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What are the Economic Substance Regulation requirements?

07 December, 2020

By: Kevin Cowley and Phil Morris, PwC Isle of Man

 

What are the Isle of Man Economic Substance Regulations and who do they apply to?

The Isle of Man substance legislation was introduced to comply with commitments made to the EU. It applies to companies’ resident in the Isle of Man for tax purposes and targeted at companies which derive income from 'relevant sectors'. Those companies have to have sufficient economic substance in the Isle of Man to support profits and income generated. A key point here is that it is income that is relevant. If there is no income the company will not be caught, but the legislation should be considered each year. The legislation was introduced with effect from 1st January 2019 and applied for accounting periods commencing on or after that date.

What should businesses be doing to consider the potential impact of the regulations and does it matter?

To begin with unless it is a new company, most companies will have had a relevant accounting period and so now be in scope. A readiness assessment would be the next step - Does the company have relevant income? Does the company meet the tests? What practical steps can the company take to be compliant? If the company does not meet the tests, sanctions will apply and these could be financial penalties, automatic exchange of information and ultimately being struck off as an Isle of Man company.

Are there specific sectors that are proving to be problematic?

There are some obvious and less obvious sectors. Examples include:

IP holding:

This is potentially the hardest sector to satisfy the tests. For high risk IP companies there is a starting presumption that they won’t meet the test unless they can rebut that presumption, which requires a lot of evidence.

Shipping:

It is important to consider who is the operator of the ship, it is the operator that is caught, not the owner (e.g. bareboat charter). There are also issues around the core income generating activities, ideally these should be carried out in the Isle of Man, but practically they are carried out where the ship operates.

Financing and Leasing:

A less obvious sector and more unexpected problem area. An issue area we have found is with intra-group interest bearing loans that have been in scope. It is important to note there are no de minimis limits.

How have the substance requirements impacted the tax return preparation?

The rules have led to additional information needing to be included in the corporate income tax return via a series of questions, which typically require a yes or no answer. Some do require factual information, such as the number of Isle of Man employees or expenditure, so it is important to consider the answer and have the information to support this. There is a question asking if the company has met the requirements, which is effectively a self-assessment and needs consideration. It is possible that the Income Tax division could make an enquiry and the company needs to be able to support conclusions reached.

What issues are you seeing as a result of COVID 19?

An interesting and challenging area is the impact of travel restrictions with one substance test being on the direction and management of the company and what is taking place at a strategic level in the Isle of Man.

There is no formal guidance and so we cannot definitively say that the Income Tax Division will exercise any discretion in this area. We hope that the Income Tax Division will consider all relevant circumstances when reaching a view on governance issues and expect that Isle of Man government imposed travel restrictions and quarantine rules would be considered as a factor when looking at physical attendees at Isle of Man board meetings in current circumstances. It is important to monitor the position and encourage Isle of Man physical attendance as soon as practically possible as restrictions are lifted in future.

 

In summary, the key to the requirements is to understand if the substance rules apply and if so, how they apply and what the tax implications are. The rules are live and urgent attention is needed.

Contact us

Kevin Cowley

Kevin Cowley

Partner, Tax Leader, PwC Isle of Man

Tel: +44 (0) 1624 689714

Phil Morris

Phil Morris

Director, PwC Isle of Man

Tel: +44 (0) 1624 689713