Introduction
Overview
Recent reforms
Updated guidance
Along with its fellow Crown dependencies and overseas territories, the Cayman Islands now has comprehensive economic substance legislation, under which in-scope entities that carry on particular activities must demonstrate economic substance in the Cayman Islands. These requirements have been effective since 1 January 2019 and are governed by the International Tax Cooperation (Economic Substance) Law (2020 Revision), as amended by the International Tax Cooperation (Economic Substance) (Amendment) Law 2020 (Amendment Law) and the International Tax Cooperation (Economic Substance) (Amendment of Schedule) Regulations 2020 (Amendment Regulations and together the Economic Substance Law).
The Tax Information Authority (TIA), which is responsible for monitoring and enforcing the substance requirements in the Cayman Islands, publishes guidance on the Economic Substance Law. On 13 July 2020 the TIA published the latest guidance on economic substance for geographically mobile activities (updated guidance).
This article discusses the substance regime in place in the Cayman Islands and highlights the key changes and practice points referenced in the Amendment Law, the Amendment Regulations and the updated guidance.
TIA
As stated under the Amendment Law below, all Cayman entities must make an annual report to the TIA as to whether they are carrying on one or more of a defined list of activities (relevant activities) and, if so, whether they are a 'relevant entity' (as defined in the Economic Substance Law), together with certain prescribed information as set out below. A relevant entity that is carrying on a relevant activity must submit a subsequent report to the TIA within 12 months of the end of its financial year, containing certain prescribed details and demonstrating how it has satisfied the economic substance test set out in the Economic Substance Law. The TIA is then responsible for determining whether a relevant entity has satisfied the economic substance test based on the evidence that it provides.
Relevant entities
Relevant entities include most Cayman-exempted companies (including foundation companies – see below), Cayman limited liability companies, Cayman limited liability partnerships and registered foreign companies, except:
- investment funds and entities through which investment funds directly or indirectly invest or operate;
- entities which are tax resident outside the Cayman Islands;
- entities which are authorised to carry on business locally in the Cayman Islands as domestic companies; and
- Cayman-exempted limited partnerships and trusts.
Relevant activities
All Cayman entities must state in their annual return whether they have conducted any relevant activities in the preceding financial period. 'Relevant activities' are:
- fund management;
- banking;
- insurance;
- finance and leasing;
- distribution and service centre business;
- headquarters business;
- IP business;
- shipping business; and
- holding company business.
Economic substance test
Relevant entities that carry on relevant activities must satisfy the economic substance test and must therefore:
- conduct core income-generating activities (CIGAs) in relation to the relevant activity in the Cayman Islands;
- be directed and managed in an appropriate manner in the Cayman Islands; and
- having regard to the level of 'relevant income' (ie, gross income recorded in their books and records under applicable accounting standards) derived from the relevant activity carried out in the Cayman Islands:
- incur an adequate amount of operating expenditure in the Cayman Islands;
- have an adequate physical presence (including maintaining a place of business or plant, property and equipment) in the Cayman Islands; and
- have an adequate number of full-time employees or other personnel with appropriate qualifications in the Cayman Islands.(1)
The Amendment Law, which came into force on 12 February 2020, was introduced primarily to expand Section 7 of the Economic Substance Law, which relates to the requirement for relevant entities to provide information to the TIA. The framework around the circulation of information in relation to relevant entities which are tax resident or incorporated in a foreign jurisdiction has also been elaborated.
Requirement to provide information
Prior to the Amendment Law, a relevant entity had to annually notify the TIA whether:
- it was carrying on a relevant activity; and
- the gross income generated by this relevant activity was taxable in a foreign jurisdiction.
Under the Amendment Law, all entities must now provide prescribed information, not only relevant entities. Entities must now confirm not only whether they are conducting a relevant activity, but also whether they are relevant entities for the purpose of the Economic Substance Law. Entities that are carrying on a relevant activity and are tax resident outside the Cayman Islands must provide the additional information listed below. Relevant entities are now also expected to share with the TIA their financial year end together with the name and address of the officer responsible for providing information to the TIA.
Requirement to provide information – outsourcing
A relevant entity can satisfy the economic substance test in relation to a relevant activity if it outsources the relevant CIGA to another person in the Cayman Islands and can monitor and control the carrying out of the CIGA by that other person. The Amendment Law provides that the person to which the CIGA is outsourced may be required to verify within 30 days the information relating to its services which the relevant entity has provided to the TIA.
Failure to share information with the TIA
The Amendment Law provides for penalties to be imposed on relevant entities which fail to comply with their obligation to report to the TIA under the Economic Substance Law. A relevant entity which fails to send its economic substance test report will be notified by the TIA of such failure and will be fined CI$5,000, with an additional fine of CI$500 accruing for each day that the failure to comply continues. Such penalty must be settled within 30 days of the day on which it is due and can be appealed to the Grand Court, where it may be affirmed, reversed or substituted by a penalty of the court.
