Regulators go one step further with new economic substance laws: what it means and how to stay compliant

It is no secret that the past few years have seen a huge increase in the regulatory compliance burden on multinationals. In particular, regulators have sought to create greater transparency on tax matters. However, we have now entered a new phase. While international regulations were previously focused on the exchange of information, economic substance regulations now request actual evidence of physical presence and activity in each jurisdiction.

Responding to the European Union and the OECD’s concerns about attracting profits which do not reflect real local economic activity, key affected jurisdictions – like The Bahamas, Barbados, Bermuda, British Virgin Islands, Cayman Islands, Curacao, Mauritius, and the Channel Islands – enacted what is known as “Economic Substance” Legislation.

Meeting the requirements

From 2019, any local entity that qualifies within the jurisdiction’s definition of a “Relevant Entity” and carries on a “Relevant Activity” must meet either the full or the reduced economic substance tests, depending on the type of Relevant Activity carried on.

For the full test, the Relevant Entity must cumulatively demonstrate that, in the jurisdiction:

  1. it conducts a “core-income generating activity”;
  2. it is “directed and managed”, and;
  3. it has “adequate” operating expenditure, physical presence and “appropriate” number of full-time  employees or other personnel with “appropriate” qualifications (this criterion applies to the reduced test as well).

For the reduced test, the Relevant Entity must cumulatively demonstrate that, in the jurisdiction: 

  1. it complies with local companies law filings, and;
  2. it has “adequate” human resources and premises for holding and managing its equity participations

Furthermore, from 2020 onwards, a Relevant Entity must annually notify the local tax authorities whether it carried out a Relevant Activity during the past financial year. Where applicable, a detailed report demonstrating how each of the stipulated criteria has been met will be required.

While the “directed and managed”, “adequate” and “appropriate” concepts are currently not defined by any of the regulations, it is already widely accepted within the industry that palliative or half measures will not be sufficient to satisfy the tests.

Therefore, resident entities that are currently remotely managed with only the minimum local presence must meet the challenge of finding experienced personnel and available premises in labor and rental markets that are already constrained.

Time is of the essence

All entities newly incorporated in 2019 must be compliant with the local economic substance requirements since inception, and pre-existing entities are subject to the same obligation since 1 July 2019 in most jurisdictions. Notification and reporting are due as early as January 2020 in some jurisdictions.

If a local entity has not yet looked at its economic substance obligations, this task should be prioritized as soon as possible. Citco GSGS stands ready to assist you through our local presence and to provide you with the support you need at each stage of the process.

Local obligations, global stakes

To make matters more complicated, each jurisdiction has its own definition of a Relevant Entity and of each of the nine Relevant Activities, exponentially increasing the difficulty of meeting the requirements.

Based on its expertise in these key jurisdictions over the past 70 years, Citco Governance Services has developed integrated solutions to assist local entities in meeting their new obligations. First we establish the client’s compliance needs through a brief set of questions, and then adequate local services and human resources are provided to the entity or entities in question. These services may of necessity include the provision of board support and office space, the provision of local directors and corporate secretaries, or accounting and filing support.

These business alternatives are appealing to companies who may want to keep using their vehicles located in a jurisdiction where Economic Substance Legislation applies in their global structure while avoiding the significant sanctions associated with the offence that non-compliance constitutes. Aside from the risk of fines and penalties applicable to both the entity and its officers (including imprisonment up to several years), non-compliance could lead to the entity being struck off from the local companies’ register and therefore, being unable to continue its activity in the jurisdiction, disrupting the overall tax planning in place.


Laurie Henric, Senior Vice President, Citco Governance Services 
Citco GSGS Focus – Winter 2020

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Laurie Henric

Laurie Henric

Senior Vice President,
Citco Governance Services

T+1 647 777 7000
LToronto, Canada

Kariem Abdellatif

Kariem Abdellatif

Head of Mercator by Citco

T+352 47 23 23 265