These measures have been introduced alongside anti-money laundering (AML) measures with full disclosures of beneficial ownership requirements, but tax planning must be seen in a different light to the legitimate fight against terrorism. Even aggressive tax planning should not be compared to terrorist plots, but having said that, aggressive tax planning should be considered a thing of the past. I and my IFS colleagues have always maintained that tax schemes are short lived and ultimately more costly to unwind than the tax potentially saved. It has always amazed me that the UK tax bar have created opportunities to avoid legitimate tax assessments through semantically interpreting tax law at the expense of its intention, something that our European counterparts would have laughed at with their general anti-abuse rules. At least BEPS and the MLI have addressed these issues, BEPS advising countries to address artificial hybrid schemes as an example and the MLI recommending that the preamble to all double tax treaties should be replaced with the wording “Intending to eliminate double taxation with respect to the taxes covered by this agreement without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance (including through treaty shopping arrangements aimed at obtaining reliefs provided in this agreement for the indirect benefit of residents of third jurisdictions)”.

Where does this leave the clients who also do not believe in aggressive tax planning but wish to minimise their overall tax costs, as they do for all their overhead and other costs? Have they any certainty as to how their planning will be viewed by various tax administrations, something surely to which they are entitled? Let me review the essential ingredients for acceptable and intelligent tax planning.

Substance

In the sixties and seventies, tax professionals would slot offshore companies into structural diagrams without regard to how they would be viewed by tax administrations. No longer. Not only offshore but also ‘onshore’ companies will be disregarded if they don’t have the acceptable level of substance to justify their existence.

Recently introduced Dutch rules demonstrate how this works in practice from the viewpoint of the Dutch tax administration. According to the new minimum substance requirements, a foreign qualifying company should have annual payroll costs at the minimal level of €100,000and adequate functional office space for the company’s activity for the period of at least a 24-month duration.

Countries such as Jersey, Guernsey and the BVI have proudly confirmed their substance related legislation to comply with the latest ECOFIN and EU requirements. Broadly, with effect from 1 January 2019, the EU has “blacklisted” jurisdictions which have not implemented substance requirements for the businesses which are registered in these jurisdictions and which have paid zero-rate corporate tax without any economic and substantial presence in that jurisdiction.

Thus on 23 April 2019, the BVI Government published the first draft of the Economic Substance Code outlining the corporate substance requirements for BVI registered companies.

Jersey has also implemented new rules determining specific substance requirements for its domestic companies. These include the requirement to conduct board meetings in Jersey, to have adequate composition and competence of board members in Jersey and for the company to conduct its Core Income Generating Activity (CIGA) in Jersey. The concept of CIGA encompasses certain activities which should be carried out in the island in order to generate income and to incur expenditure in Jersey which is relevant and proportional to its activity.

Another example is the Cayman Islands, which has passed the Economic Substance Law which now requires real presence in the islands. In order to satisfy the substance test, the following criteria should be met: Cayman-based relevantexpenditure; sufficient physical presence including office, property and equipment; and full time employees. The law introduced heavy penalties for non-compliance, including fines of between $10,000 and $100,000 and even the risk of the company being struck-off from the Registrar of Companies.

However, local legislative measures will not prevent countries where the ultimate beneficial owner resides, challenging the acceptability of relevant entities within international corporate structures. Case law only will determine whether such local entities have the required degree of substance for their activities.

Beneficial Ownership

Ascertaining who is behind a structure has always been one of the greatest challenges of tax administrations. No longer. The EU has recommended to change the local legislation of many offshore jurisdictions in order to comply with the EU criteria of Fair Tax Competition.

There is now a PSC register of Persons with Significant Control in many countries which may indicate who is behind a particular structure. Opening a bank account nowadays is one of the most difficult tasks in establishing a new business, and this of course discloses who is the ultimate beneficial owner of the relevant entity.

Information exchange has materially increased over the past few years, and with ultimate beneficial owners now having to verify the source of their wealth, transparency has overtaken confidentiality in the world of international business structuring.

Principal Purpose Test (PPT)

Many countries have tried to implement a PPT into their legislation, although the subjectivity of such a test means relatively few cases have come to court. The MLI has introduced a PPT which denies treaty benefits “if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of the Covered Tax Agreement (CTA)”. More about CTAs below, but it is clear that the intention behind a structure or transactions underlies this Article 7 of the MLI and whether treaty benefitsmay be enjoyed, and this intention is determined by the relevant tax administration (competent authority) which has the burden of proof to establish a subjective view.

The inclusion of this provision in the MLI may scare those who have created a structure with tax planning as one of the objectives (who doesn’t?) but otherwise have adhered to the requirements to disclose beneficial ownership and ensure each entity has the relevant level of substance to justify its existence. Surely it is a requirement that the structure must only have been created for tax purposes (after all that is what a Principal Purpose means), but the Article provides that tax planning per se would jeopardise the acceptability of any structure.

The MLI does have minimum requirements to adopt for all countries who have signed the MLI, but also allows certain provisions to be excluded or adopted in part. So, when countries sign up to the MLI, they can reserve the right to include or otherwise specific provisions. However, the PPT is a minimum standard, although countries have a right to choose a limitation of benefits model which I will not detail in this article.

Therefore, treaty shopping arrangements of the past will certainly be caught by the PPT, which I believe is the main intention of the Article 7. I do not believe that treaty denial will be made where companies have a legitimate purpose and are not seen as merely conduit companies.

Conduit companies

Typically, these are holding, financing and licensing companies interposed within a group structure for the purposes of obtaining tax treaty related benefits (generally lower withholding taxes on receipt of dividends, interest and royalties).

The ECJ have helpfully recently issued six judgments setting a new interpretation of what constitutes a conduit company which is not acceptable as the ‘beneficial owner of the income’. According to these judgments, the beneficial owner is a designated entity which actually benefits from the income that is paid to it and has the power to freely determine the use of such income. The ECJ has also confirmed that the concept of a ‘beneficial owner’ in the Interest & Royalty directive (IRD) has the same meaning as in tax treaties based on the OECD Model Tax Convention.

Apart from this the ECJ has broadened the definition of ‘tax avoidance’ from previously ‘wholly artificial structures’ to ‘artificial arrangements in which the principal objective or one of the principal objectives is to obtain a tax advantage’.

Also, the ECJ has provided the following indications of such artificial arrangements:

-formal nature of conduit companies without economic justification;
avoidance of dividend withholding tax due to intermediary holding company in the relevant jurisdiction;

– evidence of various contractual arrangements between companies which do not have any substance and are used exclusively for such contractual arrangements;

– the sole activity of an intermediary company is the receipt of dividends and their further payment together with the absence of economic activity, management costs, staff costs and other premises and equipment that the company should otherwise have.

