Conduct is not a legally binding instrument but rather, is a political commitment by member states to:
Whilst the original focus of the Code of Conduct was on EU member states, member states are also committed to promote the adoption of its principles by third countries and in territories to which EU treaties do not apply.
Based on the tax policy of states and their attempts and commitments to be in full compliance with EU standards, the EU classifies three types of jurisdiction; non-cooperative (“black list” jurisdiction), fully cooperative (“white list” jurisdiction) and semi-cooperative (“grey list” jurisdiction). Accordingly, “black list” jurisdictions are the states which are far from being in total compliance with EU standards. “Grey list” jurisdiction states have taken some undertaking and commitments to be in correspondence with aforementioned standards, but despite their attempts, the EU deems their efforts “unsatisfactory.” Finally, the “heavenly ones”, called the “white list” states, which are under special “protectorate” of the EU due to the fact that they have fully harmonized their tax policy with EU requirements.
Generally, the Council of European Union (represented by Economic and Financial Affairs Council, based on recommendations and assessment of European Commission) annually chooses “reputable and deserved” states (especially qualified as “grey list” or “black list” states) under some criteria and gives them recommendations and a timeframe to adopt policies and internal legislation that will draw up a route directly to “white list” jurisdictions.
WHAT CRITERIA ARE CHOSEN TO FIGHT AGAINST TAX AVOIDANCE WITHIN THE REALMS OF “ECONOMIC SUBSTANCE?”
The listing and delisting of some states are accomplished through screening and dialogue guided by the requirements, policies and regulations issued by the EU and the OECD based on criteria relating to tax transparency, fair taxation, the implementation of the OECD domestic tax erosion and profit shifting (“BEPS”) measures. Furthermore, the states will implement additional criteria in order to keep the business entities in compliance with internal legislation and aforesaid standards as a whole.
The essence of criteria described above are the following:
Based on the mandatory criteria prescribed above, the new legislation imposes several tests on some states (such as the British Virgin Islands and Cayman Islands) that help determine whether or not a business is in compliance with the requirements of “Economic Substance.” Namely, the tests are the following:
WHAT PROCEDURE IS FOLLOWED WHEN FILING RELEVANT REPORTS AND WHAT CONSEQUENCES MAY OCCUR IF ENTITIES FAIL TO MEET REQUIREMENTS?
The main regulation regarding timing and procedure of appropriate reports to competent authorities in Cayman Islands is provided under Sections 4 to 8 of Economic Substance Law (dated December 27, 2018). Namely, the said rulings oblige the relevant entity to annually notify the Tax Information Authority (hereinafter referred to as “Authority”) of Cayman Islands of information on the end date of its financial year and on the existence or absence of conducting a relevant activity. Furthermore, Subsection (4) of Section 7 of the Law states that the entity shall provide information concerning the type of relevant activity conducted by it, the amount and type of relevant income, the amount and type of expenses and assets, the location of the place of business or plant, property or equipment used for the relevant activity of the relevant entity, the number of full-time employees or other personnel with appropriate qualifications, as well as other information and details that the Authority may deem appropriate, expedient and necessary at its discretion. Accordingly, the first reports by the entities of Cayman Islands are expected to be provided on or by 31 December 2020.
If the foregoing requirements and conditions are not met, the Authority may be entitled to impose a penalty in the amount of 10,000 US dollars on a relevant entity that is required to satisfy the economic substance test in relation to a relevant activity and fails to do so. If the entity additionally fails to comply with the prescribed requirements after the initial notice of the Authority, it will be subject to a severe penalty in the amount of 100,000 US dollars (Section 7 and 8 of Economic Substance Law). If the prescribed breach lasts for two consecutive years, the competent court may render a judgment on dissolution and defunction of relevant entity.
Similar approach and regulations, except for the amounts of penalties (which are respectively 20,000 US dollars for the first failure and 200,000 US dollars for the further failure to comply with rules pertaining to the obligations promulgated by International Tax Authority of BVI), are also incorporated under the Economic Substance (Companies and Limited Partnerships) Act, 2018 of British Virgin Islands.
HOW CAN WE HELP?
During the past 12 months, our team has accumulated immense experience in helping our clients "mitigate" this new tax paradigm and selecting alternative home jurisdiction.
 Armenia is classified as a “grey list” jurisdiction, however, the European Commission said in March 2019 that Armenia was among the 34 jurisdictions that have already taken many positive steps to comply with the requirements under the EU listing process.
 Because, among others, of the large network of operators and tax advisors that we have.