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Panama: New economic substance requirements for offshore jurisdictions

New laws in key offshore jurisdictions came into force at the beginning of 2019 which require entities engaging in specific types of business to demonstrate adequate economic substance in that jurisdiction. Failure to comply with substance requirements could lead to grave consequences, such as incurring significant fines or being struck off by local registries.

Economic substance is a broad term that encompasses numerous areas of a business, such as management, control, operations, physical presence and decision-making procedures. It is thus crucial for entities incorporated in relevant jurisdictions to assess whether they are carrying out relevant activities as prescribed, and whether there is a requirement to demonstrate substance. Equally vital is for administrators of such entities to demonstrate that they have shown regard towards the legislation by resolving that their company is either in or out of scope and, if in scope, that they have or are taking steps to comply with the new legislation.

In 1997, the EU adopted a resolution on a Code of Conduct for business taxation to counteract the effects of zero tax and preferential tax regimes around the world, and to introduce economic substance requirements.

Years later, in 2015, the OECD's Base Erosion and Profit Shifting (BEPS) project centered on income attributed to intangibles with an objective of curtailing perceived artificial profit-shifting by multinational entities. A key part of this project is a renewed emphasis on the concept of economic substance.

In 2017 the EU Code of Conduct Group investigated the tax policies of both EU member states and third countries, assessing tax transparency; fair taxation; and implementation of anti–BEPS measures. Following assessment by the Code Group, each non-EU relevant jurisdiction (which includes Bermuda, the British Virgin Islands, the Cayman Islands, Guernsey, Isle of Man and Jersey) was required to address the Code Group's concerns about economic substance.

As a result of these efforts, several international finance centres have introduced economic substance requirements legislation. This includes all the traditional offshore jurisdictions, including the British Virgin Islands (BVI), the Cayman Islands, Anguilla, Bahamas, Bermuda, and the Crown Dependencies of Jersey and Guernsey, as well as other important locations around the world.

The scope of the economic substance regulations varies from jurisdiction to jurisdiction. As a primary step, businesses should take an inventory of all their entities in the affected jurisdictions and make note of the type of company – LLC or partnership – and how they are taxed.

The following are considered relevant activities in each jurisdiction:

  • Banking business
  • Insurance business
  • Fund management business
  • Finance and leasing business
  • Headquarters business
  • Shipping business
  • Holding business
  • Intellectual property business
  • Distribution and service centre business

In general terms, an entity (other than a holding entity, and entities that conduct intellectual property business, for which there are different criteria) conducting a relevant activity will satisfy the economic substance requirements if:

  • it is managed and directed within the jurisdiction;
  • core income-generating activities (CIGA) are undertaken in the jurisdiction in relation to the relevant activity;
  • it maintains adequate physical premises within the jurisdiction;
  • there are adequate employees in the jurisdiction with suitable qualifications;
  • there is adequate expenses incurred in the jurisdiction in relation to the relevant activity; and
  • it files an annual confidential economic substance report with the applicable authority in its jurisdiction which will assist the authority in assessing compliance.

In addition, various substance regulations set out the circumstances where the above activities may be outsourced from third parties.

Most of the jurisdictions that had made commitments to the EU to introduce substance requirements successfully passed legislation before the 2018 year-end deadline, in addition to providing guidance around the application of the legislation. In March 2019 and with a subsequent review in May, the EU published an updated list, moving those jurisdictions who had reached the requisite standard off the list, or onto a grey or black list depending on their respective progress. As a result, a majority of jurisdictions have since been adapting their local substance legislations and providing additional guidance on economic substance requirements.

Carlos Ucar

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