Covered Tax Agreements

CTAs are double tax treaties where the relevant countries have signed up to the implementation of the MLI. To date 78 countries have done so, and have accepted the minimum standards of the MLI. One of these is that the required wording of a preamble of a treaty must reflect the intention of the parties to prevent treaties being used to reduce taxation through tax evasion or avoidance; another minimum standard is to include some form of the PPT.However, countries have been permitted to make reservations to the remaining articles of the MLI at the time of signing up to the MLI agreement, and most have done so (including countries such as the UK, Luxembourg and Cyprus). Therefore, besides the US not being party to the MLI at all, countries may have decided not to accept the hybrid instrument clause, the permanent establishment extension clause, and particularly the mandatory arbitration clause which I refer to below.

So in order to determine whether a CTA is relevant to a particular structure or transaction, one not only needs to know whether the two countries involved have signed up to the MLI, but also whether each one has accepted the relevant MLI provision or reserved its rights in respect of that provision. Only if one is able to mirror the relevant provisions would the MLI, and therefore the BEPS Action issue, be applicable.

Mandatory Arbitration clause

Action 14 of BEPS dealt with dispute resolution, and faced with subjective decisions taken by tax administrations, it was hoped that the MLI would introduce a mandatory arbitration clause. Unfortunately, although 78 countries signed the MLI, only 25 to date have agreed to be bound by a mandatory arbitration provision which is disappointing. It means that taxpayers in the remaining countries still need to go through the inadequate competent authority provisions of existing double tax agreements, which is yet another example of covered tax agreements falling short of what the MLI was intended to deal with.

Summary

As demonstrated above, BEPS has brought a sea change to the scope of international tax planning, at least according to the guidelines that have been published. In reality, with many countries having taken full benefit of the derogations permitted by the MLI, they have essentially reserved the right to maintain the status quo while formally demonstrating commitment to the anti-abuse agenda.

Having said this, aggressive tax planning should be very clearly unacceptable, not only to tax administrations but to professional advisers. Knowing the ultimate beneficial owner, his or her source of funds, and ensuring relevant entities within any international corporate structure have the right degree of substance for the activity involved, must be minimum standards for the international tax adviser who wishes to plan appropriately for the client’s business objectives.

With warm regards

ROY SAUNDERS

The post The True Impact of BEPS on International Business Structures appeared first on IFS Consultants Ltd.

For over a century, the UK has attracted people seeking better fortunes — fleeing the horrors of wars, following the economic beckoning of the centre of the Empire or looking to start a business in a safe environment. Following the introduction of the Tier 1 Investor visa in 2008, the UK has also been the destination of choice for wealthy migrants. Together with the beneficial taxation of foreign domiciliaries, this route has offered unparalleled opportunities to enjoy the British way of life with little or no tax liability.

Perhaps the most important outcome of the Tier 1 Investor route has been the possibility to remain in the UK indefinitely after as little as two years and become a British citizen after six years. Unfortunately, with the doubtful value of the British passport in the post-Brexit reality, many are now forced to reconsider their plans — whether it was worth spending three quarters of the year in the UK to obtain the document that no longer promised any travel or work benefits in the rest of the EU. Those who can afford it, turn to other EU countries offering citizenship by investment — Cyprus, Malta, Portugal. The rest are hoping to enjoy the resurrected blue passports.

Although it is easy to focus on the negative side of leaving the EU, beside the lack of access to the European freedoms, it is difficult to come up with the direct disadvantages caused by Brexit for those HNW migrants who want to make the UK their home. In this month’s article, prepared with the help of our colleague Igor Persidskiy, I have considered the tax implications particular to Tier 1 Investor migrants and made a few planning suggestions.

Many of you of course know about the International Business Structuring Association (IBSA) of which IFS Consultants is the founding member. The IBSA has refrained to date from including any Brexit centric discussions at our meetings but we don’t believe we can ignore these realities any longer, which is why our next UK meeting is going to be devoted to planning our way forward in a very uncertain European community.

Click here for details of the discussion and to register your attendance.

With warm regards.

Dmitry Zapol
ADIT(Affiliate) LL.M(Tax) LL.B(Hons)
Partner, IFS Consultants, London
(www.interfis.com, dmitry@interfis.com)

Tax planning considerations for Tier 1 HNW migrants in the UK(1)

The UK encourages foreign direct investments by granting high net worth individual investors and entrepreneurs the right to remain temporarily in its territory, with the associated tax benefits of the resident “non-dom” regime. Similar rights are extended to members of their immediate family. After a qualifying period, whose length generally depends on the amount invested in the British economy or growth of the British business, the individual and their kin can obtain indefinite leave to remain (ILR) in the UK. Later, they can even apply for settlement in the UK to become British citizens.

The Immigration Rules that regulate the process are complex and subject to frequent and unexpected changes. In the latest amendments to the rules published on 7 March 2019, the Home Office announced sweeping reforms of the Tier (Investor) category alongside with the launching of the Tier 1 (Innovator) category.

The Home Office’s explanatory notes are comprehensive; however, clients rarely submit applications themselves. Usually they engage a triad of advisors who are experts in the fields of UK immigration law, financial and tax planning. It is not a coincidence that tax consultants are right at the end of the list — experience has shown that despite moving to a high-tax country, seeking comprehensive tax advice often comes as an after-thought, when the investments are made, and the arrival dates are set. This article highlights the primary tax planning considerations relevant to non-domiciled investors and entrepreneurs at different stages of the UK immigration process for high-value migrants.

Immigration
There are two routes that most high-value migrants can take — Tier 1 (Investor) and Tier 1 (Innovator). The latter replaced the old Entrepreneur category, although there is also a new Start-Up pathway, which is unlikely to be pursued by anyone without pre-existing strong ties with the UK.

The Tier 1 (Investor) category is for high-net-worth individuals who can afford to invest at least £2 million in the UK. The investor does not need a job offer in the UK nor is he required to prove a good command of the English language although the latter will be required when applications for the ILR and settlement are made. The investment funds must be their own savings, which the investor has held for at least 2 years. The holding period has gone up from 90 days, which had been the condition under the old regime. Investments in UK Government bonds no longer meet the investment criteria and a few new conditions applying to investments into active and trading UK registered companies were imposed. Also, mandatory due diligence and “Know Your Client” enquiries should be carried out by a UK bank in respect of sources of wealth of all Tier 1 (Investor) applications after 29 March 2019. Up until a few years ago, a substantial number of investors making the application had been wives of wealthy foreigners; the latter, together with the couple’s children being her dependants. Under the old rules, the dependants — particularly the husband — were free to visit the UK as they please without any commitments as to the duration of visits. Currently, in order for dependants to meet the UK settlement requirements, they must spend the same length of time as the main applicant in the country, which has alienated a significant number of applicants.

