Joint Guidance on the Application of the Economic Substance Rules to Partnerships

‘Governing body’ for the purposes of directed and managed test

One of the Economic Substance Tests requires partnerships to be directed and managed on island. Whilst for companies this is determined by the conduct of the Board of Directors, the Guidance establishes the concept of a ‘governing body’ in the case of partnerships.

The governing body is defined in the Guidance as ‘the person or group of persons responsible for making the partnership’s strategic and management decisions, i.e. it has the general supervision of the affairs of the relevant partnership.’

Given the differing natures of partnerships, clearly the process for establishing a partnership’s governing body will vary for each partnership. The Guidance provides considerations for each partnership type; for limited partnerships the governing body will be considered to be the Board of Directors of the body corporate (typically the General Partner). The Guidance does however caveat that where there is evidence of substantive decision making taking place by other persons this may not be the case. If a single governing body is unable to be determined, all of the partners in the partnership will be deemed the governing body.

It will, therefore, be important to undertake a thorough review of who the persons are who are undertaking the substantive decision making process on behalf of the partnership and to ensure this is appropriately documented, and the appropriate policies and procedures are put in place and adhered to to prevent any unintentional deviation from this position during the year.

The “Place of Effective Management”

The Guidance expands on the concept of Place of Effective Management (POEM) which determines where a partnership is resident for the purposes of the Economic Substance rules.

The concept of POEM is one which is used across the globe and is set out in the OECD model treaties. The islands’ legislation follows the OECD guidelines, which notes: “The place of effective management is the place where key management and commercial decisions that are necessary for the conduct of the entity’s business as a whole are in substance made.” Even if there are multiple places of management, partnerships may only have one POEM at any one time; the intent is to establish where a partnership is actually managed.

The Guidance recognises that there is no one set test for POEM given that each situation will depend on the particular facts of each partnership. However, consideration should be made to the partnership agreement, partnership registers, minutes of meetings, and to the records at the registry. The Guidance also lists relevant factors to consider in the case of uncertainty including where the majority of partnership meetings take place (i.e. if there is no mandated governing body) and whether the partners, particularly those involved in its management, were resident in the island.

The Guidance also includes a list of jurisdictions which are deemed to have substantially similar substance requirements and are, therefore, considered qualifying jurisdictions. Partnerships whose POEM is in one of these jurisdictions will not be required to satisfy the Crown Dependencies substance requirements (except where POEM is in one of the Crown Dependencies). These jurisdictions are listed in Annex 1 of the Guidance here.

The assessment of POEM has always been a complex area, which is a lot more subjective than a central management and control test. Businesses will need to undertake an assessment of the factors listed in the Guidance, in the context of the OECD principles on which the test is based, to assess where the POEM for each partnership resides.

Exemptions

The Guidance provides further clarity and examples on the exemptions that apply to partnerships. We have focused here on the domestic exemption. The domestic exemption applies where the partnership is not part of a multi-national group and carries out its activities only in the island. Such partnerships fall out of scope of the substance requirements.

Whilst the definition of a multi-national group will be determined by each island’s legislation, the Guidance more generally defines such a group as a collection of enterprises (which are not all tax resident in the same jurisdiction) that are required to prepare consolidated financial statements, in accordance with International Accounting Standards.

The place where the partnership carries out its activities will be more subjective. When determining where a partnership carries out its activities, consideration should be made to whether there is a fixed place of business/ premises through which the partnership’s trade or business is carried on. This approach is more akin to the OECD’s definition of a permanent establishment, although it should be noted that each jurisdiction has its own rules when determining whether a permanent establishment is created. In the case of limited partnerships, activities will be considered to be carried out through the fixed place of business/ premises of the General Partners. Performing services for the benefit of the resident partnership (for example meeting with a bank outside the Island to agree more favourable lending terms), rather than a customer, are not considered part of the partnership’s activities in this context.

Businesses should work through each available exemption to assess whether they apply to their partnerships. Again, key areas, such as where a partnership carries out its activities, have their base in OECD principles. It will therefore be necessary not only to consider the local legislation and Guidance but also the broader OECD approach when undertaking any reviews.

Other clarifications

In respect of the adequacy tests for employees, expenditure and premises, all resources on island should be considered. Similar to companies, when determining adequate employees, partnerships should, include Guernsey based employees of:

• the partnership;
• the governing body, including a general partner, or any other partners; and
• persons to whom activities have been outsourced.

Next steps

Given that certain partnerships are already in their first year of substance and many more may fall in from 1 January, businesses should now be taking steps to ensure that they assess the relevance of the new legislation and ensure their partnerships are able to comply with the new Economic Substance legislation. The first step will be to establish which partnerships are undertaking relevant activities and put the appropriate measures in place to ensure in-scope partnerships are able to pass the test or take appropriate remedial action. The various exemptions should be given particular attention, to establish whether they can be relied upon.

As mentioned previously, preparing a revenue defence pack can help ensure that those responsible for approving the tax returns have the appropriate supporting information to do so with confidence. Our experience from the corporate substance regime was that those who had performed an initial assessment/ review before or during the first in-scope accounting period found it much easier when completing their tax returns further down the line.

Although not discussed in the Guidance, the partnership reporting obligations are starting to take shape. In Guernsey, partnerships are now required to register with the Guernsey Revenue Service (GRS) by 14 July after the end of the first year of applicability to the partnership. There will also be an annual tax filing requirement. In Jersey, a consultation is expected shortly that will likely shed light on the reporting obligations. However, it is anticipated that annual confirmations from partnerships will be required which would be aligned with the corporate filing deadline of 31 December.

Should you require any more information or assistance, please get in touch with one of the individuals listed below, or your normal PwC contact in our Channel Islands tax team.