Economic substance - update

12 March 2021

The economic substance rules have now been in place across the various jurisdictions since January 2019. Since then there have been various updates to the rules in all the relevant jurisdictions and further guidance has been issued. In addition, a new regime has been introduced in the UAE.

Broadly, initial differences in the way the jurisdictions interpreted the requirements and transposed them into their domestic legislation have been harmonised, with the result that there is now a standardised approach to economic substance requirements (which is then modified slightly between jurisdictions).

Background to the economic substance rules, and their application to trust structures, can be found in our previous briefing note.

The standard requirements

As a reminder, the “Relevant Activities” in all the jurisdictions are:

  • banking;
  • distribution and service centre;
  • fund management;
  • headquarters;
  • holding company;
  • insurance;
  • intellectual property (IP);
  • finance and leasing; and
  • shipping.

Each of the relevant jurisdictions now also imposes standard economic substance requirements (Standard Requirements) for entities carrying on a Relevant Activity, which are as follows:

  1. the entity is managed and directed in the jurisdiction;
  2. core income generating activities (CIGAs) are undertaken in the jurisdiction with respect to the Relevant Activity;
  3. the entity maintains adequate physical presence in the jurisdiction;
  4. there are adequate full-time employees in the jurisdiction with suitable qualifications; and
  5. there is adequate operational expenditure incurred in the jurisdiction in relation to the Relevant Activity.

However, there are some variations to the Standard Requirements, depending on the Relevant Activity being undertaken:

  • in general, holding companies are subject to fewer requirements;
  • a widespread update across the jurisdictions has been to subject IP companies which carry out so-called “High Risk IP Relevant Activities” to additional obligations; and
  • outsourcing of core income generating activities is generally permitted under the regulations, as long as the outsourced activities are still performed within the jurisdiction, and the entity is able to demonstrate an adequate level of control or supervision of the activities.

Specific jurisdictional updates


In December 2019, Bermuda’s economic substance regime was amended to bring it into closer alignment with the regimes implemented by other jurisdictions. The most significant amendments were as follows:

  • the definition for the Relevant Activity of “Holding Company” is now limited to “pure equity holding entities”. The original definition was much broader and included all entities that held or managed any assets or equity participations. The new definition means that the regulations only apply to a “pure” holding company (and not, for example, a Bermuda company that holds real estate). For the regulations to apply the sole function of the “Holding Company” must be to acquire and hold equitable interests, the entity must hold a controlling interest in any subsidiary and it must perform no commercial activity;
  • the Relevant Activity of “Insurance” is now limited to engaging in insurance business. It now only applies to entities that effect and carry out insurance contracts and so insurance intermediaries are no longer within scope;
  • the Relevant Activities of Financing and Leasing have been restated and more clearly set out as a single relevant activity of “Financing and Leasing”, reflecting the approach in other jurisdictions;
  • the Relevant Activity of “Shipping” now excludes entities which own a vessel, but do not otherwise take part in its operation and management; and
  • local companies are now only subject to reduced requirements, provided that the local entity does not carry out “Banking” or “Insurance” activities and that it is not part of a group that includes two or more enterprises for which the tax residence is in different jurisdictions (i.e. a multinational enterprise group).

Updated guidance notes published by the Bermuda Ministry of Finance became effective on 18 September 2020, providing further clarity and industry examples. These incorporate the Registrar’s earlier clarification that a Relevant Activity would be considered as being carried on by an entity as a business where such entity earns any gross revenue from that Relevant Activity.

British Virgin Islands

The “BVI Rules on Economic Substance” were released in October 2019, with an updated version being published in February 2020. The BVI Rules closely follow the previously published draft Economic Substance Code; however, they provide clarification. In particular, that:

  • where an entity claims it is outside the scope of the rules by virtue of being tax resident outside of the BVI it will be required to submit information to its Registered Agent to evidence this, and about whether or not it carries on a Relevant Activity, although it does not need to meet any economic substance test;
  • if an entity notifies the International Taxation Authority (ITA) that it intends to relocate to the BVI a Relevant Activity that is currently being carried out elsewhere, the timescale for full compliance with the legislation will not extend beyond two financial periods;
  • the requirement for a Relevant Activity to be “directed and managed” in the BVI is that, in essence, the strategic decisions for the Relevant Activity must be taken in the BVI; and
  • where an entity has outsourced any part of its CIGA to a third party, the entity is required to monitor the outsourced work from within the BVI.

