Ahead of the additional EU substance requirements coming into force from 1 January 2019, Deloitte’s recent client seminars in Guernsey and Jersey examined what these new rules will mean to Channel Islands tax resident companies.
The event set out to examine which companies are impacted, secondly how to determine the company’s classification and finally what judgement will be required to decide whether the level of substance in the company is adequate, taking into account its core income generating activities.
Jo Huxtable, Deloitte Tax Partner, reported that some companies will approach this work as part of a general review of the group’s transfer pricing policy where the focus is also on where key roles and functions are carried on. Deloitte is also supporting corporate service providers (CSP) to review their client structures to determine which will be impacted and what changes may be required by the CSP in delivering its services. What is clear is that there is little time before the new rules come into effect and so many companies are starting to work through the impact now.
In response to concerns raised by the EU Code of Conduct (the Code Group) about profit shifting, Jersey, Guernsey and Isle of Man (the Crown Dependencies “CDs”), along with 10 other jurisdictions, have committed to introducing new legislation by the end of 2018. This will require companies resident in their jurisdiction to demonstrate a link between the economic activity carried on there and the economic substance which supports that activity.
The CD governments have worked since then to develop their own new legislative framework to be in place by the end of 2018 and to take effect in respect of all companies resident in one of the CDs for accounting periods starting after 1 January 2019.
The Code Group published some guidance in a Scoping Paper dated 8 June 2018 which confirmed their focus on so-called geographically mobile businesses carrying on “relevant activities” which are perceived to be at risk of profit shifting: intellectual property, banking, insurance, headquartering, shipping, finance and leasing and fund management. Pure equity holding companies should be subject to reduced substance requirements on the basis that they are passive and as long as they do not carry out any of the relevant activities. The timetable is tight; it is expected that the draft law and guidance will only be published in around late October/early November.
What are the requirements in the Channel Islands?
The rules will be introduced through new provisions in the respective Guernsey and Jersey tax legislation requiring companies carrying on certain defined activities to certify on their annual tax return that:
- the company is directed and managed in its location of tax residence;
- its core income-generating activities are conducted in the location of tax residence;
- there are an “adequate” number of directors and employees, expenditure and premises in the context of the specific activities carried on by that company.
In addition, the tax return is likely to require additional information about the company’s activity type, gross income and employee numbers.
Companies which are not able to respond to any of the new requirements on the tax return will face sanctions in the form of financial penalties, potential exchange of information with relevant EU tax authorities and ultimately, may be struck off.
Impact for Channel Islands business
There are some important points to note:
- The new rules will not impact all businesses. It is only entities which are treated as companies for the purposes of the income tax law and also that are tax resident in Guernsey or Jersey (respectively);
- It is only certain activities that are relevant – companies not carrying out relevant activities should not be within scope
- Confirming the correct classification of the company will be important. Although each activity will be defined in legislation there will inevitably be grey areas that will warrant careful attention. When is a holding company a headquarter company, for example?;
- Other than for companies with income from intellectual property, it is not a requirement of the directed and managed test that directors should be resident in Guernsey or Jersey;
- It will be essential to determine what are the core income generating activities of the company (compared to other administrative functions) and ensure that these are undertaken in Guernsey/Jersey;
- Terms like “adequate” are inherently subjective and although these rules are not the same as transfer pricing (they seek to challenge the incorporation and operation of companies rather than the proportion of profits which can be recognised) some principles of transfer pricing will be helpful;
- Outsourcing of core income-generating activities to service providers in the same jurisdiction is permitted as long as there is sufficient supervision of the activity by the company. It will be essential to ensure that outsourcing does not result in double counting of resources when determining if the adequate employees test is met.