Cayman Islands: economic substance requirements

In line with other United Kingdom’s dependent territories such as British Virgin Islands (BVI), Bermuda, Jersey, Guernsey and Isle of Man, on 1 January 2019 Cayman Islands has enacted legislation on economic substance for legal entities. 30 April 2019 the official document that regulates some issues of application of the new legislation named  Guidance on Economic Substance For Geographically Mobile Activities version 2.0 (the Guidance) which replaced version 1.0 of the same document dated 22 February 2019 has been adopted.

Scope of economic substance requirements

Economic substance requirements are applicable to:

1. companies of different legal forms and partnerships incorporated in Cayman Islands;
2. foreign companies and partnerships registered in Cayman Islands in accordance with relevant legislation.

The following entities are exempt from economic substance requirements:

1. entities (including those incorporated in Cayman Islands) tax resident in foreign jurisdictions. Such entities are obliged to prove their status of tax resident in foreign jurisdiction by provision of tax residency certificate or document of payment of tax. As distinct from BVI, the Tax Identification Number issued for Cayman Islands company in any foreign jurisdiction may be sufficient evidence of foreign tax residency. The fact that such foreign jurisdiction has been blacklisted by any state is not taken into account;
2. domestic companies (i.e.entities that carry on business only within Cayman Islandsand are tax resident inCayman Islands for tax purposes);
3. investment funds. According to legal definition, investment fund is “an entity whose principal business is the issuing of investment interests to raise funds or pool investor funds with the aim of enabling a holder of such an investment interest to benefit from the profits or gains from the entity’s acquisition, holding, management or disposal of investments and includes any entity through which an investment fund directly or indirectly invests or operates (but not an entity that is itself the ultimate investment held)”, but does not include a person with banking or insurance license.

Essence of economic substance requirements

Economic substance requirements are applicable starting from 1 July 2019 only to companies that conduct relevant activities. This requirement is as follows:

• Company must conduct core income generating activities in relation to any relevant activity in the territory of Cayman Islands on their own or through an outsourcing agent;
• Company must be directed and managed in an appropriate manner from the territory of Cayman Islands in relation to its relevant activity. It means that:
  1. company’s board of directors, as a whole, has the appropriate knowledge and expertise to discharge its duties as a board of directors;
  2. meetings of the board of directors are held in Cayman Islands at adequate frequencies given the level of decision making required;
  3. there is a quorum of directors present in Cayman Islands during the meetings;
  4. the minutes of those meetings record the making of strategic decisions of the company at the meeting; 
  5. it keeps all such director meeting minutes and appropriate records in Cayman Islands.
• With respect to the level of income derived from the relevant activity carried out in Cayman Islands –
  1. company must have an adequate amount of operating expenditure incurred in Cayman Islands;
  2. company must have an adequate physical presence (including maintaining a place of business or plant, property and equipment) in Cayman Islands; 
  3. company must have an adequate number of full-time employees or other personnel with appropriate qualifications in Cayman Islands.

Such term as “adequate” is not measured by any particular number or proportion and is defined as

“as much or as good as necessary for the relevant requirement or purpose”.

Holding companies are subject to simplified economic substance requirements which include only two parameters:

1. registration of a company in accordance with the relevant legislation;
2. adequate number of employees and adequate premises in the territory of Cayman Islands.

In its turn, enhanced economic substance rules are applicable to high risk companies that conduct intellectual property (IP) business. High risk status must be attributed to any IP company which:

1. did not create an IP asset that it holds for the purposes of its business;
2. acquired the IP asset from an entity in the same group or in consideration for funding research and development by any foreign person;
3. licences the IP asset to one or more affiliates or otherwise generates income from the asset in consequence of activities performed by affiliates of the same group;

Such enhanced economic substance requirements are:

1. high degree of control over development, exploitation, maintenance, protection and enhancement of the IP asset, exercised by full-time employees who permanently reside in Cayman Islands;
2. provision of detailed business plans, employee information and evidence that decision making is taking place within Cayman Islands to public authorities responsible for monitoring of compliance with economic substance rules.

