Economic Substance and EU Blacklist Update

27.04.2020

Following the EU’s inter-governmental Code of Conduct Group (Business Taxation) report in 2018, no or nominal tax jurisdictions including the Cayman Islands, the British Virgin Islands (BVI), Bermuda, Barbados, the Isle of Man, Guernsey and Jersey quickly introduced economic substance legislation late 2018 to avoid being blacklisted by the EU. The legislation introduced sought to follow the recommendations set out by the OECD in its BEPS documentation. While they were still being reviewed by the EU, a number of amendment bills were pushed out to meet EU expectations.

Question that we hear quite often from clients – what is economic substance and do I need to be concerned having an offshore company?

In the context of economic substance legislation, “substance” is a broad term that embraces various areas of a business, including management, control, operations, physical presence and decision-making procedures. The economic substance required varies for different types of relevant activities. Relaxed requirements apply to pure equity holding companies. The registered agent and office services may be already sufficient to satisfy the economic substance test. At the other end, stringent requirements apply to high risk Intellectual property (IP) business. A high degree of control over the development, exploitation, maintenance, protection and enhancement of the IP should be exercised in the jurisdiction by an adequate number of staff with suitable qualifications. Belize goes one step further and prohibits IBC’s from holding IP assets altogether.

It is thus crucial for entities incorporated in relevant jurisdictions to assess whether they are carrying out activities subject to economic substance requirements and what substance is required.

Regardless whether a company is caught by the new laws or can operate outside the scope of the requirements, directors of entities must demonstrate that they have considered the legislation by reporting that the company is either in or out of.

On February 18, 2020 the Economic and Financial Affairs Council of the EU (ECOFIN) adopted a revised EU blacklist of non-cooperative jurisdictions for tax purposes. The EU Finance Ministers agreed to add four new jurisdictions to the list: Cayman Islands, Palau, Panama and Seychelles. 

The Council completely delisted Armenia, Antigua and Barbuda, Bahamas, Bermuda, Belize, British Virgin Islands, Cabo Verde, Cook Islands, Marshall Islands, Montenegro, St Kitts and Nevis, Vietnam.

The EU blacklist comprises the following twelve jurisdictions: American Samoa, the Cayman Islands, Fiji, Guam, Oman, Palau, Panama, Samoa, Seychelles, Trinidad and Tobago, the US Virgin Islands and Vanuatu.

According to the Council of the European Union, the Cayman Islands does not have appropriate measures in place relating to economic substance requirements for collective investment vehicles. 

Palau failed to implement any automatic exchange of financial information measures, including signing and ratifying the OECD Multilateral Convention on Mutual Administrative Assistance and has therefore been re-added to the blacklist. Palau had previously been moved from the blacklist to the grey list, but was re-instated to the blacklist due to its failure to fulfill its commitments within the agreed deadline. 

Panama failed to obtain at least a “Largely Compliant” rating from the Global Forum on Transparency and Exchange of Information for Tax Purposes for Exchange of Information on Request.

Seychelles was moved from the grey list to the blacklist, for failure to address issues in relation to existing harmful preferential tax regimes. 

The Council also noted that given that Turkey has internal legislation in place enabling automatic exchange of information and that it notified all EU Member States, with the exception of Cyprus, to OECD, it will be given more time to solve all open issues for the automatic exchange of information to be implemented effectively with all EU Member States. Turkey is expected to make progress in solving its issues, but if it fails to put arrangements in place for the effective implementation of the automatic exchange of information with all EU Member States by December 31, 2020, it will be moved to the blacklist.  

Since the first EU blacklist was published in December 2017, it has been revised twelve times. The decision to only review the list twice a year may be a welcome development in terms of certainty but will mean that any progress achieved by listed jurisdictions will be reflected with some delay. Given the new timeline (next revision planned for October 2020), each of the four jurisdictions that were added in February 2020 will be blacklisted for more than seven months. 

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