Along with its fellow Crown Dependencies and Overseas Territories, the Cayman Islands now has comprehensive economic substance legislation, under which in-scope entities that carry on particular activities are required to demonstrate economic substance in Cayman. These requirements were effective from 1 January 2019 and are governed by the International Tax Co-operation (Economic Substance) Law (2020 Revision) as amended by the International Tax Co-operation (Economic Substance) (Amendment) Law, 2020 (Amendment Law) and the International Tax Co-operation (Economic Substance) (Amendment of Schedule) Regulations, 2020 (Amendment Regulations and together the ES Law).
The Tax Information Authority (TIA), which is responsible for monitoring and enforcing the substance requirements in Cayman, publishes guidance on the ES Law. On 13 July 2020, the TIA published the latest guidance on economic substance for geographically mobile activities (Updated Guidance).
This briefing note discusses the substance regime in place in Cayman and highlights the key changes and practice points referenced in the Amendment Law, Amendment Regulations and Updated Guidance.
Ogier is experienced in advising on the economic substance regime in Cayman, Jersey, Guernsey and the British Virgin Islands and on cross-border queries that often arise in the context of global groups. We would be delighted to discuss your specific requirements. Please get in touch with your usual Ogier contact or one of the key contacts listed under economic substance services on ogier.com.
Economic substance in the Cayman Islands – an overview
As stated under the Amendment Law below, all Cayman entities are required to make an annual report to the TIA as to whether or not they are carrying on one or more of a defined list of activities (Relevant Activities) and if so, whether or not it is a Relevant Entity (as defined in the ES Law), together with certain prescribed information as set out below. A Relevant Entity that is carrying on a Relevant Activity is required to submit a subsequent report to the TIA within a 12 month period after the end of its financial year, containing certain prescribed details and demonstrating how such Relevant Entity has satisfied the economic substance test (ES Test) as set out in the ES Law. The TIA is then responsible for determining if a Relevant Entity has satisfied the ES Test based on the evidence provided by the Relevant Entity.
Relevant Entities include most Cayman exempted companies (including foundation companies – see below), Cayman LLCs, Cayman limited liability partnerships and registered foreign companies except:
(a) investment funds or entities through which investment funds directly or indirectly invest or operate;
(b) entities which are tax resident outside the Cayman Islands;
(c) entities which are authorised to carry on business locally in the Cayman Islands as a domestic company; or
(d) Cayman exempted limited partnerships and trusts.
All Cayman entities will have to state in their annual return whether they have conducted any Relevant Activities in the preceding financial period. Relevant Activities are fund management, banking, insurance, finance and leasing, distribution and service centre business, headquarters business, intellectual property business, shipping business, and holding company business.
The Economic Substance Test
Relevant Entities that carry on Relevant Activities must satisfy the ES Test and must therefore:
(a) conduct core income generating activities (CIGAs) in relation to the Relevant Activity in the Cayman Islands;
(b) be "directed and managed" in an appropriate manner in Cayman; and
(c) having regard to the level of relevant income (i.e. gross income recorded in its books and records under applicable accounting standards) derived from the Relevant Activity carried out in Cayman:
(i) have an adequate amount of operating expenditure incurred in Cayman;
(ii) have adequate physical presence (including maintaining a place of business or plant, property and equipment) in Cayman; and
(iii) have an adequate number of full-time employees or other personnel with appropriate qualifications in Cayman.
A more detailed overview of economic substance requirements in the Cayman Islands can be found in our client briefing.
The Amendment Law, which came into force on 12 February 2020, was introduced primarily to expand section 7 of the ES Law which relates to the requirement for Relevant Entities to provide information to the TIA. The framework around the circulation of information in relation to Relevant Entities which are tax resident or incorporated in a foreign jurisdiction has also been elaborated.
The requirement to provide information
Prior to the Amendment Law, a Relevant Entity had to annually notify the TIA (i) whether it was carrying on a Relevant Activity and (ii) if the gross income generated by this Relevant Activity was taxable in a foreign jurisdiction. Under the Amendment Law, all entities are now required to provide prescribed information, not only Relevant Entities. Entities are now required not only to confirm whether they are conducting a Relevant Activity but also whether or not they are Relevant Entities for the purpose of the ES Law. Entities that are carrying on a Relevant Activity and are tax resident in a jurisdiction outside Cayman are required to provide the additional information listed below. Relevant Entities are now also expected to share with the TIA their financial year end together with the name and address of the officer responsible for providing information to the TIA.
The requirement to provide information – outsourcing
A Relevant Entity can satisfy the ES Test in relation to a Relevant Activity if it outsources the relevant CIGA to another person in Cayman and is able to monitor and control the carrying out of the CIGA by that other person. The Amendment Law provides that the person to which the CIGA is outsourced may be required to verify within 30 days, the information relating to its services, which has been provided to the TIA by the Relevant Entity.
Failure to share information with the TIA
The Amendment Law provides for penalties to be imposed on Relevant Entities which fail to comply with their obligation to report to the TIA under the ES Law. A Relevant Entity which fails to send its ES Test report will be notified by the TIA of such failure and will be fined CI$5,000, with an additional fine of CI$500 accruing for each day the failure to comply continues. Such penalty will need to be settled within 30 days from the day it is due and can be appealed to the Grand Court, where it may either be affirmed, reversed or substituted by a penalty of the Grand Court.
