The drive to put a stop to unfair tax competition has led to some important legal changes in Europe.
Sustained international pressure to ensure that businesses pay a ‘fair’ amount of tax in each of the jurisdictions in which they operate, has led to the EU taking action.
It is screening 92 jurisdictions against internationally recognised good governance criteria, to determine which to include on the EU blacklist of non-cooperative tax jurisdictions.
The EU blacklist1 is used for applying sanctions to jurisdictions seen to be promoting unfair tax competition; in other words, ‘tax havens’.
This has led to new legislation to ensure companies and certain other entities incorporated in such ‘tax havens’ have sufficient ‘substance’, either in the jurisdiction where they are incorporated, or another jurisdiction where they are tax resident. This is to discourage the use of ‘brass plate’ companies and nominee directors, which are seen to represent unfair tax practices.
The new legislation only applies to entities incorporated or registered in a relevant tax haven location which carry on a ‘relevant activity’. These include: banking, insurance, shipping, fund management, financing and leasing, headquarters, distribution and service centres, holding companies and intellectual property.
The economic substance requirements broadly cover three areas:
- The business must be directed and managed in the relevant jurisdiction. In other words, adequate, frequent board meetings must be physically held in the jurisdiction involving directors with the necessary knowledge and/or expertise to fulfil their obligations.
- Core income generating activities must be carried out in the jurisdiction. For example, taking relevant management decisions; incurring expenditure on behalf of group entities; and co-ordinating group activities.
- In the relevant jurisdiction, there is a requirement for adequate levels of: physical assets and/or premises; expenditure proportionate to the activities of the company; and qualified employees to fulfil the company’s business needs.
What does this mean in practice?
Jurisdictions applying the new rules have stated that sanctions, generally in the form of financial penalties or dissolution, will be applied to businesses that do not comply with the economic substance requirements.
Businesses operating in such jurisdictions should consider whether they carry on a relevant activity and, if so, review the entity’s substance requirements in line with the substance legislation in the territory in question and address any gaps.
Companies are advised to revisit relevant corporate structures in the light of the economic substance rules and evaluate how the business operates across jurisdictions.
An overall tax risk assessment is recommended, given the changing international taxation framework and its potential impact on an international business in a number of areas.
Saffery Champness has prepared a detailed briefing on economic substance requirements in Guernsey, which you can read here.
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Date: July 2019