Economic Substance Update | Tax Talk

Transcript

Kevin: The economic substance rules have been with us for some time now in the Isle of Man Phil, so to recap what are the rules and how do they apply.

Phil: So, the legislation was introduced to meet commitments made to the EU and it applies to Isle of Man tax resident companies that generate income from certain sectors. So, for those companies that are caught they have to demonstrate that they have economic substance in the Isle of Man, which relates to that income and the profits made from it. It’s important to note that it applies to income, and so for a company that doesn’t generate income during that period they’re not caught, but they do need to consider the position on a year by year basis.
The legislation itself was introduced with effect from 1 January 2019 and applies to accounting periods commencing on or after that date.

Kevin: What should businesses be doing to consider the potential impact of these rules?

Phil: The starting point is that other than new companies all other companies should have an accounting period on or after that date, so are potentially now within scope. What we’ve been suggesting to companies is that they undertake so form of readiness assessment that asks certain questions to consider the position. For instance, do they generate income from one of the relevant sectors, if so, do they meet the test as set out within the regulations and what potential steps do they need to take to be compliant with the rules. Ultimately there are sanctions that can apply if they don’t meet the test and these can include financial penalties, automatic exchange of certain information and ultimately being struck off as an Isle of Man company.

Kevin: Now you mentioned different sectors that these rules apply to, are there any sectors where you have seen particular issues?

Phil: That’s a good point we’ve seen some obvious and some less obvious cases. For instance, for IP companies these are companies that have been specifically targeted and for high risk IP companies there is a starting presumption that they won’t meet the test unless they can rebut that presumption, which requires an awful lot of evidence to be able to counter that. Another area we have seen are companies in the shipping sector, now an important issue to consider here is are you the operator of the ship? Because it is the operator that’s caught. So, for example in a bare boat charter scenario it wouldn’t be the owner of the vessel that is caught it would be the operator of the vessel that is caught. There are also some particular issues around looking at the core income generating activities, because ideally the core income generating activities in the shipping sector need to be carried out in the Isle of Man, but practically speaking they are carried out where the ship actually operates and where it bases itself.

Perhaps a less obvious sector is financing and leasing and a particular issue we have found has been in a group of companies and where there have been interest bearing group loans between them that have been caught within this. An important point to note is there is no de minimis limit, so if there is an interest-bearing loan you are potentially caught.

So Kevin, practically speaking you’ve been involved with the preparation of income tax returns, what types of issues have you been seeing during the course of that?

Kevin: Well the rules have led to additional information needing to be included in the corporate income tax return and that is facilitated by answering a series of questions which are now there. Some of these are simple yes, no answers, but some require a more involved response, providing information for example around employees or around expenditure in the Isle of Man. Important to consider those questions and answer them carefully and make sure there is substance to support the answers given. Ultimately there is a question around whether or not the directors feel that the company has satisfied the substance requirements which is obviously the key consideration. Important to bear in mind that Income Tax Division may well raise enquiries around returns, so be prepared to respond robustly to those. And I think that’s an interesting point because lots of businesses may have been struggling of late with restrictions on travel, with interaction between personnel, so that can affect the answers given.

Is that something you’ve seen in practice Phil?

Phil: It’s been a challenging issue we have seen for companies. One of the particular tests is around the direction and management of the company which looks at whether what’s actually taking place at strategic level in the Isle of Man. With the current travel restrictions things like board meetings and directors being physically present in the Isle of Man has been a challenge. Whilst we don’t have any specific guidance we are hopeful that the Income Tax Division will take a pragmatic and sympathetic view on this, but what we would recommend to business is that as soon as practically possible they revert to carrying out these functions in the Isle of Man and making sure they do take place to satisfy this particular test.

Kevin: Ok, so in summary then, the key to these rules is to understand them, to understand if they apply and if so how and what the tax implications are and to remember that these rules are with us now, they’re live so if this matter hasn’t been considered and addressed now is the time to do so.