Questions Remain Over Cayman Islands Tax Avoidance Law
* The Caymans new tax law requires firms registered there to undertake activities of “economic substance” in the territory.
* However, recent government guidance failed to clarify what it means for a company to have an “adequate” physical presence, operating expenditures and human resources on the islands
(Beijing) — Three months after the Cayman Islands enacted a new law to combat cross-border tax avoidance, questions remain about its central plank — a test that requires firms to prove they undertake activities of “economic substance” there ahead of a July 1 deadline.
The British Overseas Territory in the western Caribbean, where registered companies pay no corporate tax, has long been described as a “tax haven” — a magnet for multinational companies looking to set up subsidiaries to shield their incomes.
It bowed to international pressure last year with a new law that tightened regulations over shell companies. The International Tax Co-operation (Economic Substance) Law, approved by the Caymans government in December and implemented in January, requires firms registered there to undertake activities of “economic substance” in the territory.
The so-called “ES law” holds that companies that do not satisfy an economic substance test by July 1 of this year could be fined or ultimately even rendered “defunct” in the future.
“The law is set to clean up shell companies and to fight cross-border tax avoidance. If (China’s) red-chip companies can’t satisfy the economic substance test, they will have to change their variable-interest entity (VIE) structures,” said a lawyer specializing in such structures, who asked to remain anonymous because he was not authorized to speak to the media.
VIE structures are designed to skirt Chinese rules restricting foreign investment and ownership in certain sectors, including internet businesses and value-added telecommunications services.
The Cayman Islands has been a popular offshore incorporation destination for Chinese companies, including internet giants like U.S.-listed Alibaba Group Holding Ltd. and Baidu Inc., as well as Hong Kong-listed Tencent Holdings Ltd.
To satisfy the new economic substance test companies must be managed and directed from within the Cayman Islands’ jurisdiction, conduct core income-generating activities, maintain an “adequate” physical presence on the islands, and have “adequate” operating expenditure and human resources.
The legislation said authorities would undertake private sector consultation before issuing guidance on satisfying the test, including on the meaning of “adequate.” But guidance issued in February also failed to provide detailed thresholds.
Detailed filing procedures have not yet been released, and another lawyer who wasn’t authorized to speak publicly told Caixin the July 1 deadline was likely to be delayed.
The law takes in companies in sectors that include banking, distribution and service centers, financing and leasing, fund management, holding companies, insurance, intellectual property, shipping and more. Investment fund businesses are not included.
“There are certain exceptions to these general economic substance requirements for holding companies (which will only be required to meet a reduced test for economic substance) and intellectual property companies (which will face more onerous requirements),” according to a report released in February by accounting firm KPMG.
Other “tax havens,” including the British Virgin Islands, Bermuda in the North Atlantic Ocean, and Guernsey in the English Channel, have enacted similar legislation to comply with the EU’s “fair taxation principle” and to avoid their inclusion in its list of noncooperative jurisdictions, the report said.
This story has been updated to clarify that Chinese rules only restrict foreign investment and ownership in certain sectors. They do not ban it.
Contact reporter Liu Jiefei (firstname.lastname@example.org)
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