Relevant activities and core income generating activities

As it was mentioned previously, economic substance requirements are applicable only to companies that carry on relevant activities, which, in their turn, are subdivided onto core income generating activities. Generally, Cayman Islands legislation and Guidance establish the list of relevant and core income generating activities identical in its structure and essence to one of BVI.

Relevant activity	Legal definition of relevant activity	Core income generating activities
Banking business	Business of receiving and holding on current, savings, deposit or other similar account money which is repayable by cheque or order and may be invested by way of advances to customers or otherwise	raising funds, managing risks including credit, currency and interest risk; taking hedging positions; providing loans, credit or other financial services to customers; managing capital and preparing reports to investors and/or public authorities
Distribution and service center business	Business of purchasing from an entity in the same group component parts or materials for goods or goods ready for sale, and reselling such component parts outside Cayman Islands, materials or goods, and providing services to an entity in the same group in connection with the business outside Cayman Islands	transporting and storing goods, components and materials; managing stocks; taking orders; providing consulting or other administrative services
Financing and leasing business	Business of providing credit facilities for any kind of consideration to another person but does not include financial leasing of land or an interest in land, banking business, fund management business or insurance business	negotiating or agreeing funding terms; identifying and acquiring assets to be leased; setting the terms and duration of financing or leasing; monitoring and revising financing or leasing agreements and managing risks associated with such financing or leasing agreements
Fund management business	Business of managing securities carried on by a relevant entity licensed or otherwise authorized to conduct such business	taking decisions on the holding and selling of investments; calculating risk and reserves; taking decisions on currency or interest fluctuations and hedging positions; preparing reports to investors and/or public authorities
Headquarters business	Business of providing any of the following services to an entity in the same group – a) the provision of senior management; b) the assumption or control of material risk for activities carried out by any of those entities in the same Group; or c) the provision of substantive advice in relation to control of such risks	taking relevant management decisions; incurring expenditures on behalf of other group entities; co-ordinating group activities
Holding company business	Business that is comprised exclusively of holding equity participations in other entities and earning dividends and capital gains only	No core income generating activities prescribed
Insurance business	Business of accepting risks by effecting or carrying out contracts of insurance, whether directly or indirectly, and includes running-off business including the settlement of claims	predicting or calculating risk or oversight of prediction or calculation of risk; insuring or re-insuring against risk; preparing reports or returns, or both, to investors and/or public authorities
IP business	Business of holding, exploiting or receiving income from intellectual property assets (i.e. intellectual property right including a copyright, design right, patent and trademark)	If the company is not a high risk IP business company: research and development in case of patent or an asset that is similar to a patent;  branding, marketing and distribution in case of non-trade or intangible asset (including a trademark)
Shipping business	Activities involving the operation of a ship anywhere in the world other than in the territorial waters of Cayman Islands, such as: the business of transporting, by sea, passengers or animals, goods or mail for a charge; the renting or chartering of ships for the purpose described in paragraph (a); the sale of travel tickets and ancillary ticket related services connected with the operation of a ship; the use, maintenance or rental of containers, including trailers and other vehicles or equipment for the transport of containers, used for the transport of anything by sea; the functioning as a private seafarer recruitment and placement service	managing crew (including hiring, paying and overseeing crew members); overhauling and maintaining ships; overseeing and tracking deliveries; determining what goods to order and when to deliver them, organizing and overseeing voyages

The list of core income generating activities in relation to each relevant activity is not exhaustive or limiting,and particular actions that result in income generating and form relevant activity will be analyzed in practice individually for each company.

Economic substance reporting

As opposite to BVI, obligations to report compliance with economic substance rules are conferred directly to companies, not to their registered agents. The required documents are to be submitted to public authorities directly by companies.

Starting in 2020 Cayman Islands companies must submit notification of economic substance to public authority named Tax Information Authority (TIA). The notification must contain the following information:

1. whether company carries on any relevant activity;
2. if company is carrying on a relevant activity, whether or not all or any part of the company’s gross income in relation to the relevant activity is subject to tax in a foreign jurisdiction;
3. the date of the end of company’s financial year.