Tier 1 (Innovator) is for non-European migrants who want to start a genuine innovative business in the UK by setting up and being actively involved in the running of, a UK business or businesses. Broadly, the applicant needs to invest £50,000 in a UK company and comply with a host of other requirements, including excellent command of English language and having enough money to support themselves in the UK. The new Innovator category requires the applicant to have a detailed business plan, which is subject to reviewed by a UK endorsing body, which includes British universities and business accelerators and whose list is published online.3.. The endorsing body will continue scrutinising the business to ensure that it is sufficiently innovative. With the gradual tightening of the rules allowing foreign students to seek work in the UK after finishing their studies, the Innovator visa is likely to remain as attractive as the now-extinct Entrepreneur, although it’s yet to be seen, how many applicants will take on the innovation challenge.

Both routes allow the migrant to apply for the ILR after a continuous residence period in the UK of five years. This can be reduced to three years for the investor who invests £5 million or the innovators who makes extraordinary progress with developing their business. A further reduction to two years is available to the investor who invests £10 million. Interestingly, the Rules only allow the main applicant to reduce the length of time before they apply for the ILR and exclude their dependants, who need to wait the whole five-year period before submitting the application. There are also strict requirements regarding the number of days that the migrant can spend outside the UK in any 12-month period. Failing to meet them will result in the inability to apply for the ILR and settlement.

Statutory Residence Test
Taxation in the UK primarily depends on a person’s residence status. Since April 2013, residence has been determined under the statutory residence test (SRT). The SRT is explained in brochure RDR3, which also contains useful practical examples, which are worth reviewing by anyone attempting to ascertain their residence situation. The SRT establishes residence status according to the number of days (counting midnights only) that a person spends in the UK during the tax year that runs between 6 April and 5 April of the following calendar year. Residents generally pay tax on their worldwide income and gains, whilst non-residents are generally only taxed on income from sources in the UK. However, individuals resident but not domiciled in the UK can elect to be taxed on the remittance basis where non-UK income and gains are only liable to tax when directly or indirectly remitted (brought) into the UK.

On its own, an individual’s immigration status or current nationality has no bearing on their UK tax liability whatsoever. The migrant should be treated as a regular typically non-domiciled taxpayer who requires the usual pre- and post-arrival tax planning measures. Nevertheless, tax advice should take into account two considerations that pertain to the granting of the Tier 1 Investor or Innovator status.

Firstly, it’s safe to assume that the end goal of most migrants and their families is to settle in the UK. To achieve, this they must spend at least 185 days in any 12-month period in the UK on the rolling basis starting from the day of arrival in the UK under the newly issued leave to enter. This immediately denies the benefit of the UK-residence planning techniques based on the extended periods of absences from the UK. As a result, most tax planning measures should be undertaken before the investor’s arrival in the UK during Stage one as explained below while they are non-UK resident.

Secondly, the Rules require the migrants to physically bring the investment funds into the UK. Unless these are derived from clean capital, accumulated during the period of non-UK residence, the investor or the entrepreneur will suffer the consequences of making a remittance of foreign income or gains, which will be taxed at the appropriate rates. Further remittances might occur where the migrant pays for services rendered to them in the UK, such as various professional fees. Taxation of remittances can be avoided under the business investment relief as described below; however, the expense of planning for the minimisation of tax burden might nullify the tax benefits it aims to achieve.

The Tier 1 (Investor) process
It is possible to split the Tier 1 (Investor) immigration process in three stages. Stage one is preparatory during which the migrant collects documents and submits the visa application. As Stage two, the investor arrives in the UK after receiving leave to enter the country. Stage three involves the migrant making the investment, which will permit them to remain in the UK and to apply for the extension of their stay until they can apply for the ILR and later for citizenship. There might be a period of several months between Stages one and two during which the investor stays in their home country waiting for the outcome of the application. The migrant typically has up to three months from the day of their arrival in the UK to fulfil the requirements of Stage three. The investor should plan to remain non-UK resident at Stage one and even partly through Stage two; and during this period of non-residence he should aim to perform the larger share of his tax planning strategy.

During Stage one the applicant prepares and submits documentary evidence of their ability to invest at least £2 million in the British economy. This amount must be in cash and kept in a regulated financial institution (typically a bank) in the UK or overseas. Sometimes instead of clear funds the future migrant has an asset portfolio that includes capital assets and undistributed income, but the Home Office will not take these into consideration. Funds held by companies or trusts are equally excluded. The investor should convert these assets into cash: any gains accumulated in securities and properties should be crystallised by selling them; where there is a right to receive income — dividends, interest, salary, royalties, business profits — this right should be exercised and the proceeds received into a bank account.

It might seem reasonable only to create sufficient cash to fund the £2 million investment. In fact, when converting assets into cash or receiving income, the investor might be subject to a double tax liability, determined by their current tax residence and the source of funds, although this might be reduced under double tax agreements or domestic tax exemptions. However, any non-UK gain that is crystallised and non-UK income that the investor receives after they become UK resident will be liable to UK’s fairly high taxes unless the taxpayer claims the remittance basis of taxation and does not bring the funds to the UK. As a result, the migrant might face the situation where they cannot pay for his life in the UK without incurring a significant tax cost.

The following discussion also largely applies to Tier 1 Innovators except that the funds that they are expected to invest are significantly lower.

“Clean capital”
Conversely, income and gains received before becoming resident form so-called “clean capital”. If the migrant loans clean capital to someone, the loan principal will always remain clean capital when repaid to the investor (but note the position with regard to loan interest below). Gifts received from related and third parties are also clean capital provided they are not considered to be a form of hidden income or gains distribution. In practice, some UK-resident investors live off the gifts made to them from their non-UK resident spouses, who earn income and gains not liable to UK tax. Clean capital will not be taxed in the UK, whether brought in its territory or not. However, in the case of an investor’s death, clean capital kept in a UK bank account will form their UK-situs asset liable to 40% inheritance tax. Therefore, it might be prudent to bring to the UK only the amounts necessary to fund current expenses.

Clean capital should be credited to a separate bank account and never mixed with non-UK income and gains that might be derived after assuming UK residence. In fact, considering that income and gains are taxed differently in the UK, they should also be kept in separate bank accounts. Moreover, if clean capital generates income — say it has been loaned and the migrant receives interest — this should be paid to the income bank account and not into the clean capital account to avoid tainting it. Counterintuitively, the same cannot be done with gains generated with the use of clean capital. For example, if clean capital is used to buy shares, any gain realised on their future disposal will always form part of the proceeds and it cannot be segregated from clean capital by being paid to a separate bank account.