In addition, on 7 July 2020 the Tax Information Authority (Amendment) Law 2020 (TIA Amendment Law) came into force, providing additional powers to the TIA to assist with its monitoring of compliance with certain laws and regulations relating to its function, including the power to examine the affairs or business of any person by:
- conducting on-site inspections;
- auditing reports and annual returns; and
- collecting and sharing statistical data.
The TIA Amendment Law also provides for enhanced collaboration between the competent authority and other government entities – for example, the Cayman Registrar of Companies and the Cayman Islands Monetary Authority (CIMA) – under appropriate legal channels. Lastly, the TIA Amendment Law introduces a summary offence of knowingly or wilfully submitting false or misleading information to the authority. The offence attracts a fine of CI$10,000, up to five years' imprisonment or both.
New information framework for relevant entities tax resident or incorporated overseas
The Amendment Law provides that relevant entities which are tax resident outside the Cayman Islands must supply to the TIA:
- the name and address of their immediate parent, ultimate parent and ultimate beneficial owner and any other information reasonably required to identify their immediate parent, ultimate parent and ultimate beneficial owner;
- the date of the end of their financial year; and
- the jurisdiction in which they are claiming to be tax resident and any other information as may reasonably be required to support that claim.
The Amendment Law created new information-sharing obligations for relevant entities that are liable to tax or established outside the Cayman Islands. Where the TIA has been provided with information under the Economic Substance Law in relation to a relevant entity which is tax resident outside the Cayman Islands, it will share that information with the competent authority in the relevant jurisdictions of:
- the relevant entity; and
- the immediate parent, ultimate parent and ultimate beneficial owner of the relevant entity.
Where a relevant entity is incorporated in a foreign jurisdiction, the TIA will provide the same information to the competent authority of the jurisdiction where the relevant entity is incorporated.
In light of the above, the TIA has updated its guidance on the application of the Economic Substance Law. In addition, the updated guidance provides further clarifications regarding certain existing provisions within the Economic Substance Law.
TIA's power to monitor and investigate circumventions
The TIA confirmed in its updated guidance that it will monitor compliance with the Economic Substance Law, including monitoring and investigating arrangements created specifically to circumvent obligations under that law, such as mechanisms set up by relevant entities to manipulate or artificially suppress their income in order to circumvent substance requirements.
New detailed sector-specific guidance
The updated guidance includes more-detailed sector-specific guidance. Each sector now benefits from a more comprehensive scrutiny of its status under the Economic Substance Law in respect of whether it is a relevant entity and whether it carries on a relevant activity. The updated guidance now also includes concrete sector-specific examples.
As an illustration, the updated guidance provides extended definitions and examples of financing and leasing business activities that could be within the scope of the Economic Substance Law. The TIA explains that the activity of providing credit facilities for any kind of consideration is considered in scope, except for certain businesses which are listed therein. As such, an entity which provides credit facilities to customers and charges an interest rate or a lending fee is considered a relevant entity carrying on a relevant activity, even if the action of providing credit facilities is separate from the consideration (eg, where a loan advanced for consideration by one company is transferred to another company which will receive the interest rate). Intragroup loans will also fall within the scope of financing and leasing business where they are interest bearing. The updated guidance also provides a list of activities which would not be considered relevant activities, especially when these are incidental (ie, occasional, minor and without any profit-making purpose).
Exception of investment funds and applicability to private funds
The updated guidance confirms that private funds which are registered with CIMA for the purpose of the Private Funds Law (Revised) are regarded as investment funds for the purpose of the Economic Substance Law and will therefore benefit from the relevant exception (ie, will not have to satisfy the economic substance test).
Cayman insurers acting as controlled foreign corporations under US Internal Revenue Code
The new sector-specific guidance also provides that a Cayman insurer that is electing itself to be liable for tax in the United States under the Internal Revenue Code as if it were a US corporation will be considered as tax resident outside the Cayman Islands and will therefore not be a relevant entity for the purpose of the Economic Substance Law, which will exempt it from the substance obligations contained therein. However, such company must submit to the TIA proof of its tax election by providing, for example, a tax identification number or evidence of payment of tax to the US Internal Revenue Service.
Foundation companies
On 10 July 2020 the Amendment Regulations were published. These regulations removed the reference to Section 9 of the Companies Law from Part (b) of the definition of 'domestic company' so that companies limited by guarantee are no longer automatically classified as domestic companies unless they otherwise satisfy the criteria for a domestic company. As mentioned above, domestic companies are not relevant entities.
Accordingly, absent another exception, a Cayman foundation company that is a company limited by guarantee is a relevant entity and, if it conducts a relevant activity, must now satisfy the economic substance test.
For further information on this topic please contact Bradley Kruger at Ogier by telephone (+1 345 949 9876) or email ([email protected]). The Ogier website can be accessed at www.ogier.com.
