The economic substance law came into effect for accounting periods commencing on or after 1 January 2019, so for most companies the 2019 tax returns are the first returns to be filed under the new law. This period closed before COVID-19 emerged, therefore the Jersey Tax Office expects companies to be fully compliant with no concessions or relaxations in the law and penalties for non compliance have already been issued.
It is therefore concerning that some companies are undertaking their 2019 substance review during 2020 as part of the preparation of the 2019 tax return. If the test is failed, it cannot be rectified for 2019 and we are now three quarters of the way through 2020. It’s late in the day, but it is possible to ensure compliance for 2020. In short, act now, and don’t just look to 2021 being the year where you should aim to start the process.
In addition to this, we are seeing common themes emerging which include:
- Boards comprised of 100% non Jersey directors who meet outside Jersey but the company remains Jersey tax resident due to incorporation. Common examples are countries such as the US and Middle Eastern territories, where tax residence is not established by management and control.
- Board minutes not clearly documenting both direction and management and consideration of Core Income Generating Activities (CIGA). It is important to distinguish between direction and management which only needs a quorum in Jersey and CIGA, which if conducted in board meetings, needs a majority of directors physically present. The expectation of the EU Code Group is that the directors and staff needed to perform the CIGA will always be on the Island, so COVID-19 will not impact this. Further, if you have assistance from investment advisers or treasury professionals in New York or London, be very clear that you are not presenting this as conduct of CIGA but rather as implementation and support of the CIGA being carried out on Island by the business.
- Agendas for board meetings covering a calendar year which do not include CIGA and board minutes where CIGA were on the agenda, but the discussion is not reflected in the board minutes, so there is no evidence that the CIGA were discussed.
- Standardised, rolled forward board minutes. These should generally be avoided and should not be used for companies with significant profits.
- Substance reviews not being tabled at a board meeting and signed off by the board.
- Errors in classification. As an example, we have seen entities holding both debt and equity instruments classified as a “holding company”, based on a substance over form type argument. A holding company, with debt, is more likely than not going to be within finance and leasing, rather than a pure equity holding company, which is deliberately a very narrow definition and excludes a company which carries on any commercial activity.
- The requirement to attach accounts and the correct format in which they are required. The tax office is clear that the accounts should be GAAP compliant. It is a Jersey local law requirement for a Jersey incorporated company to have GAAP compliant accounts. However, the position is less clear for an overseas incorporated company. The tax office may allow some leeway for 2019 for overseas companies but will require a profit and loss account, balance sheet and notes signed by the directors.
Another area of concern is the level of knowledge of teams carrying out the classifications and preparing the tax returns. Whilst this is the first attempt to introduce economic substance legislation and, therefore, there are no precedents, the legislation and guidance draws to a large extent on terminology used in UK tax law, the meaning of which is well understood by tax professionals. Consequently, Jersey tax returns for companies within the scope of the economic substance law require careful consideration not only of the Jersey issues but, in the case of multinational groups, of the tax strategy of the wider group.
We are frequently asked questions about how to approach companies with multiple activities but, when you look a little closer, there is only one activity. This is because a number of combinations are excluded by the law and, for those that are not, if you can argue it is one business and pick the highest compliance threshold, you are unlikely to expose the company to additional risk. It is normal for a fund manager to advance loans at interest and hold shares in subsidiaries but this is typically part of the wider fund management business. The most common example of genuine multiple activity is where a company without a relevant activity, such as a real estate company, lends surplus cash at interest which is finance and leasing.
There is also, in some cases, a lack of understanding of what the CIGA are for a particular business. As a starting point, you need to identify the CIGA including any additional CIGA, ensuring for multinational groups that they are aligned to the transfer pricing policy. Otherwise you risk critical meetings being incorrectly categorised as non-CIGA. This could also result in CIGA not being discussed and documented in future periods. Remember, the defined CIGA are there to guide and are not an absolute definition. The box on the tax return for “Other” CIGA is there to be used.
The risk is increased when businesses use junior members of the team who do not have sufficient understanding of the business activities or tax law to capture and document information. This often creates inconsistency both in the way the rules are being applied and the assumptions used to prepare the information included on the returns, which may not be picked up on review.
This means that administrators will need detailed policies and procedures to minimise the risks of non, or inconsistent, compliance. This is in addition to ensuring that the rationale for the classification is documented and approved by the board. The Jersey Tax Office will commence a program of audits next year to ensure that they can demonstrate to the EU Code Group that they are monitoring compliance with the law. These documents will need to be provided as part of any audit.
