A new layer of compliance designed to clamp down on the use of ‘international finance centres’ by multinational companies as low or no tax jurisdictions has been added to the already increasingly complex offshore world.
These jurisdictions have traditionally competed for business by offering attractive tax rates to corporates without any specific requirement for the companies to have adequate business operations there.
However, this world has changed with the introduction of economic substance legislation in these jurisdictions, says Hanneke Farrand, director at ENSafrica’s private client and tax practice. She was speaking at the annual Tax Indaba hosted by the South African Institute of Tax Professionals.
Farrand says the new legislation focuses mainly on globally mobile businesses with activities in, among others, banking, insurance, intellectual property, fund management, distribution or service centres and shipping.
The requirements have been in place since the start of the year. Companies were given six months to become compliant or face fines starting at £3 000 for the first year, moving up to £100 000.
Jurisdictions that do not comply face being “blacklisted” by the European Union (EU), which creates reputational risk. They also risk forced exchange of the financial information of the companies in their jurisdiction to other revenue authorities where the companies or their directors could be tax resident.
Non-compliant companies also face being struck off the companies register in the jurisdiction in which they have set up business if they do not adhere to the new requirements set out in the legislation.
Farrand says the main thrust is to ensure that the income generated in a country correlates with the activities and operations conducted in these jurisdictions.
‘Letter box’ or ‘brass plate’ companies – where directors and board members fly in to conduct board meetings, but where no substantial activities take place in the jurisdiction – will not be considered compliant under the new rules.
Money laundering in the crosshairs
Farrand says the offshore tax world has changed considerably over the past five to 10 years in order to ensure greater transparency and prevent money laundering activities.
The EU and the Organisation for Economic Cooperation and Development (OECD) have been introducing measures such as country-by-country reporting and the automatic exchange of information between tax authorities to curb base erosion and profit shifting.
The Forum on Harmful Tax Practices agreed to level the playing field and introduced the substance requirement in order to allow countries to become OECD framework members and to stay off the EU’s tax haven black list.
According to Cynthia Fox, KPMG’s associate director in international tax, nine jurisdictions introduced the economic substance legislation at the start of this year in order to avoid reputational damage and to meet their commitment to the EU.
These jurisdictions include Mauritius, the Cayman Islands, Bermuda, Jersey, Guernsey, the Seychelles and the British Virgin Islands.
Fundamantals and variances
Farrand says the fundamental scope and principles of the different pieces of legislation will be the same in all jurisdictions. However, there will be different applications depending on the sector and how mobile the business is.
On the Isle of Man, for example, adequate economic substance requires that a company be directed and managed on the island and that it have a number of qualified employees proportionate to the level of activities.
“There must be a correlation between your employees and your activities and there must be a correlation between your expenses and your operations,” says Farrand.
On top of that there must be an adequate physical presence, and the company must conduct “core income generating activities” on the isle.
It is not uncommon to see non-compliant companies having their bank accounts closed, she adds.
“The risk of non-compliance is no longer just a tax audit,” Farrand warns. Companies risk having their accounts closed and the business will be struck off the company register.
“The economic substance rules are a continuation of the wave of increased governance and compliance.”
The following jurisdictions areecurrently blacklisted by the EU: American Samoa, Belize, Domenica, Fiji, Guam, the Marshall Islands, Oman, Samoa, Trinidad and Tobago, the United Arab Emirates, the US Virgin Islands and Vanuatu.
Being on a blacklist means the jurisdiction is considered to be an uncooperative tax haven. Landing on the grey list means there is some commitment to introducing legislation that will meet EU requirements.
According to Fox, Aruba was removed from the blacklist in May, and Barbados and Bermuda were moved to the grey list.