In a situation where clean capital needs to be used to invest in capital assets, one can think of a few planning options. First, the investment may consist of assets that will not generate gain on disposal, in which case the purpose of the investment would typically be earning income — coupon or dividend — that can be easily segregated in a separate offshore bank account. Alternatively, clean capital can be offered to a bank as collateral to secure a lombard loan used to acquire the assets. Finally, the investor might just buy the bullet and come to terms with paying (typically) 20% capital gains tax (CGT) on the amount of gain brought in the UK as well as professional fees incurred in connection with determining the composition of the mixed fund. Considering that the top 28% rate of CGT on disposal of securities and financial instruments is still significantly lower than the top 45% income tax rate, the very last option may not be the worst, especially seeing that once tax is paid, the taxpayer needs not to worry about future remittances of gains in the UK and can fully enjoy the proceeds.

If the investor runs out of clean capital, they might have no choice but to bring foreign income and gains to the UK and face the prospect of the maximum 45% taxation. They can borrow from an overseas lender provided that the loan is made on commercial terms and the interest is serviced from UK-source income or gains.

There is no requirement or in fact possibility to declare clean capital to the UK tax authorities (HMRC) upon becoming UK resident. Equally, there is no requirement to report the use of clean capital on UK’s tax returns. However, the taxpayer should keep documents that reflect dates and methods of creation of non-UK income and gains to prove that they were received while they were non-UK resident and thus form their clean capital. Such documents include bank statements, sale and purchase agreements, loan agreements. They might be necessary in case of a future dispute with HMRC.

The Rules also allow the investor to rely on money that is owned either jointly with or solely by his close relative (spouse or partner). If the close relative is a lower rate taxpayer then, subject to the rules of their residence jurisdiction, the investor can gift the assets to the relative, which she can dispose of subject to the payment of a smaller amount of tax.

Provided the requirements of Stage one are satisfied, the investor will receive the leave to enter the UK as a Tier 1 (Investor). The arrival to the UK should be timed with regards to the residence planning considerations as discussed next. At the same time the investor should not delay their arrival in order to satisfy the continuous residence requirement required to apply for the ILR at the end of his stay.

“Connecting factors” of tax residence
Under the SRT, UK residence may be acquired automatically if the individual spends over 182 days in the UK in a tax year, has a home in the UK without having a home abroad or works in the UK on a full-time basis. If the migrant is not UK resident automatically, they might be resident under the sufficient ties test. This looks at the connections that the individual has with the UK in any tax year. The relevant factors include having a family — spouse or minor children — resident in the UK; availability of UK accommodation (rented or owned), working in the UK for over 40 days during the tax year (continuously or intermittently; for a UK or a non-UK employer or a in a self-employed capacity); and length of visits to the UK in the preceding tax years. The more UK ties the investor has in a tax year — the smaller number of days they can spend in the UK during that period without becoming UK tax resident. It is also possible to be automatically non-UK resident under a separate set of circumstances, for example, if one works abroad on full-time basis and they spend under 91 days in the UK with a limited number of UK work days.

Residence is determined for the entire tax year starting from 6th April regardless of the taxpayer’s relocation date. However, there is a possibility to split the tax year and only begin UK tax residence from the day of arrival in the UK. This is typically achieved by starting to have a home in the UK or by commencing full-time employment in the country.

Experience shows that in the tax year of arrival in the UK, most migrants have two ties: they acquire a home in the UK and their families become UK resident. The SRT allows them to stay in the UK for up to 120 days without becoming resident here provided they are not UK resident automatically. However, there are plenty of pitfalls and before determining their residence situation, the migrant should avoid buying accommodation in the UK or entering into long-term leases, moving family and sending children to school and spending over 90 days in the UK in any tax period. Additional planning opportunities might be offered by the tie-breaker clause in the residence article of the double taxation treaty that the UK might have with migrant’s residence State, although complications might arise that stem from the mismatch between the tax years’ periods. This typically arises if the migrant is coming from a country where a tax period is the same as a calendar year, which may conflict with the UK’s 6th April-to-5th April tax year. HMRC provides an interesting explanation of this rule in part INTM154040 of its International Manual (http://tinyurl.com/INTM154040)

Remittance rules and Business Investment relief
Under Stage three, the investor must invest £2 million by way of share capital or loan capital in active and trading companies that are registered in the UK. Similar rules apply to the innovator although the amount is £200,000.

Provided that the investment comprises clean capital accumulated during Stage one, there will be no UK tax consequences on bringing the funds in the UK. In the opposite scenario, where the investments consist of foreign untaxed income and gains made after the date of first becoming UK tax resident, these will constitute remittances, on which the migrant will be taxed at their applicable income tax or CGT rate. HMRC explain the meaning of remittance in part RDRM33140 of its Residence, Domicile and Remittance Basis Manual (http://tinyurl.com/RDRM33140).

If they satisfy terms of the business investment relief (http://bit.ly/1wq9Wj6) the invested amounts shall not be treated as remittances and shall not be liable to UK tax. There are additional income tax and capital gains tax reliefs such as EIS, SEIS and VCT intended to encourage investment in the shares of unquoted trading companies. Finally, if the investor is appointed director or taken on as an employee of the company in which he has invested, he might be able to receive a substantial reduction on future disposal of its shares under the terms of the ‘Entrepreneurs’ Relief’ where the personal tax rate may be 10% on gains made.

Thus, pre-arrival tax planning for a Tier 1 migrant is a complex matter that should be done prior to finalising immigration plans. Future migrants should consider their medium to long-term planning strategy, which includes residence planning, creation of clean capital and acquisition of assets in the UK.

Law as stated on 16 April 2019

Law as stated on 16 April 2019
https://www.gov.uk/government/publications/endorsing-bodies-innovator

Dmitry Zapol

The post Tax planning considerations for Tier 1 HNW migrants in the UK appeared first on IFS Consultants Ltd.

Dear Reader

Changes in the world of Investment Funds

By Roy Saunders, Dmitry Zapol and Igor Persidskiy 

The most recent announcement was on 5 February 2019 when the European Commission welcomed a political agreement reached by the European Parliament and EU Member States on new rules to make it easier, quicker and cheaper for EU asset managers to sell funds to a wider range of investors. We will be discussing this and many other aspects of fund structuring at an IBSA meeting to be held at The Hotel in Brussels on 2 April.

Traditional Fund structures
IFS has been involved in the creation of more than forty investment funds over the past decade, many of them in real estate in EU capital cities including Berlin, Sofia, London, Paris and many others. The typical Fund used to be a Cayman Island based limited liability company managed by a Cayman Islands Investment Manager with an Investment Advisory company located in a jurisdiction where relevant personnel were resident. These individuals, who were actually managing the Fund’s investments, were often resident in high tax jurisdictions such as the UK. The Investment Manager in the Cayman Islands administered the Fund but the real decisions affecting the investments made by the Fund were made in a higher tax jurisdiction, the structure therefore being designed to limit the tax exposure for the principals involved.

