Update on Economic Substance requirements in the Cayman Islands

1 September 2020

The Cayman Islands, along with fellow Crown Dependencies and Overseas Territories, currently has comprehensive economic substance legislation in place requiring entities to report to the Tax Information Authority (“TIA”) whether or not they are carrying on one or more specific activities defined in the legislation.  These requirements came into effect on 1 January 2019 and are encapsulated in the International Tax Co-operation (Economic Substance) Law (2020 Revision) as amended by the International Tax Co-operation (Economic Substance) (Amendment) Law, 2020 and the International Tax Co-operation (Economic Substance) (Amendment of Schedule) Regulations, 2020 (collectively, the “ES Law”).

This newsletter discusses the economic substance requirements in place in the Cayman Islands as well as key changes in the ES Law and the Updated Economic Substance Guidance Notes issued by the TIA on 13 July 2020.

You can review all legislation related to economic substance here: Legislation and Resources

Overview of Economic Substance requirements in the Cayman Islands

What is the role of the TIA?

The TIA is responsible for monitoring and enforcement of, and issuing guidance on, the ES Law in the Cayman Islands.  All Cayman-based “relevant entities” must make an annual filing to the TIA as to whether or not they are carrying on one or more “relevant activities”.  If a relevant entity is carrying on at least one relevant activity, it must submit a report to the TIA, within 12 months of its financial year end, providing certain prescribed information and demonstrating how the relevant entity has satisfied the economic substance test (“ES Test”) set out in the ES Law.  The TIA will review the report and make a determination as to whether or not the relevant entity has satisfied the ES Test.

Is it a Relevant Entity?

The ES Law imposes reporting obligations on the following entities, which are considered relevant entities:

  1. A company that is:
  1. Incorporated under the Companies Law (2020 Revision);
  2. An LLC registered under the Limited Liability Companies Law (2020 Revision);
  1. An LLP registered in accordance with the Limited Liability Partnership Law, 2017; or
  1. A company incorporated outside of the Cayman Islands and registered under the Companies Law (2020 Revision);

But does not include the following excluded entities (“Excluded Entities”):

  1. Investment funds, including the following which are regarded by the TIA as investment funds:
    1. entities through which an investment fund directly or indirectly invests or operates;
    2. Mutual Funds licensed or regulated with the Cayman Islands Monetary Authority (“CIMA”); or
    3. Private Funds registered with CIMA under the Private Funds Law, 2020;
  2. An entity that is tax resident outside the Cayman Islands;
  3. Domestic companies (ordinary resident companies);
  4. Cayman exempted limited partnerships;
  5. Trusts; or
  6. Associations not for profit.

Is the Relevant Entity conducting a Relevant Activity?

All Cayman entities must report to the TIA whether or not they have conducted any relevant activities during the 12 months from the financial year end.  Relevant activities includes each of the following:

  1. Banking business;
  2. Distribution and service centre business;
  3. Financing and leasing business;
  4. Fund management business;
  5. Headquarters business;
  6. Holding company business
  7. Insurance business;
  8. Intellectual property business; or
  9. Shipping business.

What are the requirements of the ES Test?

A relevant entity conducting at least one relevant activity satisfies the ES Test, if the relevant entity:

  1. Conducts core income generating activities (“CIGA”) from within the Cayman Islands in relation to that relevant activity;
  2. Is directed and managed appropriately from within the Cayman Islands; and
  3. Having regard to the level of relevant income derived from the relevant activity carried out from within the Cayman Islands:
  1. Has an adequate amount of operating expenditure incurred in Cayman;
  2. Has an adequate physical presence in Cayman; and
  3. Has an adequate number of full-time employees or other personnel with appropriate qualification in Cayman.

Recent amendments to the ES Law

The International Tax Co-operation (Economic Substance) (Amendment) Law, 2020 (“Amendment Law”) came into force on 12 February 2020.  This amendment expanded the requirements for relevant entities to provide information to the TIA and elaborated on the framework used to circulate information regarding relevant entities which are tax resident or incorporated outside the Cayman Islands.

What is the requirement to provide information?

Prior to the Amendment Law – a relevant entity had to report to the TIA annually (i) whether it was carrying on a relevant activity and (ii) if the gross income generated by such relevant activity was taxable in a foreign jurisdiction.

