Does your business have substance?

Substance legislation – what’s it all about?

The aim is to ensure that business activity does not simply relocate to a low tax jurisdiction, such as the Isle of Man, without adequate tangible substance behind it. This new global standard means that mobile business income can no longer simply be parked in a low tax jurisdiction.  The legislation will put increasing demand on core business functions being undertaken on Island and for some businesses, this might mean making huge changes.

These substance requirements apply to companies with any income from the following categories of geographically mobile financial and other service activities:

  1. Banking
  2. Insurance
  3. Shipping
  4. Fund Management (this does not include companies that are Collective Investment Vehicles)
  5. Financing & leasing
  6. Headquartering
  7. Distribution and service centres
  8. Holding Companies (a pure equity holding company)
  9. Intellectual Property (for which there are specific requirements in high risk scenarios).

The legislation requires relevant companies to demonstrate that they:

  1. Have substance in the Island by being directed and managed in the Island
  2. Conduct Core Income Generating Activities (CIGA) in the Island
  3. Have adequate people, premises and expenditure in the Island

Is this relevant to your company?

The first question to ask is whether the activities might fall into one of the categories above. You then need to ask a series of questions and the Manx Government have issued a flowchart to assist companies and this can be found “here”.

The legislation is effective for accounting periods commencing 1 January 2019. Of those companies that do not meet the Substance Requirements, expensive sanctions will apply. Compliance reporting will be by way of the Manx company tax return form.

Background

In 2016 the EU Code of Conduct Group were instructed by the EU Council to undertake a screening process whereby jurisdictions, including the Crown Dependencies, were assessed against three tax standards. In respect of two standards (tax transparency and anti-BEPs compliance), no issues were raised in respect of the Crown Dependencies’ standards. However, during the screening process the Code of Conduct Group expressed concern that the Crown Dependencies did not have a “legal substance requirement for entities doing business in or through the jurisdiction”. The Code of Conduct Group were concerned that this “increases the risk that profits registered in a jurisdiction are not commensurate with economic activities and substantial economic presence”

On 22 November 2018 the Assessor of Income Tax issued an Industry Advisory Notice. This sets out the OECD position which is that Manx companies must now meet the ‘Substantial Activities Requirements’. The aim is to ensure that business activity does not simply relocate to a zero tax jurisdiction in order to avoid the Substance Requirements. This new global standard means that mobile business income can no longer be parked in a zero tax jurisdiction without the core business functions having been undertaken by the same business entity, or in the same location.

Very significant penalties can be imposed for non-compliance.

On 11 December 2018 Tynwald approved the Income Tax (Substance Requirements) Order 2018.

References:

Legislation is “here”.

Guidance issued on 20 December 2018 is “here” and on 26 April 2019 is “here”.

Disclaimer:

Professional advice should be taken before taking any action with regard to this article. Harding Lewis Limited and the author do not accept any responsibility for action taken as a result of reading the above article. The above information is relevant at the time of writing on 20 August 2019.

I would urge relevant companies to seek advice about this now, if they have not already done so. Most Manx companies trading locally with no off island customers or connections are likely not to need to be concerned.