The activities carried out by these individuals are in fact core activities for the Fund, and include carrying out market research regarding potential investments, negotiating terms for an investment, preparing transaction documents, and only finally reporting to the Investment Manager when the dots and crosses ere confirmed. The Investment Manager would then only need to formally resolve whether to invest or not on behalf of the Fund. These individuals are often shareholders in both the Investment Management company and also the Fund itself, perhaps via an offshore entity, referred to as the ‘carry vehicle’. Other investors in the Fund would either invest direct or possibly through a separate collective investment vehicle such as a limited liability partnership.

The Fund itself would then invest in the opportunities negotiated by the Investment Advisor company, and this would itself require a degree of structuring to minimise the exposure to local taxation where the investment is made. This structuring would particularly address the secondary taxes that are distributed through the structure where withholding tax on dividend distributions could reduce the return to the investors. This may require the creation of interest deductions through a separate finance vehicle located in a high tax jurisdiction which would enjoy double tax treaty protection through the minimisation of interest withholding taxes. The resultant gross income would then be passed through to the Fund with or without appropriate tax rulings (which is why the finance companies were often referred to as conduit vehicles).

The investments themselves may be made through special purpose vehicles (SPVs) which would be owned through one or more holding companies owned by the Fund, again for the same purposes of minimising withholding taxes on dividend distributions and potentially avoiding capital gains tax in the local jurisdiction.

What has changed?
Current practice demands a thorough review of traditional Fund structures in view of extensive measures introduced by many OECD countries. These include:

• denial of interest deductibility in companies in which the Fund invests as a result of the BEPS initiative;
• conduit regulations aimed at non-recognition of companies interposed for tax avoidance purposes;
• the elimination of tax treaty benefits according to the Multilateral Convention to Implement tax treaty related measures to prevent BEPS (the MLI);
• the ‘substance’ requirements in low-tax jurisdictions involving a degree of personnel and office accommodation for corporate entities;
• new regulations within the EU enabling fund managers to market their products across the EU at lower costs, giving investors more choice and better value without compromising on investor protection;

Development of Luxembourg Funds
An alternative to the Cayman Islands could therefore be an Investment Fund created under the laws of Luxembourg, one of the jurisdictions to be discussed at the IBSA meeting on 2 April (others being Cyprus and Malta). Personnel resident in Luxembourg with local offices would be employed by a Luxembourg Investment Manager, able to demonstrate proper management and control of a Luxembourg Fund. Thus the Fund could be AIFMD compliant (under the Alternative Investment Fund Management Directive). Should there be a requirement to have certain market research and other functions conducted in a jurisdiction such as the UK, the Investment Manager could contract with a separate UK company for such purpose.

If the Investment Manager wishes to expedite the creation of the Fund prior to becoming AIFMD compliant, there are many AIFMD regulated companies who would delegate the portfolio management to the Investment Manager whilst itself providing the service of risk management and fund administration. In addition to the AIFMD, there is a venture capital directive (EuVECA) which is within the overall EU regulatory environment of AIFMD, but was a 2013 regulation designed to create the opportunity to establish a European venture capital fund under a new regulatory directive. The EuVECA is less regulated than the AIFMD and recognises that venture capital funds may invest in specialised portfolio undertakings and other speculative investments which the AIFMD would not permit. Thus, up to 70% of aggregate capital contributions may be invested in small undertakings in the initial stages of their corporate existence, clearly evidencing the requirement to develop small and medium sized enterprises. Such Funds can only be marketed to investors who are professional clients or otherwise sophisticated high net worth individuals.

Tax Status of the Fund
We should then consider the taxability of the Fund in the country where it is incorporated. A UK Fund would normally be subject to UK corporation tax on its profits if created as a corporate vehicle (as opposed to a limited liability partnership where the investors would be taxed only in relation to UK source income if they are non-UK resident). The Fund, however, could rely on the Investment Manager Exemption (IME) which enables non-residents to appoint UK based investment managers without the risk of UK taxation, and is known as one of the key components of the UK’s continuing attraction for investment managers.

Application of the IME provisions is restricted to certain transactions which include stock exchange securities, but there are limitations regarding investments in land. The IME was particularly set up for hedge funds where trading activities take place on a daily basis.

If the Fund is to be created in Luxembourg, a SICAR (Société d’Investissement en Capital à Risque) may be incorporated which has specifically opted to own investments with the principle of risk spreading, marketing only to well informed investors. These are defined by law to be institutional investors, a professional investor or any other investor who meets certain conditions. The SICAR regime is designed for private equity/venture capital type investments that bear a significant amount of risk. Subject to that provision there are no further restrictions on the investments a SICAR can make in terms of geography or instruments e.g. debt, equity, warrants etc. A SICAR can be a common contractual fund (FCP) which is like a unit trust, or a corporate entity

SICAVs or SICAFs are corporate entities which are subject to risk spreading requirements, meaning that they could not be used to hold just a single asset, but must have no more than 30% of its total assets in a single asset. The benefit of a corporate entity is that it will be able to benefit from the wide range of double tax treaties entered into by Luxembourg, which is a key consideration when comparing Luxembourg (or Cyprus) with somewhere like the Cayman Islands, which does not have a double tax treaty network enabling income to be received gross of foreign withholding taxes.

The above type of Funds are exempt from Luxembourg tax in respect of dividends and capital gains, and are not subject to withholding tax on dividend distributions or liquidation proceeds, or indeed interest payments made to the Investors. Thus the Investors can be located in any onshore or offshore jurisdiction regardless of the existence of a relevant double tax treaty.

Securitisation Vehicles
Investors may require a Fund which enables certain assets to be held in a ‘compartment’, the profits of which will benefit only that individual investor. Thus, protective cell companies (PCCs) were a feature of (initially) Guernsey law but often were not recognised outside of the Island, i.e. foreign jurisdictions would regard the individual assets of the PCC as available for claims made against the company in respect of other assets held by the PCC. An alternative to the PCC is the securitisation vehicle (SV) established under the laws of Luxembourg.

The SV was introduced by the Law of 22 March 2004 to create different compartments within its own assets and to issue to investors Participating Notes or specific classes of shares which give the investor the rights to the compartment’s revenues. In relation to the compartments:

• each compartment is an individual entity on a tax and legal basis;
• the rights and obligations of a compartment are limited to the assets of this particular compartment;
• the assets of a compartment cannot constitute any guarantee for other compartment’s commitments;
• the rights and obligations of a compartment are limited to the assets of this particular compartment;
• the assets of a compartment cannot constitute any guarantee for other compartment’s commitments;

and investors are entitled through the Participating Notes or classes of shares to the income received by the compartment which would therefore be fully tax deductible against the corporate income received by the SV itself.