In addition on 7 July 2020 the Tax Information Authority (Amendment) Law, 2020 (TIA Amendment Law) came into force which provides additional powers to the TIA to assist with its monitoring of compliance with certain laws and regulations related to its function including the power to examine the affairs or business of any person through on-site inspections, by auditing reports and annual returns, and by collecting and sharing statistical data. The TIA Amendment Law also provides for enhanced collaboration between the competent authority and other government entities, for example, the Cayman Registrar of Companies and the Cayman Islands Monetary Authority (CIMA), under appropriate legal channels. Lastly the TIA Amendment Law introduces a summary offence of knowingly or wilfully submitting false or misleading information to the authority. The offence attracts a fine of CI$10,000 or imprisonment for a term of five years or both.
A new information framework for Relevant Entities which are tax resident or incorporated in a foreign jurisdiction
The Amendment Law provides that Relevant entities which are tax resident outside Cayman must supply to the TIA:
(a) the name and address of their immediate parent, ultimate parent and ultimate beneficial owner and any other information reasonably required to identify their immediate parent, ultimate parent and ultimate beneficial owner;
(b) the date of the end of their financial year; and
(c) the jurisdiction in which the entity is claiming to be tax resident and any other information as may reasonably be required to support that claim.
The Amendment Law created new information sharing obligations for Relevant entities that are liable to tax or established in a jurisdiction outside the Cayman Islands. Where the TIA has been provided with information under the ES Law in relation to a Relevant Entity which is tax resident outside Cayman, it will share that information with the competent authority in the relevant jurisdictions of (i) the Relevant Entity and (ii) the immediate parent, ultimate parent and ultimate beneficial owner of the Relevant Entity. Where a Relevant Entity is incorporated in a foreign jurisdiction, the TIA will provide the same information to the competent authority of the jurisdiction where the Relevant Entity is incorporated.
In light of the above, the TIA has updated its guidance on the application of the ES Law. In addition, the Updated Guidance provides further clarifications regarding certain existing provisions within the ES Law.
Power of the TIA to monitor and investigate circumventions
The TIA confirmed in its Updated Guidance that it will monitor compliance with the ES Law provisions, including the monitoring and investigation of arrangements created specifically to circumvent obligations under the ES Law, such as mechanisms set up by Relevant Entities to manipulate or artificially suppress their income in order to circumvent substance requirements.
New detailed sector specific guidance
The Updated Guidance includes much more detailed sector specific guidance. Each sector now benefits from a more comprehensive scrutiny of its status under the ES Law in respect of whether it is a Relevant Entity or not and whether it carries on a Relevant Activity. The Updated Guidance now also includes concrete sector specific examples.
As an illustration, the Updated Guidance provides extended definitions and examples of financing and leasing business activities that could be within the scope of the ES Law. The TIA explains that the activity of providing credit facilities for any kind of consideration is considered in scope, except for certain businesses which are listed therein. As such, an entity which provides credit facilities to customers and charges an interest rate or a lending fee is considered a Relevant Entity carrying on a Relevant Activity, even if the action of providing credit facilities is separate from the consideration, such as for example where a loan advanced for consideration by one company is then transferred to another company which will receive the interest rate. Intra-group loans would also fall within the scope of financing and leasing business where they are interest-bearing. The Updated Guidance also provides a list of activities which would not be considered as Relevant Activities, especially when these are incidental, i.e. occasional, minor and without any profit-making purpose.
The exception of investment funds and its applicability to Private Funds
The Updated Guidance confirms that 'private funds' which are registered with CIMA for the purpose of the Private Funds Law (Revised) are regarded as investment funds for the purpose of the ES Law and will therefore benefit from the relevant exception (i.e. will not have to satisfy the ES Test).
Cayman insurance companies acting as controlled foreign corporations under the US Internal Revenue Code (IRC)
The new sector specific guidance also provides that a Cayman insurance company that is electing itself to be liable for tax in the United States under the IRC as if it were a US corporation will be considered as tax resident outside Cayman and will therefore not be a Relevant Entity for the purpose of the ES Law, which will exempt it from substance obligations contained therein. Such company will however have to submit to the TIA proof of its tax election by providing, for example, a tax identification number or evidence of payment of tax to the US Internal Revenue Service.
On 10 July 2020, the Amendment Regulations were published. These regulations removed the reference to section 9 of the Companies Law from part (b) of the definition of "domestic company" so that companies limited by guarantee will no longer be automatically classified as domestic companies unless they otherwise satisfy the criteria for a domestic company. As mentioned above, domestic companies are not Relevant Entities.
Accordingly, absent another exception, a Cayman Islands foundation company will be a Relevant Entity and if it conducts a Relevant Activity, such foundation company will now be required to satisfy the ES Test.
For further information, or to discuss specific requirements, please get in touch with your usual Ogier contact or one of the key contacts listed under economic substance services on ogier.com.