Perspectives

Economic substance legislation

Impact on family offices

May 2021

Further to commitments made to the EU Council of Ministers during 2017, several offshore jurisdictions have introduced new rules regarding “economic substance”, which came into effect during 2019. Jurisdictions introducing such rules include Jersey, Guernsey, Isle of Man, BVI, Cayman, Bermuda and Bahamas (the EU substance jurisdictions), plus UAE.

What are the economic substance regulations?

There are subtle differences between the legislation in each jurisdiction, but the common principle is that any entity which is tax resident in these jurisdictions must demonstrate compliance with certain substance tests where the entity undertakes an activity in a “relevant sector”, as defined in each jurisdiction.

The substance tests to be met for entities undertaking activities in a relevant sector include demonstrating that the entity:

  • is “directed and managed” in the jurisdiction of tax residence (including consideration of board meeting attendance and associated documentation);
  • undertakes “core income generating activities” in the jurisdiction of tax residence;
  • has “adequate” people, premises and expenditure in the jurisdiction of tax residence.

The method of compliance differs between each jurisdiction. For instance, the Crown Dependencies will include specific certifications on company tax returns, whereas BVI are updating the Beneficial Ownership Secure Search (“BOSS”) system. Penalties, exchange of information and ultimately potential strike off will arise in cases of non-compliance.

What are some considerations from a family office context?

The concept of substance is not new and family offices have been carefully considering the jurisdictions of their structures for a number of years. These substance rules serve to reinforce the importance of that process and family offices should continue to consider the following points:

  • The first step towards compliance with the substance rules is to identify entities within a structure which are tax resident in one of the EU substance jurisdictions and which undertake an activity in the relevant sector.
  • For many offshore companies, the jurisdiction of tax residence may not have historically been particularly important (as they may not be subject to tax in any event). For many groups, there is a preliminary tax residence review that needs to be undertaken as initial housekeeping before the substance analysis is completed.
  • Holding companies, fund managers, service centres and financing entities are examples of entities undertaking activities in a relevant sector in family office structures.
  • For entities in scope, a review should be undertaken now as the rules have been live since 1 January 2019 and, where issues are identified, remedial actions may be necessary.
  • The rules generally allow outsourcing and therefore consideration of how the family office interacts with the structure (in particular where entities are located in different jurisdictions) forms a key part of this analysis. This may include consideration of the resources provided by third party trust and company service providers.
  • Family offices will probably want to be able to demonstrate (and document) compliance with these rules, in order to avoid the penalties and reputational impact of non-compliance.
  • Many family offices may view these rules as an opportunity to validate the economic substance where they operate, which in any event has been a core focus for a number of years.
  • The global pandemic has of course introduced challenges around the usual operating patterns of some companies. It is important to refer to any specific guidance or relaxations which have been published by some governments to confirm the requirements for the tax return in relevant years.
Economic substance legislation
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