As a matter of Luxembourg law, the investors would have no right to the underlying assets (the assets themselves will be owned by the SV); the SV is therefore different from a Protected Cell Company. Each investor or group of investors is in effect the creditor of one or more compartments dedicated to the assets. Furthermore, the investors have no control over the management of the Company’s assets. Thus the principals remain in full control of the company and its assets, but may raise funds from investors who wish to benefit only from specific investments/assets acquired by the company. The company could raise funds generally from the public, perhaps by way of IPO, in which case shares may be issued in the company giving those IPO investors sub-ordinated rights to income from all the assets of the company, subject of course to the prior rights of the compartmental Investors. The SV therefore provides flexibility as regards raising finance from a variety of investors.

The corporate form of a SV is in principle fully liable to Luxembourg income tax on taxable profits and should therefore benefit from Luxembourg’s network of double tax treaties. The distribution of dividends to investors is not subject to taxation on the basis that, for tax purposes, amounts paid to investors are treated as a deductible expense of the SV (being the agreed return for the assets securitised). No withholding tax applies on such payments. Therefore, essentially the company has no corporation tax base in view of the fact that its distributions are tax deductible.

Cyprus Funds
Cyprus amended its Fund regime in 2018 to place itself as an alternative to Luxembourg for Fund structuring and management. Cyprus Funds are generally created as companies subject primarily to the Cyprus corporate income tax rate of 12.5%. As a fully taxable entity, a Cyprus Fund incorporated as a company would in principle be able to benefit from Cyprus’ extensive double tax treaty network with 64 countries, subject to the comments below regarding the changes as a result of BEPS.

Cyprus Funds are fully tax exempt in respect of gains from trading in securities, as well as dividend income (irrespective of the participation in paying entities), capital gains from sale of non-Cyprus situs real estate as well as shares in foreign companies. Although interest income is subject to the 12.5% corporate income tax rate, there is a notional interest deduction allowed of up to 80% of interest income, reducing the effective tax rate therefore to 2.5%.

Cyprus also has an alternative to the Luxembourg SV with compartmentalised Funds, although in Cyprus the compartments are not legally treated as separate entities, giving rise to issues referred to above with PCCs. However, for tax purposes, each compartment is indeed treated as a separate entity.

Other jurisdictions who have a network of double tax treaties are vying with each other to attract investors to subscribe for Funds in their jurisdiction, such as Malta for example. And of course more ‘traditional’ countries including Jersey and Guernsey have significant Fund management providers, although here structuring to maximise income which would otherwise be subject to withholding tax, will rely on intermediate holding companies being created, which then may be affected by the changes detailed below.

Changes in ‘Substance’ requirements
The level of substance of corporate entities is a feature of new EU regulations and has been adopted in many countries. The Netherlands has actually suggested a figure for personnel costs in a particular jurisdiction to justify a corporate entity’s existence for the benefit of double tax treaty arrangements and unilateral law, so that if personnel costs are less than €100,000 and there is no office available for the corporate entity, the provisions of unilateral law dictate that the corporate entity should be disregarded and effectively treated as a nominee for the ultimate beneficial owners.

Jersey and Guernsey have now incorporated substance requirements which state that to meet the economic substance test, a company should be directed and managed in the Islands. There are specific requirements regarding the number of board meetings, composition and competence of the board, keeping the minutes etc. Although similar to the management and control test, which determines where the company is tax resident, the new test emphasises the procedural aspects that reflect that the company is physically directed and managed in the Islands. For example, it is expected that even for companies with a minimal level of activity there will be at least one meeting of its board of directors in the Island.

This approach signifies a marked departure from the pre-2019 customs, when corporate stakeholders were content with having board meetings anywhere other than in the countries where they did not want the company to be tax resident. In this paradigm, most Island-hosted board meetings would be perfunctory affairs run by corporate services providers to rubberstamp the decisions taken elsewhere.

Fund management companies in places like the BVI, Cayman Islands, and indeed the islands of Jersey, Guernsey and the Isle of Man, should be aware of these new requirements of the EU, effective from 1 January 2019. Under these requirements, competent local directors need to be appointed to administer Fund Management companies and make decisions on behalf of relevant Funds.

Changes as a result of BEPS
The Multilateral Convention to Implement tax treaty related measures to prevent BEPS (MLI) is now in force as of 1 July 2018, and identifies which entity has the ultimate right to income and what is the principal purpose of a structure or transaction. Whilst over 78 countries have now signed the MLI, interestingly the US has not yet participated in the project. Apparently it is of the opinion that it currently has sufficient national anti-abuse legislation to counter treaty abuse, which is what the MLI aims to prevent.

The BEPS initiative has fifteen action points to combat tax avoidance. One of the action points, and a major target of the OECD, is to prevent the abuse of double tax treaties to create double non-taxation, or minimise withholding and other tax impositions if this does not accord with the intentions of the bilateral parties to the double tax treaty. The recommendation in BEPS has now been embodied in the so-called MLI which is intended, at a stroke, to implement the BEPS recommendations without bilateral parties having to re-negotiate each and every of the 2,500 plus double tax treaties that exist.

The problem is that when adopting the MLI, countries are entitled to elect to amend or exclude certain provisions, and thus it may be that where the adoption of the MLI is not identical between two countries, one would have to revert to the original double tax treaty to clarify taxing rights and rates of taxes. The international tax consultant will have his or her work cut out to identify whether the MLI is relevant or not!

Besides the uncertainty of whether a particular double tax treaty is covered by the MLI, my main objection is that although Articles 16 and 17 discuss the mutual agreement procedures where dispute resolution cases should be brought before either Competent Authority, and the principle of reciprocal adjustments should be accepted, there is no binding requirement of the bilateral party to agree on disputes, nor is there a mandatory arbitration clause. Undoubtedly, even if the MLI is applicable to, for example, the definition of a permanent establishment, where the two countries cannot agree on relevant adjustments to tax assessments that may have been made, the rights of the taxpayer cannot be automatically enforced through the MLI.

Article 6 of the MLI states that there should be a preamble to all treaties to include as its intention ‘to eliminate double taxation with respect to the taxes covered by the agreement without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance (including through treaty shopping arrangements aimed at obtaining reliefs provided in this agreement for the indirect benefit of residents of third jurisdictions)’. Do transparent Funds create the opportunity for non-taxation if untaxed in Luxembourg or Cyprus, and should they therefore be able to benefit from the provisions of their treaty network? Would the above mentioned SICARs or SVs be able to utilize double tax treaty provisions to minimize withholding tax deductions, for example, if they do not pay tax themselves in Luxembourg or Cyprus, creating the opportunity therefore for double non-taxation?

Article 7 introduces the ‘principal purpose test’ (PPT), which states that the treaty is inapplicable if obtaining the relevant treaty benefit was one of the principal purposes of an arrangement or transaction, unless in accordance with the object and purpose of the treaty. It should be arguable that collective investment vehicles are not created to obtain the benefits of any one specific treaty, but clearly tax mitigation must be one of the considerations when establishing relevant Funds.

So, besides the subjectivity around substance, we now have the uncertainty around the applicability of the MLI to double tax treaties, and indeed the principal purpose test only requires there to be a tax objective (even if the structure otherwise is entered into fully for commercial reasons) for the treaty to be inapplicable. Such subjectivity (the principal purpose test and substance) is undesirable and their interpretation may only be understood in future once court cases have been adjudicated.

Reputation and AML requirements
It would be wrong to conclude this article without mentioning the anti-money laundering directives (AML) which require an extensive review of the sources of wealth of the individual investors who may otherwise be subject to UWO (unexplained wealth orders). The KYC compliance requirements are extensive and Fund investment managers have to realise that they cannot simply accumulate funds from Investors without undertaking full AML investigation.

So the world of Fund structuring and management has significantly changed in recent years, with the emphasis on tax transparency and substance demanding the creation of both Funds and Investment Management companies in reputable jurisdictions which have the expertise of adequate personnel to meet the demands of new laws and Directives. The corollary of this is that some countries, wishing to demonstrate the benefits of establishing Funds and their management companies in their jurisdiction, have relaxed certain regulations for specific entities. This is an encouraging feature for the development of sophisticated collective investment vehicles for financing entrepreneurial ventures, making it easier for EU alternative investment fund managers to test the appetite of professional investors in new markets, and helping them to take more informed commercial decisions before entering that market.

I look forward to seeing any of our Readers interested in this fascinating topic at our Brussels meeting on 2nd April – please don’t hesitate to contact me if you would like to attend as my guest.

With warm regards.

Roy, Dmitry and Igor

ROY SAUNDERS, DMITRY ZAPOL AND IGOR PERSIDSKIY

No responsibility can be accepted by International Fiscal Services Ltd for action taken as a result of information provided or opinions expressed in this publication. Readers are strongly recommended to take advice on their particular situations.

IFS Consultants is a trading name of International Fiscal Services Limited. Registered office: 7-10 Chandos Street, London, W1G 9DQ. Registration number: 3135388. VAT Reg no.974 8468 56. © International Fiscal Services Ltd 2009

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With warm regards

Roy Saunders 

New Offshore Economic Substance Laws

Dmitry Zapol ADIT (Affiliate) LL.M (Tax) LL.B (Hons)1

Amidst the Brexit hullabaloo and Mr Trump’s usual inciting tweets, one would be excused not to pay much heed to the announcement of the new offshore economic substance requirements at the end of 2018. Yet the legislation passed in the Crown Dependencies — Jersey, Guernsey and the Isle of Man, as well as in lands further afield such as the Cayman Islands, Bahamas and the BVI reflects the new normal; one where brass plate companies are no longer welcome.

In the last five years, the popularity of the “true” offshores has steadily declined, being the result of various anti-BEPS initiatives, receding secrecy of the beneficiaries’ identities and the unavailability of tax treaty benefits. Instead, greater use has been made of the low-tax “onshore” jurisdictions or of those with normally high taxes but offering special tax regimes for certain activities. However, the decline does not mean abandonment and a significant number of structures have merited the use of offshore companies paying nil tax and normally managed by corporate services providers. The new rules may lead to the forced review of established practices. Before looking at them in detail, it is worth examining the events that predate the changes.

Origins — BEPS and EU list of non-cooperative tax jurisdictions
In 2015, the OECD published its final Report on “Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance.”2 In part, the report requires preferential regimes to impose the substantial activity obligation with the view to align taxation with substance and ensuring that taxable profits can no longer be artificially shifted away from the countries where value is created (24).3

The Report explains the importance of the substantial activity requirement in the context of IP regimes. Because IP regimes are designed to encourage R&D activities and contribute to growth and employment, the principle underlying the substantial activity requirement in the context of IP regimes is only to permit taxpayers that did in fact engage in such activities and did incur actual expenditures on such activities to benefit from the regimes. The substantial activity requirement establishes a link between expenditures, IP assets, and IP income. Expenditures are a proxy for activities, and IP assets are used to ensure that the income that receives benefits does in fact arise from the expenditures incurred by the qualifying taxpayer. The effect of this approach is therefore to link income and activities. (71, 72).

The Report imposes similar requirements in respect of other non-IP regimes, such as headquarters, distribution and service centres, financing or leasing, fund management, banking and insurance, shipping and finally holding regimes. In these cases, the substantial activity requirement should also establish a link between the income qualifying for benefits and the core activities necessary to earn the income. The core activities at issue are geographically mobile activities such as financial and other service activities. These activities may not require anything to link them to income because service activities could be seen as contributing directly to the income that receives benefits. In each situation, a more detailed consideration of the relevant core activities would need to be undertaken at the time and in the context of a specific regime being considered (72, 73).

On 5 December 2017, the first EU list of non-cooperative jurisdictions in taxation matters was published with the aim to promote good governance worldwide, in order to maximise efforts to prevent tax fraud and tax evasion.4 No direct penalties — financial or otherwise — were envisaged for the countries on the list; however, being on it could make their lives infinitely more complicated. The European Commission has prepared a comprehensive Q&A sheet, which is worth examining.5

Amongst the EU listing criteria was Fair Tax Competition. This required that the country should not have harmful tax regimes, which go against the principles of the EU’s Code of Conduct or OECD’s Forum on Harmful Tax Practices. Those that choose to have no or zero-rate corporate taxation should ensure that this does not encourage artificial offshore structures without real economic activity.

Depending on various undertakings, the listed countries would move between “black” and “grey” sub-lists or would be removed from the list altogether. From the start, in November 2017 Guernsey, Isle of Man and Jersey amongst others, gave reassurances on the lack of a substance requirement for companies tax resident in their territories. In August 2018 the three Crown Dependencies launched public consultations on proposed corporate substance legislation effectively warning those potentially affected that the other shoe is about to drop.

The proverbial shoe did drop in November 2018 with the release of the formal guidance document (“Guidance”)6 detailing the scope of the rules, which would become law on 1 January 2019. This article quotes from the Guidance extensively and readers are encouraged to peruse it.

Economic substance rules
The following discussion revolves around Jersey legislation7 detailing the scope of the new economic substance rules, which is similar in many respects to legislation passed in the other Crown Dependencies. Also, a quick online search will reveal announcements of similar legislation that has been enacted in the Cayman Islands, Bahamas and the BVI.

The legislation has been designed to address concerns that companies could be used to artificially attract profits that are not commensurate with economic activities and substantial economic presence in the Crown Dependencies. With this in mind, the legislation requires certain companies to demonstrate they have substance in the Island by:

• being directed and managed in the Island;
• conducting Core Income Generating Activities (CIGA) in the Island; and
• taking orders, and
• having adequate people, premises and expenditure in the Island.

