Cayman Economic Substance Rules
In December 2018, the Cayman Islands (along with a number of other jurisdictions including the British Virgin Islands (BVI), and Bermuda) passed legislation that introduced increased economic substance requirements for certain entities.
The legislation is designed to meet the requirements outlined by the European Union’s (EU’s) intergovernmental Code of Conduct Group (CoCG) on Business Taxation, which are aimed at jurisdictions with low or zero rates of corporate income tax.
Additional guidance was issued by the Cayman Tax Information Authority on 30 April 2019.
A key point discussed within the guidance was in respect of entities which are Cayman incorporated but tax resident outside of the Cayman Islands. The guidance notes that (our emphasis):
“A company, limited liability company or limited liability partnership incorporated or established in the Islands is not regarded as a relevant entity for the purposes of the ES (Economic Substance) Law if it is tax resident outside the Islands. The Authority will regard an entity as tax resident in a jurisdiction other than the Islands if the entity is subject to corporate income tax on all of its income from a relevant activity by virtue of its tax residence, domicile or any other criteria of a similar nature in that other jurisdiction. Additionally, in the event that the entity is a “disregarded entity” for U.S. income tax purposes, and has a U.S. corporation as its parent, the Authority will consider the entity as tax resident outside of the Islands if satisfactory evidence is provided.
The Authority will require any entity claiming to be tax resident outside the Islands to produce satisfactory evidence to substantiate the same. For example, the evidence may include a Tax Identification Number, tax residence certificate and assessment or payment of a corporate income tax liability on all of that entity’s income in the Islands from a relevant activity, or, in the case of a disregarded entity for U.S. income tax purposes, a signed statement under penalty of perjury from an external tax advisor or ‘C’ level officer stating that all of that entity’s income has been included on the corporate tax return of the U.S. parent company. In the absence of such evidence the entity will be regarded as a relevant entity that is subject to the ES Law. The ES Test must be satisfied with respect to any part of relevant income that is not subject to corporate income tax imposed by a jurisdiction other than the Islands”
As such, provided a Cayman incorporated and, for example, Irish tax resident company engaged in leasing activities can produce satisfactory evidence, as outlined, demonstrating that all of the leasing income it earns is subject to corporate income tax in Ireland, then such a company should not be considered a “relevant entity” for the purposes of the Cayman Economic Substance Law.
However if in a particular structure involving a Cayman incorporated entity that is not tax resident in Cayman, some of the income from a “relevant activity”, as defined, is not subject to corporate income tax in another jurisdiction (e.g. if it is completely exempt) then the entity in question may need to consider the impact of the Economic Substance rules.
Failure to satisfy the Cayman Economic Substance rules can lead to fines of $10,000 for the first year of non-compliance and $100,000 fines for non-compliance in subsequent years. In addition the company could be struck off.
The use of Cayman incorporated vehicles which are tax resident outside of the Cayman Islands is relatively common. As such taxpayers should consider the potential implications the Cayman Economic Substance rules may have on their own structures.