Global Implications For Offshore Financial Centres And Companies In The Wake Of EU Requirements For Economic Substance

Introduction

The first quarter of 2019 has seen the passage of economic substance legislation in most offshore financial jurisdictions. This uniform adaptation of legislation can be traced to adoption by the European Union's Economic and Financial Affairs (ECOFIN) Council of the 2015 OECD recommendations1 to address tax base erosion and profit shifting. At its meeting in May 2016, ECOFIN decided to establish a list of non-cooperative jurisdictions for tax purposes.2 Council conclusions regarding the criteria for inclusion on the list followed in November 2016,3 and further conclusions were made in December 2017,4 when the work of the Code of Conduct Group on Business Taxation (CCG) in determining the relevant jurisdictions and analyzing and assessing their tax legislation was approved.

The upshot of this is that jurisdictions that did not meet the criteria established by ECOFIN and the CCG are placed on a list of non-cooperative jurisdictions until they meet the criteria. The criteria in question are broadly divided into three categories: transparency, fair taxation, and anti-Base Erosion and Profit Sharing (BEPS)5. It is this last category, anti-BEPS, from which the requirements for entities in a jurisdiction to show "real economic activity" and meet substantial economic presence tests derive.

In response to the EU's requirement that jurisdictions listed in its Annex II, that is, jurisdictions that have not met all of the EU's tax criteria but have given commitments to comply, economic substance legislation was passed. This list includes offshore jurisdictions such as Bermuda, British Virgin Islands, the Cayman Islands, Guernsey, and Jersey. In this article, the focus will be the British Virgin Islands, the Cayman Islands, and Jersey.

Since the genesis of the economic substance legislation for all these jurisdictions is the same, it is no surprise that the framework for legislation in each jurisdiction follows a similar pattern. The general framework requires entities claiming tax residence in an offshore jurisdiction to demonstrate that the entity has "economic substance" in that jurisdiction. However, only certain "relevant entities" that are conducting or engaging in "relevant activities" are required to demonstrate economic substance.

Since the genesis of the economic substance legislation for all these jurisdictions is the same, it is no surprise that the framework for legislation in each jurisdiction follows a similar pattern. The general framework requires entities claiming tax residence in an offshore jurisdiction to demonstrate that the entity has "economic substance" in that jurisdiction. However, only certain "relevant entities" that are conducting or engaging in "relevant activities" are required to demonstrate economic substance

Relevant/in-scope entities

Each jurisdiction identifies the type of entity that may be subject to the economic substance requirements. In all jurisdictions, companies incorporated in that jurisdiction, as well as foreign companies registered in that jurisdiction, are potentially caught by the economic substance legislation.

Broadly speaking, companies operating in jurisdictions with economic substance legislation are caught by the legislation but only to the extent that they are tax resident in the jurisdiction in question.

In the British Virgin Islands, all BVI companies are considered "legal entities" and are subject to the...

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