The first Economic Substance Act annual report for a Cayman company is due on 31 December 2020
Under the International Tax Co-operation (Economic Substance) Act (2020 revision), a relevant entity — a Cayman company, including an exempted company, a segregated portfolio company or an LLC — must satisfy the economic substance test for any relevant activity it carries on: conducting core income-generating activities in the Islands, being directed and managed there, and having adequate operating expenditure, physical presence and full-time employees there. Entities whose financial year ran from 1 January to 31 December 2019 had to file their first annual report with the Tax Information Authority by 31 December 2020. Failure brings a fine of 12,500 US dollars, rising to 125,000 US dollars.
5 October 2020
The economic substance test under the revised International Tax Co-operation (Economic Substance) Act (2020 revision) (the "ES Act") requires a "relevant entity", that is a Cayman company, including an exempted company, a segregated portfolio company or an LLC, that carries on a relevant activity:
i. to conduct core income-generating activities (CIGA) in relation to that relevant activity;
ii. to be directed and managed in the Cayman Islands in an appropriate manner in relation to that activity; and
iii. having regard to the level of relevant income generated by the relevant activity in the Cayman Islands,
a. to have adequate operating expenditure in the Cayman Islands;
b. to have adequate physical presence in the Cayman Islands, including maintaining a place of business or plant, property and equipment; and
c. to have an adequate number of full-time employees or other suitably qualified persons in the Cayman Islands.
Unless a relevant entity existed before 1 January 2019, the date the ES Act came into force, it is subject to the ES Test from the date it begins to carry on a relevant activity, and it must begin to comply with the ES Act before 1 July 2019. Cayman companies carrying on business as investment funds, and entities investing or operating directly or indirectly through an investment fund, and Cayman exempted limited partnerships and trusts, are excluded from the scope of the ES Act. A Cayman company that is tax resident outside the Cayman Islands need not pass the ES Test, but must still file documents proving that it is tax resident overseas.
CIGA are the activities that are essential to a relevant entity in generating relevant income, and they must be carried out in the Cayman Islands. A relevant entity carrying on a relevant activity may satisfy the ES Test by outsourcing its CIGA to another person in the Cayman Islands. A relevant entity that outsources CIGA must be able to monitor and control the carrying out of those CIGA.
What are "relevant activities"?
Relevant activities are insurance business, fund management business, finance and leasing business, headquarters business, shipping business, banking business, intellectual property business, holding company business, and distribution and service centre business. Each relevant entity must satisfy the ES Test by preparing and submitting to the Cayman Islands Tax Information Authority (TIA) an annual report containing the prescribed information, on which the TIA determines whether the activity meets the ES Test. On the evidence provided by the relevant entity, the TIA assesses whether the ES Test was met within twelve (12) months after the last day of each financial year beginning on or after 1 January 2019.
A relevant entity whose financial year runs from 1 January 2019 to 31 December 2019 must submit its first annual report to the TIA on or before 31 December 2020.
In determining whether a relevant entity has met the ES Test requirements for its relevant activity in any financial year, the TIA will take a "principles-based approach". If the TIA determines that a relevant entity has failed the ES Test in a financial year, it must give that entity notice of the determination with reasons, directing any action to be taken to meet the ES Test and advising the entity of its right of appeal.
Penalties for breach
Where the ES Test requirements are not met, the TIA will impose a fine of 12,500 US dollars on the relevant entity, and if the requirements are not met in the next financial year after the first notice of failure, the TIA will impose a fine of 125,000 US dollars. After two consecutive years of failure, the Grand Court of the Cayman Islands may make an order requiring the entity concerned to take specified action to meet the ES Test, or order that it be dissolved or struck off.
Contact our team
We have a specialist team of lawyers able to provide in-depth legal analysis, advice and guidance on every aspect of the ES Act regime, including reporting to the TIA before 31 December 2020, and look forward to advising you as that deadline approaches.
For specific advice on the economic substance regime and compliance, please contact us: