Economic Substance Requirements: What Your Offshore Company Must Now Demonstrate

What Economic Substance Means

Economic substance, in the context of offshore companies, means that the entity conducts genuine business activity in the jurisdiction where it is incorporated. This is not just a registered office address. Substance requirements typically require that: the entity is directed and managed from within the jurisdiction; core income-generating activities take place in the jurisdiction; the entity has an adequate number of qualified employees; the entity has adequate operating expenditure; and the entity has adequate physical assets.

The bar for 'adequate' varies by the type of income earned. Holding companies that simply hold shares have lower requirements. Companies earning income from intellectual property, banking, insurance, fund management, headquarters functions, shipping, distribution and service centres, and financing face higher tests.

• Core Income Generating Activities (CIGA): the specific activities that produce the entity's income must be performed in the jurisdiction
• Board meetings: must be held in the jurisdiction; a quorum of directors must be physically present
• Director presence: at least some directors must be resident in the jurisdiction and have the knowledge and expertise relevant to the business
• Outsourcing: CIGAs can be outsourced to a service provider in the jurisdiction , but not to a provider outside the jurisdiction

Jurisdictions with Substance Legislation in Force

The following jurisdictions have enacted economic substance legislation as a direct result of BEPS pressure. All of these apply to entities incorporated there that earn 'relevant income': broadly, income from geographically mobile activities.

• British Virgin Islands: Economic Substance (Companies and Limited Partnerships) Act, 2018; annual substance reporting required
• Cayman Islands: International Tax Co-operation (Economic Substance) Act, 2018; penalties up to USD 100,000 for first-year failures
• Bermuda: Economic Substance Act, 2018; strong enforcement; substance certificates required for certain entities
• Isle of Man, Guernsey, Jersey: all have substance legislation; GFSCs and other regulators actively review compliance
• UAE: Cabinet Resolution 57 of 2020; substance requirements apply to UAE companies earning specific categories of income

What Does Not Constitute Substance

The most common failing is conflating administrative presence with economic substance. A registered office, a nominee director who is also the nominee director for 500 other companies, and an annual general meeting held via email do not satisfy substance requirements. Tax authorities and jurisdictions themselves have become significantly more sophisticated in identifying paper substance.

• Nominee directors: a professional nominee who does not actually manage the company does not create substance
• Registered office only: the entity's address in the jurisdiction is the minimum required; it does not demonstrate management or activity
• Virtual meetings: board meetings held by video conference from outside the jurisdiction generally do not create local substance
• Outsourcing to non-local providers: if core activities are performed by staff located in another country, substance requirements are not met

Building Real Substance: Practical Options

For entities that need to satisfy substance requirements, practical options include hiring actual employees in the jurisdiction (even part-time for small entities), engaging a local managed service provider who genuinely performs core activities, maintaining a genuine office space, and ensuring that directors with real authority and knowledge reside in the jurisdiction.

Alternatively, for structures where substance would be expensive and operationally burdensome, the cleaner solution may be to incorporate in a jurisdiction that does not impose substance requirements on the entity's income type, or to use a structure in the owner's own country of residency.

Our custom structuring services and Nomadic Go's offshore company formations (fulfilled by our sister brand) both include substance planning as a mandatory step; no jurisdiction is recommended without working through what ongoing substance compliance will look like for your operation.