The Economic Substance Test
The Crown Dependencies’, together with other offshore jurisdictions including the British Virgin Islands and the Cayman Islands, have introduced a legal substance requirement for entities doing business in, or through, their jurisdictions. The legal requirement is in the form of an Economic Substance Test that will help entities demonstrate that the profits they register in the Crown Dependencies are commensurate with their economic activities and substantial economic presence there.
Each of the Crown Dependencies have introduced their own Economic Substance Tests, which applies to accounting periods commencing on or after 1 January 2019. These tests are broadly similar to each other, but subtle differences do exist.
Fundamentally, all companies that are tax resident in the Crown Dependencies and are also undertaking a ‘relevant activity’ must satisfy the appropriate Economic Substance Test applicable to that jurisdiction.
Relevant activities include:
- Banking business
- Insurance business
- Fund management business
- Finance and leasing business
- Headquarters business
- Holding company business
- Shipping business
- Intellectual property holding business
- Distribution and service centre business
Where the Economic Substance Test applies, companies must demonstrate that they have economic substance in that jurisdiction by satisfying all of the following:
- being directed and managed there;
- conducting Core Income Generating Activities (CIGA) there; and
- having adequate people, premises and expenditure there.
Companies that are required to meet the Economic Substance Test will also be required to provide additional information on their annual tax filings. The directors of those companies will, therefore, need to self-assess as to whether they have satisfied the Economic Substance Test and make a declaration thereof on the companies’ tax returns.
Failure to meet the Economic Substance Test
Failure to meet the Economic Substance Test can result in a penalty of up to £10,000, increasing to £100,000 if the test is not met for consecutive financial periods.
The Crown Dependencies’ tax authorities will also have the authority to commence proceedings to wind up companies that fail to satisfy the Economic Substance Test.
Failing to meet the Economic Substance Test will also result in the Crown Dependencies’ tax authorities being obliged to exchange information with competent tax authorities (I.e. where a bilateral agreement or multilateral convention permits).
What must you do
Directors of companies that are tax resident in the Crown Dependencies must, therefore, review their portfolios to identify those companies that must satisfy the Economic Substance Test and subsequently that the test has been met. They will also need to put in place mechanisms to record the relevant supporting data for reporting purposes and to demonstrate that they have met the test.
The earlier this review is conducted, the greater the opportunity for any remedial action to be undertaken to avoid failing the Economic Substance Test.