Guernsey (along with the other Crown Dependencies and some other British Overseas Territories), has approved new economic substance requirements for tax resident companies. References below to the Bailiwick are because the legislation extends to the Islands of Guernsey, Herm and Alderney. It does not, however, extend to Sark.
Aims and scope
The Guernsey authorities (along with those in the other Crown Dependencies) have confirmed in a ‘Key Aspects’ document that the legislation was designed to address EU concerns that Guernsey companies could be used to artificially attract profits that do not reflect the economic activities and substantial economic presence.
These new rules apply for accounting periods commencing on or after 1 January 2019. A resident company must satisfy the economic substance test for any relevant activity carried on from which it derives gross income. Companies must demonstrate they have substance in the Bailiwick by:
- Being directed and managed in the Bailiwick, and
- Conducting Core Income Generating Activities (CIGA) in the Bailiwick, and
- Having adequate people, premises and expenditure in the Bailiwick.
The legislation precisely defines the nature of each activity affected but, broadly, they fall into the following:
- Banking, insurance and fund management
- Finance and leasing
- Headquarters and holding companies
- Intellectual property holding
- Distribution and service centre.
Substance requirements tests
- Directed and managed in the Bailiwick
This test will be satisfied if:
- The company’s board of directors meets in the Bailiwick at an adequate frequency for the amount of decision-making required
- At such board meetings there is a quorum of directors physically present in the Bailiwick
- The directors have the necessary knowledge and expertise to discharge the duties of the board
- The minutes of such board meetings record the making of strategic decisions of the company at the meeting and are kept in the Bailiwick along with the records of the company.
- Core-income generating activity in the Bailiwick
This test will be satisfied if the activity carried out meets the specific definitions set out in the legislation for affected businesses.
However, it is not necessary for the company to locally perform all of the CIGA listed in order to demonstrate substance: it must simply be at an appropriate level. Equally, some companies may undertake or outsource all or part of an activity outside of the Bailiwick. If that activity is not part of the CIGA (for example, back office functions are outsourced), this will not affect the company’s ability to meet the substance requirement.
For intellectual property assets, such as patents, it is expected that the CIGAs include R&D activities. For non-trade intangible assets, such as brand, trademark and customer data, it is expected that the CIGAs include marketing, branding and distribution activities.
The overriding rule is that the income subject to tax in the Bailiwick must be commensurate to the CIGA undertaken in the Bailiwick.
- Level of relevant activity in the Bailiwick
This test will be satisfied if:
- There are an adequate number of employees for that activity who are physically present in the Bailiwick (whether or not employed by the resident company or by another entity and whether on temporary or long-term contracts),
- There is adequate expenditure incurred in the Bailiwick, and
- There are adequate physical assets in the Bailiwick.
The legislation does not prohibit a company from outsourcing some or all of its activity (ie contracting or delegating to third parties or group companies). However, if some or all of the CIGA is outsourced, the company must be able to demonstrate that it has adequate supervision of the outsourced activities and, to meet the substance requirements, that those activities are undertaken in the Bailiwick.
Where a CIGA is outsourced, the resources of the service provider in the Bailiwick will be taken into consideration when determining whether the people and premises test is met. However, there must be no double counting if the services are provided to more than one company, and this will strengthen the need for such providers to keep detailed records of time (and other resources) allocated to specific clients.
As part of their income tax filing process, all companies will be required to provide details on:
- Business/income types (in order to identify the type of relevant activity), and
- Amount and type of gross income.
Companies carrying on relevant activities must also provide:
- Amount of operating expenditure
- Details of premises
- Number of (qualified) employees, specifying the number of full time equivalents
- Confirmation of the CIGAs conducted for each relevant activity
- The financial statements, and
- Confirmation of whether any CIGAs have been outsourced and if so relevant details.
This will greatly increase the Guernsey tax compliance obligations for many companies, even if they are unaffected by the regulations, particularly because Trust and Company Service Providers will no longer be able to submit “bulk” returns.
Special rules for IP companies
There are detailed requirements for ‘high-risk IP companies’. Such companies are presumed not to meet the adequate substance requirements relating to conducting core income-generating activity in the Bailiwick unless the company provides evidence to rebut this presumption, and they must provide additional information including:
- Detailed business plans which clearly lay out the commercial rationale for holding the Intellectual Property asset(s) in the Bailiwick
- Concrete evidence that the decision making is taking place in the Bailiwick, and not elsewhere, and
- Information on employees in the Bailiwick, their experience, the contractual terms, their qualifications, and their length of service.
Periodic decisions by non-resident directors or board members, or local staff passively holding intangible assets, cannot rebut the presumption.
Penalties for non-compliance
If the economic substance requirements are not met for a financial period, financial penalties can be levied (up to £100,000 for repeated failings) and information can be automatically exchanged with other tax authorities. Following repeated failures to meet the substance requirements, companies can be struck off the Guernsey (or Alderney) Register.
For help and advice on any business substance or international group planning issue, please get in touch with your usual BDO contact, Mark Savage or André Trebert.