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New economic substance requirements

Certain low tax jurisdictions including the Crown Dependencies and British Overseas Territories have recently introduced economic substance requirements. The driver for this is an EU Code of Conduct which aims to curb harmful tax competition within the EU and also promotes the adoption of its principles by other jurisdictions by "blacklisting" those which do not comply. One such principle is that jurisdictions should not facilitate offshore structures or arrangements aimed at attracting profits which do not reflect real economic activity in the jurisdiction. In other words, companies should have real economic substance in the jurisdiction in which they are resident.

As a result, countries such as the Channel Islands, BVI, Cayman Islands and Bermuda have introduced domestic legislation to ensure that various structures meet an economic substance test with effect from 1 January 2019. The precise details vary from country to country and should always be checked but, in general, certain types of finance/investment/intellectual property businesses and holding companies are subject to these rules. They require companies resident in their country to be managed and directed there, have staff and physical presence of an appropriate size and nature and to carry out core income generating activities in that jurisdiction. The requirements for holding companies are sometimes easier to meet than for other types of company and this in itself can be problematic. The EU has, for instance, already suggested that the economic substance tests proposed by the Bahamas in relation to holding companies are not sufficient and has threatened to include the Bahamas on its list of non-cooperative jurisdictions.

It remains to be seen how workable these new rules will be in practice and the impact they will have on business in these jurisdictions. Early indications suggest that some of the arrangements which were put in place may be open to challenge by the EU as not going far enough to meet their requirements. On 12 March 2019, the EU updated its blacklist of non-co-operative jurisdictions, adding ten new countries including Bermuda, and although the Cayman Islands escaped inclusion for now it will need to amend aspects of its economic substance legislation by the end of 2019.

March 2019

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240 Blackfriars Road
London
SE1 8NW
DX 53 Chancery Lane

Telephone: +44 (0)20 7629 7411
Fax: +44 (0)20 7629 2621
Email: bh@boodlehatfield.com

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