Deadlines and form of the notification will be clarified by TIA additionally. It is expected that special internet platform which enables uploading of notifications in electronic form to database will be developed.

In addition to this, Cayman Islands companies must submit economic substance report to TIA in 12 months after financial year’s end date and include the following information in it:

• the type of relevant activity;
• the amount and type of income in respect of the relevant activity;
• the amount and type of expenses and assets in respect of the relevant activity;
• the location of the place of business or plant, property or equipment used for the relevant activity of the Cayman Islands company;
• the number of full-time employees or other personnel with appropriate qualifications who are responsible for carrying on the company’s relevant activity;
• information showing the Cayman Islands core income generating activities in respect of the relevant activity that have been conducted;
• a declaration as to whether or not a company complies with economic substance rules;
• in the case of a relevant activity that is an IP business, a declaration as to whether or not it is a high risk IP business and, if it is, whether or not a company will provide necessary information;
• details of any international group of companies in respect of which the Cayman Islands company is a constituent entity;
• in case if company is carrying on a high risk IP business it must provide detailed business plans, employee information, including level of experience, type of contracts, qualifications and duration of employment, and the evidence that decision making is taking place within Cayman Islands;
• any other information as may be prescribed by TIA.

Companies existing before 1 January 2019 which conduct relevant activity and whose financial year is 1 calendar year must submit economic substance report before 31 December 2020. The Guidance sets an example for new companies incorporated after 1 January 2019 and having financial year that equals calendar year according to which they also must submit economic substance report before 31 December 2020.

The information gathered by TIA may be exchanged with competent authorities of foreign states and territories in the framework of international exchange of tax information. Thus, in case if a company does not comply with economic substance requirements in Cayman Islands, the information about such company may be transferred to jurisdiction of parent company or to jurisdiction of company’s beneficial owner. Also, information may be shared with jurisdiction in which Cayman Islands company claims to be tax resident for purposes of further tax administration.

Liability for non-compliance with economic substance requirements

Due to the fact that all economic substance obligations are assigned to companies and other persons requested to provide information about any company (but not to companies’ registered agents, as it is in BVI), the liability may be imposed only on companies themselves and on such persons.

If TIA detects non-compliance, it issues a notice to the company notifying it of such detection, giving the reasons, the amount of fine and directing any action to be taken to comply with economic substance requirements. Fine is 10 000 Cayman Islands dollars (approximately 12 000 US dollars), and if the contravention continues in the subsequent financial year after the initial notice – 100 000 Cayman Islands dollars. If a company does not eliminate such contravention further it will be subject to a maximum penalty in a form of defunction of a company by court order.

Persons requested to provide information about the company may be subject to liability in a form of fine in the amount of 10 000 Cayman Islands dollars and/or imprisonment not exceeding 2 years (for natural persons) for non-provision an information to TIA, or for provision of misleading information.

Conclusion

Generally, economic substance requirements of Cayman Islands are similar to those in BVI and other UK-related territories as in its essence, so in the list of relevant and core income generating activities to which such requirements must be applied.   

The following issues can be highlighted as important differences and distinctive features of Cayman Islands economic substance requirements:

• Investment funds which do not carry on business related with securities (investment in other types of assets) are exempt from economic substance requirements;
• It is expressly stated that TIN issued in foreign jurisdiction for Cayman Islands company is a sufficient evidence of tax residency in such foreign jurisdiction (along with tax residency certificate and documents of payment of tax);
• If Cayman Islands company is exempt from economic substance requirements because it is tax resident in other jurisdiction, the fact that such jurisdiction has been blacklisted (including EU list of non-cooperative jurisdictions) is not taken into account;
• It is emphasized that employees must work in a company on a full-time basis for purposes of compliance with economic substance requirements;
• Holding companies must have employees and premises in the territory of Cayman Islands;
• Obligations to comply with economic substance requirements are assigned to companies, not to their registered agents. Companies must submit reports to public authorities directly;
• Liability for non-compliance with economic substance requirements is applicable to companies and to persons requested to provide information about companies. The amounts of fines are fixed.

As it was mentioned, economic substance rules in Cayman Islands will be applied starting from 1 July 2019.