What is the issue?
The European Union's Code of Conduct Group on Business Taxation has recently proposed that a number of jurisdictions introduce economic substance requirements for companies that are tax resident there to avoid being treated as non-cooperative jurisdictions. In particular, concerns were raised that Guernsey and Jersey (the jurisdictions of choice for many fund managers) did not have sufficient local substance requirements. As a result, with effect from 1 January 2019, Guernsey and Jersey introduced economic substance regulations for companies that undertake specific activities there. Similar regulations were put in place in other jurisdictions.
Why is it relevant to me?
The substance regulations pose a number of potential issues for general partners ("GPs") that are incorporated in tax-haven jurisdictions, such as:
- whether they can still use the
services of local service
providers. The answer is likely
to be yes but the GPs will have
to ensure that the service
providers have appropriately
qualified employees; and
- whether GPs carry on the activities that fall within the substance regulations and, if so, whether alternative structuring options are available. For example, a GP that is carrying on a core income-generating activity in respect of the fund might be able to outsource all or part of its activities, provided that it is able to demonstrate adequate supervision of the outsourced activity and certain other conditions are satisfied. Accordingly, the terms of all outsourcing arrangements will have to be reviewed to ensure that any delegated activities are properly overseen.
In more detail…
By way of example, the Guernsey tax substance regulations require general partner companies resident in their respective jurisdictions ("Local GPs") to satisfy a number of conditions, including:
Local GPs must be directed and managed in Guernsey.
What this means in practice will depend on all facts but there is currently no requirement for company directors to be tax resident there. Therefore, UK tax resident individuals should be able to continue to travel to Guernsey for board meetings. Further, Local GPs only have to hold board meetings there "with adequate frequency", which means that, subject to regulatory requirements, not every board meeting has to take place there.
Local GPs must carry on their core income-generating activities ("CIGA") in relation to that relevant activity in Guernsey.
In the context of fund management, CIGA can include taking decisions on the holding and selling of investments, and calculating risks. Whether or not a Local GP performs a CIGA will therefore be a key consideration. The relevant Guernsey guidance provides that a company which is simply implementing the decisions of another entity (for instance, by selling investments on advice from a UK manager), may not be treated as performing a CIGA.
Local GPs must have appropriately qualified employees proportionate to their level of CIGA.
In practice, these employees may be employed by another entity and so a Local GP should be able to rely on local corporate services providers. However, depending on the wider fact pattern of the business concerned, reliance on local service providers may not be the right answer.
Although the fund vehicle itself should in most cases fall outside the scope of the substance regulations, and licenced GPs may already be in compliance with similar requirements under the relevant regulatory laws, the overall business model of the fund will have to be reviewed to confirm whether any restructuring is required.
In addition, it will now be even more important for Local GPs to maintain comprehensive records of what services they provide to the fund, what services are outsourced and what income is allocated to the activities that they perform. The board members should also have relevant expertise and qualifications, and board meetings and all key management decisions should take place in the GPs' jurisdiction of residence.
Failure to comply with these regulations may result in a fine, striking off the companies register or a disclosure of information to a tax authority of another jurisdiction, where the company's shareholders are resident in accordance with any international agreements relating to the exchange of information.