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Panama: Economic substance requirements for international financial centres

In June 2018, the EU issued a scoping paper detailing the economic substance requisites that the subject jurisdictions should adopt before 2019 regarding entities based in those jurisdictions

To address concerns raised by the EU Code of Conduct Group for business taxation (the Code Group), and under the OECD's base erosion and profit shifting (BEPS) action plan, in 2017, EU member states began a push for economic substance regulations in the tax policies of both EU member states and third countries. Following its assessment, the EU revealed a list of 13 jurisdictions that needed to deal with their findings regarding the demonstration of economic substance, or be placed on an EU blacklist. In June 2018, the EU issued a scoping paper detailing the economic substance requisites that the subject jurisdictions should adopt before 2019 regarding entities based in those jurisdictions. It's currently anticipated that these economic substance conditions will become a worldwide OECD standard, as they were recently supported by its Forum on Harmful Tax Practices.

The EU Code of Conduct Group reviewed the tax regimes applicable in over 90 jurisdictions. While it found that most international money centres were largely compliant with EU principles regarding tax guidelines, considerations were raised concerning the absence of a legal substance requisite for conducting business in, and through, some jurisdictions.

The Channel Islands, British Virgin Islands (BVI) and other jurisdictions that include Bermuda, the Cayman Islands, and the Isle of Man, were mentioned in a list of jurisdictions that should address the Code Group's 'economic substance' considerations. The governments of these jurisdictions actively engaged with the Code Group to introduce appropriate legislative responses to these issues.

In order to meet the EU's December 31 2018 deadline, a number of British Overseas Territories (including the Cayman Islands, BVI and Bermudas) and Crown Dependencies (including Jersey, Guernsey and the Isle of Man) adopted legislations regulating the economic substance of companies (and in some cases, other types of entities).

Subject to each jurisdiction's legislation, entities carrying out the following relevant activities will require an 'adequate' level of economic substance: (a) banking; (b) insurance; (c) fund management; (d) finance; (e) leasing; (f) headquarters; (g) shipping; (h) intellectual property; (i) distribution and service centres; and (j) holding entities.

The purpose of these pieces of legislation is to confirm that entities incorporated in offshore jurisdictions have the required substance (either within the jurisdiction in which they are incorporated, or another jurisdiction where they're tax resident).

An entity in an applicable jurisdiction that is carrying out one or more relevant activities will be required to comply with the substance requirements, unless it proves its tax residency in another jurisdiction. Noncompliance with these requirements will result in substantial fines and/or the company being struck off. The substance required will depend on the relevant activity being executed (in attention to the nature and scale of the relevant activity) but it will be important whether, from that jurisdiction: (a) activities are being directed and managed; (b) there are adequate numbers of employees; (c) there is adequate expenditure; and (d) appropriate physical offices or premises are maintained.

Special attention should be given to confirm if a company or other entity incorporated in one of these jurisdictions is carrying out a relevant activity and is required to comply with economic substance requirements. If this is the case, and it is determined that the company does not maintain sufficient economic substance, in most instances the entity will have two possible courses of action: either it must develop more local substance, or it must become a tax resident in another jurisdiction.

An entity's response to economic substance regulations will require a global perspective. Many affected entities will have to review their tax residency position globally. In addition, actions taken to address the economic substance rules may also impact the entity's position under the Common Reporting Standard (CRS) and FATCA.

For individual jurisdictions, the impact of the new economic substance regulations is probably going to stay unclear for some time. Notwithstanding, international financial centres have an extended history of adapting to change, given the vital role they play within the world economy. They offer efficient, helpful platforms for facilitating cross-border activities and permit important investment to flow around the globe, supporting economic growth, jobs and tax revenues. International financial centres are geared to meet the needs of international commerce and investments, with specialised and efficient regulatory regimes for specific types of financial sector activity.

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