The ITA has also confirmed that if an entity does not earn gross income from a Relevant Activity during the relevant financial period it will not be carrying on a Relevant Activity and its only obligation is to declare that it is not carrying on a Relevant Activity.

Cayman Islands

A revised and consolidated version of the Cayman Islands' economic substance legislation became effective in February 2020, with updated guidance released in July 2020. These updates resulted in the Cayman Islands being removed from the EU “blacklist” of non-cooperative jurisdictions for tax purposes on 6 October 2020. Further economic substance updates were contained in the industry advisories on 23 December 2020 and 11 January 2021.

Notable updates to the guidance included:

  • every Cayman Islands entity must submit an annual economic substance notification, even if it does not meet the definition of a “relevant entity” and therefore is not required to comply with the economic substance rules;
  • the broadening of notification and reporting requirements by “non-relevant entities”;
  • the introduction of a new circumvention and non-compliance regime. The Cayman Islands Tax Information Authority (TIA) will monitor apparent circumvention mechanisms and will investigate instances where an arrangement has been established with the purpose of avoiding the economic substance obligations;
  • further detail as to what is and is not a “relevant entity”, including confirmation that private funds registered with the Cayman Islands Monetary Authority (CIMA) are not considered “relevant entities” and therefore are not required to satisfy the economic substance test; and
  • clarification that where some or all of the CIGA for a Relevant Activity are outsourced, the relevant entity must be able to demonstrate that both the supervision of the outsourced activities and the relevant CIGA are undertaken in the Cayman Islands. The TIA will require a person who provides outsourced services to a relevant entity to verify the information on outsourcing within thirty days of such information being submitted by the relevant entity.

On 11 August 2020, the International Tax Co-operation (Economic Substance) Regulations, 2020 came into force. These regulations list the information required by the CIMA on an annual basis.

Crown Dependencies

In November 2019, the tax authorities of Guernsey, Jersey and the Isle of Man released revised joint guidance in order to provide additional detail on the application of their respective economic substance legislation.

The guidance confirms that:

  • collective investment vehicles regulated in the territories will be outside the scope of the legislation, although their subsidiaries will have to meet the substance requirements if they carry on any Relevant Activity; and
  • isolated decisions constituting CIGA may be taken outside the relevant island provided it can be shown that the CIGA decisions taken on the island clearly outweigh those taken outside.

In light of the difficulties faced by companies as a result of the Covid-19 pandemic, in March 2020 the Comptroller of Revenue in Jersey released a concession confirming that where companies had to alter their operating practices to compensate for the coronavirus outbreak, the Comptroller would not determine that such company had failed the economic substance test.

United Arab Emirates

The UAE introduced economic substance regulations in April 2019, updating them in August 2020. The update clarified to whom the regulations apply and centralised the notification procedure.

The regulations prescribe minimum substance requirements for UAE entities (including those based in the UAE’s Free Zones) which earn income from Relevant Activities. The following have been specifically exempted from the regulations:

  • investment funds;
  • entities that are tax resident in a foreign jurisdiction;
  • UAE branches of a foreign entity if the branch’s income is taxed in a foreign jurisdiction; and
  • entities wholly-owned by UAE residents/nationals that are not part of a multinational group, provided they carry on business in the UAE.

Entities that are within scope of the regulations are required to submit an annual Notification form to their Regulatory Authority, along with an Economic Substance Report within 12 months from the end of their financial year. An exempt entity or one that has not earned income from a Relevant Activity will still be required to submit a Notification.

What next?

The key next steps for advisors and offshore trustees will be to review entities and structures to ensure compliance, and to prepare for the relevant reporting deadlines. Many of the jurisdictions have introduced online portals to make reporting easier. The relevant reporting are summarised in this table.

This article was also co-authored by trainee solicitor Carrie Gothard.