Current requirementall entities, not just relevant entities, must provide prescribed information to the TIA.  Such information includes:

  1. Whether or not the entity is conducting a relevant activity.
  2. Whether or not the entity is a relevant entity for the purposes of the ES Law.
  3. Entities carrying on a relevant activity that are tax resident outside the Cayman Islands must provide the information listed below*.
  4. Relevant entities must provide the TIA with the financial year end and the name and address of the officer responsible for reporting to the TIA.

AMS Financial Group requested confirmation of (a)-(d) above from existing entities which was reported to the TIA.  New entities are required to provide the same information.

What is the requirement to provide information regarding outsourcing?

Prior to the Amendment Law – a relevant entity satisfied the ES Test in relation to a relevant activity by outsourcing relevant CIGA to another person in Cayman and if the relevant entity is able to monitor and control the carrying out of that CIGA by that other person.

Current requirement – The TIA has the power to request that the person carrying out the outsourced CIGA verify, within 30 days, the information relating to the relevant entity’s services, which was previously submitted to the TIA by the relevant entity itself.

Where AMS Financial Group provides outsourcing, we will notify you if we are requested by the TIA to make such verification.

*What new information must relevant entities tax resident or incorporated outside the Cayman Islands provide?

Current requirement – the following information must be provided to the TIA:

  1. The name and address of the immediate parent, ultimate parent and ultimate beneficial owner and any other information reasonably required to identify the same;
  2. The date of the financial year end; and
  3. The jurisdiction the entity claims to be tax resident in and supporting evidence thereof.

AMS Financial Group requested confirmation of (a)-(c) above from entities which are tax resident or incorporated outside the Cayman Islands which was reported to the TIA.  New entities are required to provide the same information.

The TIA will share the above information relating to relevant entities that are tax resident or incorporated outside the Cayman Islands with the competent authority in the relevant jurisdictions of the relevant entity and its immediate parent, ultimate parent and ultimate beneficial owner.

The Updated Economic Substance Guidance Notes

The TIA has updated its Guidance Notes to reflect the changes discussed above as well as to clarify existing provisions in the ES Law, as summarized below:

  1. TIA’s power to monitor and investigate circumventions – The TIA will monitor compliance with the ES Law including arrangements created specifically to avoid compliance with the ES Law.
  2. Sector specific guidance – More detailed sector specific guidance and examples are included in the updated Guidance Notes to give entities more clarity on whether or not their business activities constitute relevant activities for the purposes of compliance with the ES Law.  Guidance on activities which do not constitute relevant activities due to being incidental, i.e. occasional, minor and without profit-making purpose is also included.
  3. Exception of Investment Funds and non-applicability to Private Funds – Private Funds registered with CIMA are regarded as investment funds for the purposes of the ES Law and are therefore not required to satisfy the ES test.
  4. Cayman Insurance Companies acting as controlled foreign corporations under the US Internal Revenue Code – Cayman insurance companies that elect to be liable for tax in the USA as if it were a US Corporation are considered tax resident outside the Cayman Islands and therefore do not meet the requirements of a relevant entity for the purposes of the ES Law.  Evidence of such tax election must be provided to the TIA.
  5. Foundation Companies – a Cayman Foundation Company will be regarded as a relevant entity for the purposes of the ES Law and must therefore satisfy the ES Test.

AMS Financial Group can assist you with navigating the new Economic Substance Guidance to ensure your business is compliant.

Registration and Key Dates

  • Relevant entities conducting a relevant activity in existence before 1 January 2019 must have satisfied the ES Test in relation to its relevant activity from 1 July 2019.  See Figure 2 below outlining the timetable for these entities.
  • Relevant entities conducting a relevant activity in existence after 1 January 2019 must submit a report to the TIA demonstrating compliance with the ES Test within 12 months of the financial year end.  See Figure 3 below outlining the timetable.

Penalties

  • Relevant entity fails to submit proof of satisfaction of the ES Test to the TIA – KYD$5,000 fine, with an additional KYD$500 accruing each day the failure continues.  The fine must be paid within 30 days and can be appealed to the Grand Court.
  • Relevant entity fails to satisfy the ES Test – KYD$10,000 fine following issuance of a notice to direct the relevant entity to take action to satisfy the ES Test.  If the notice is not complied with in the subsequent financial year an application for a court order to require the entity to take specific action, to declare the entity defunct or for the entity to be struck off.

Please contact David Fiebig at david.fiebig@amsfinancial.com or 517-213-8096 to discuss how the Economic Substance requirements and recent amendments may affect your business and how AMS Financial Group can assist you with compliance.

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