Since January 1 of this year, companies registered in offshore jurisdictions such as the British Virgin Islands (BVI) and the Cayman Islands have had to comply with Economic Substance laws. These laws were imposed by the European Union (EU) to address alleged concerns around too much profit with too little substance in low or zero-rate tax jurisdictions.

After reviewing more than 200 countries against their new standard, the EU released a “list of non-cooperative taxation jurisdictions”, broadly categorized into a “black list” and a “grey list”.

As of October 10, eight jurisdictions remain on the “black list” and are potentially liable to sanctions from EU member countries. Thirty-two countries remain on the “grey list”, including jurisdictions popular among Asian clients such as the BVI and Cayman Islands. While grey-listed countries are not liable to any sanctions, they will continue to be monitored by the EU for ongoing efforts in substance compliance.

Many businesses in Asia operate subsidiary companies in jurisdictions such as the BVI and Cayman, which means that any changes to those local laws will inevitably impact Asian companies.

When the substance legislation was first introduced, many clients believed that in order to be compliant, all offshore entities would need to establish substance (i.e. to create a physical presence with employees and premises) in their offshore jurisdiction. To do so would prove challenging for Asian clients since they are operating subsidiaries in jurisdictions thousands of miles away.

Fortunately, we now understand this is not the case for many businesses: in-jurisdiction substance will only be required if entities are conducting one or more of nine “relevant activities”, including:

1)    Holding business

2)    Distribution and service centre business

3)    Shipping business

4)    Intellectual property business

5)    Headquarter business

6)    Financing and leasing business

7)    Fund management business

8)    Insurance business

9)    Banking business

It is important to note that holding is defined narrowly as ”pure equity holding”, i.e. only holding (generally a controlling interest of) shares in another company. Companies holding physical assets, such as real estate, vessels, investment portfolios, and bank accounts will generally not be required to establish substance unless they conduct another one of the listed “relevant activities”.

The level of substance required for different “relevant activities” also varies considerably. The aforementioned “pure equity holding entities” are subject to a light degree of substance requirement, which will be easy to fulfill, while intellectual property entities are expected to demonstrate heavy amounts of substance, which may involve onerous work for clients. It is also important to note that while “fund management” businesses fall within the legislation, “investment funds” are currently exempt from it.

Regardless of which category your entity falls under and the extent of substance you may need to establish, if any, it is crucial that companies conduct a detailed assessment of their business nature and activities as soon as possible; and document any measures taken. 

Ultimately, it is critical to bear in mind that nuanced differences exist in the way different jurisdictions implement their economic substance laws and that these legislative “rules” and “guidance notes” should be perceived as living documents, which may be subject to further review and changes in the future.

For now, Asian businesses should stay informed about the substance laws, and keep themselves abreast of any developments in the legislative scope and filing requirements. It is crucial for companies to maintain good corporate governance, as it is likely that in-jurisdiction authorities will require proof of an entity’s substance status in the reporting process.

Our advice is for clients to obtain a professional assessment of their entity’s standing, specifically by obtaining a classification report or legal opinion from their service provider.

Upon gaining a clear understanding of whether they need to establish actual “substance” or if they simply have to make minor adjustments to reporting practices, companies can then proceed to maintain their offshore operations, enjoy relevant benefits and carry on conducting business as usual. 

Simon Filmer is global lead, company formation, Vistra.