These substance requirements apply to companies with any income from geographically mobile financial and other service activities referred to in the BEPS Action 5 Report such as headquarters, distribution and service centres, financing, leasing, fund management, banking and insurance, shipping, holding regimes and finally IP holding regimes (“relevant activities”).

A company is not required to meet the economic substance test if it has no gross income in relation to a relevant activity carried on by it, although, is expected that the carrying on of relevant activities will result in the generation of income. If there is any indication that a company is seeking to manipulate or artificially suppress its income to avoid being subject to the substance requirements the respective Tax Administrations will take the appropriate action.

Directed and Managed in Jersey
To meet the economic substance test, the company should be directed and managed in Jersey. There are specific requirements regarding the number of board meetings, composition and competence of the board, keeping the minutes. Although similar to, this requirement is not the same as the management and control test, which determines where the company is tax resident. The new test emphasises the procedural aspects that reflect that the company is physically directed and managed in Jersey. For example, it is expected that even for companies with a minimal level of activity there will be at least one meeting of its board of directors in the Island.

This approach signifies a marked departure from the pre-2019 customs, when corporate stakeholders — UBOs, the non-Jersey directors and shadow directors — were content with having board meetings anywhere other than in the countries where they did not want the Jersey company to be resident. In this paradigm, most Jersey-hosted board meetings would be perfunctory affairs run by corporate services providers to rubberstamp the decisions taken elsewhere.

Under the new rules, clients will have to appoint competent local directors (whether the Island has enough professionals is a different question), which is reminiscent of the recent Dutch substance requirements,8 that impose the minimum wage cost to be incurred by certain domestic companies. Alternatively, foreign directors will have to make an adequate number of meetings in Jersey; “adequate” meaning that the majority of board meetings will be held in the Island.

Core Income Generating Activities (CIGA)
Another requirement necessary to meet the economic substance test is for the Jersey company to have its CIGA in Jersey. These are the key essential and valuable activities that generate the income of the company. The Law in article 4 provides a list of the CIGA for each of the relevant activities that should be performed in Jersey. For example, in respect of the distribution and service centre business the CIGA are:

• transporting and storing goods, components and materials,
• managing stocks,
• taking orders, and
• providing consulting or other administrative services.

However, to demonstrate substance, the company does not have to perform all of the listed CIGA — only those that are relevant in its circumstances. Also, activities that do not form CIGA such as IT or back-office support can be outsourced elsewhere. The scope of CIGA varies from very detailed (e.g. in respect of the IP holding business) to very broad (e.g. in respect of holding company business, which includes all activities related to that business). Anyone caring about meeting the new requirements should peruse them together with the descriptions of the relevant activities to which they apply, since they can yield surprising outcomes.

For example, the law imposes strict requirements on companies pursuing IP holding activities. Broadly, any company that receives IP income is presumed to have failed the substance requirements unless it proves to the Jersey tax authorities that the IP was created in Jersey (the Guidance provides details of the high evidential threshold). The IP CIGA depend on the nature of the IP asset and how it is being exploited — for example, for patents the CIGA include R&D activities; for brands and trademarks they include marketing, branding and distribution activities.

However, the author has seen very few Jersey-based companies receiving IP income due to the high withholding taxes imposed at source in the absence of comprehensive double taxation agreements. More often, such companies are used as passive IP-holding entities holding the assets for the group. As mentioned earlier, provided that the passive IP company has no gross income in relation to this activity, it falls outside the scope of the economic substance rules altogether. The group only should be careful to ensure that the company’s activity does not fall under other headings, for example, the headquarters business.

Another example is the distribution and service centre business which means the business of either or both of the following (a) purchasing from foreign connected persons (i) component parts or materials for goods, or (ii) goods ready for sale; and reselling such component parts, materials or goods; or (b) providing services to foreign connected persons in connection with the business. The key condition that moves the international trading activity within the scope of the new rules is dealing with a foreign connected person — presumably buying goods and services from a connected supplier in a low-cost jurisdiction and selling them with a high profit margin elsewhere. Conversely, where the Jersey company is acting as a stand-alone entity engaged in foreign trade, presumably the new substance requirements will not be an issue.

Penalties for Non-Compliance
The Law and the Guidance prescribe various pieces of information that the local companies should submit to the tax authorities. Like with all things new, the requirements might seem excessive but with the passage of time, their subjects will learn the right ways to do it. However, considering the significant financial penalties for non-compliance, clients might wish to choose corporate services providers who follow up-to-date company management practices. Recent news from Cyprus demonstrate how lax attitudes towards fulfilling local tax and compliance obligations (non-payment of the annual €350 corporate registration fee), which are probably unknown to the foreign shareholders may lead to financial penalties. 9

Besides the fines, the Law stipulates that the tax authorities may exchange information about the non-compliant Jersey-registered companies with the tax authorities in the EU Member State where their holding companies and UBOs are resident. Only if the Jersey-resident company is incorporated outside Jersey can information be provided outside the EU. Interestingly, in the BVI, the worst that can happen to a non-compliant company beside paying the fine is to be struck off the corporate register.10 Presumably, the group would then run the greater risk of attribution of the Jersey-allocated profits to the foreign jurisdictions although whether this would be included in or additional to the country-by-country reporting regime remains to be seen.

Conclusion
The news of the impending corporate substance requirements took many by surprise in the pre-Christmas period, but this should not have been so — the public was forewarned although admittedly in the dog days of 2018! In truth, this should have been expected since the publication of the Action 5 BEPS report almost four years ago. The only uncertainty had been the names of the countries that would implement the changes but then again, an attentive visitor of the EU Commission’s webpage should have spotted these as well. Whether other offshore States not mentioned here will follow the suit remains to be seen; however, arguably one should not be advised to associate with them in any case.

Readers with businesses in the Crown Dependencies should take an active role in auditing their corporate arrangements with the view to either bring in the necessary level of corporate substance or find courage to disassociate themselves with the offshore world. Luckily for them, the likes of the UK, Cyprus, Malta, Hong Kong Singapore and many other onshore jurisdictions provide adequate, cost-effective and compliant solutions.

Law as stated and links accessed on 7 January 2018

1 Partner, IFS Consultants, London (www.interfis.com, Dmitry@interfis.com)
2 https://bit.ly/2C7GAST
3 Here and in the following two paragraphs the references are to the paragraph numbers of the Report.
4 https://bit.ly/2IMX2dg
5 https://bit.ly/2nxaZWB
6 https://bit.ly/2GYm1Ov
7 “Taxation (Companies – Economic Substance) (Jersey) Law 201-” https://bit.ly/2LTQEmY
8 https://bit.ly/2AvFbp5
9 https://bit.ly/2TxpODK
10 https://bit.ly/2C41x13

ROY SAUNDERS AND DMITRY ZAPOL

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