EU Substance Requirement | Tax Talk

Introduction

The Isle of Man government has now approved legislation in relation to new substance requirements which came in to effect for accounting periods starting on or after 1 January 2019. A copy of the legislation can be found here but we have summarised some of the key points below. The legislation has been designed to address concerns that companies could be used to artificially attract profits that are not commensurate with economic activities and substantial economic presence in the IoM.

Sectors affected

The new requirements will affect Isle of Man tax resident companies deriving any income from activity in the following sectors:

• Banking;
• Insurance;
• Shipping;
• Fund management;
• Financing and leasing; 
• Headquartering;
• Operation of a holding company;
• Holding of intangible property; and
• Distribution and service centre business.

General requirements

The precise nature of the substance requirements varies between sectors and so a detailed breakdown is beyond the scope of this edition of Tax Talk. The legislation does set out some general requirements that will apply to all sectors (other than pure equity holding companies which have slightly less onerous requirements). These requirements include stipulations that the company must ensure that:

• it is managed and directed in the Isle of Man (similar to the central management and control test);
• it has an adequate number of qualified employees on the Island (this will include outsourced employees);
• it has adequate expenditure on the Island, proportionate to its level of activity on the Island;
• it has an adequate physical presence on the Island; and that
• it conducts core income generating activity on the Island.

Outsourcing

With regard to carrying on core income generating activity, the legislation allows that such activity can be outsourced provided that the company can still demonstrate ‘adequate supervision’ of such activity and that it is still conducted on the Island.

Adequacy

Clearly a vital feature of these requirements is the idea of ‘adequacy’. This will of course vary from business to business and so there are no set parameters or guides for what constitutes adequacy. Companies must therefore ensure that they have what they consider to be appropriate arrangements in place and be prepared to defend the adequacy of, for instance, their staffing levels and experience. For regulated industries such as banking, insurance and fund management there will be overlap between the adequacy requirements and the current regulatory requirements for such industries.

‘High risk IP companies’

One area of the legislation that is likely to be of relevance to a number of IoM resident companies is that relating to ‘high risk IP companies’. These are companies that (broadly) either:

• hold an IP asset that has been acquired from and is licensed to related parties; or
• hold an IP asset and do not carry on core income generating activities from within the Island.

For such companies there is a rebuttable presumption that such a company has failed the substance requirements. This means that the burden of proof is on such companies to demonstrate compliance with the substance requirements; in effect a stiffer test to pass.

Sanctions

Where the Assessor deems a company to not be meeting its substance requirements the legislation empowers her to:

• disclose the failure to other tax jurisdictions (who may then consider whether the company has any additional tax obligations in that jurisdiction);
• exact fines of up to £100,000; and
• have the company struck off the Isle of Man register (in severe or repeated cases). Depending on the situation, criminal proceedings may also be brought against specific individuals.

Guidance

The Isle of Man government has released some initial guidance on these requirements which can be viewed here though it is expected that further guidance may be released on these requirements. Find out how we can help.