The EU Code of Conduct Group undertook a screening exercise in 2017 to assess various jurisdictions on their tax transparency, fair taxation and anti-base erosion and profit shifting (BEPS) measures.
Jersey was found to be compliant in the areas of tax transparency and anti-BEPS measures, but concerns were raised about the lack of statutory substance requirements, leading to an increased risk that the profits of companies registered in Jersey might not be commensurate with their activities in the jurisdiction. Accordingly, Jersey committed to implement statutory substance requirements by no later than 1 January 2019.
As a result, the Taxation (Companies – Economic Substance) (Jersey) Law 2019 (the Law) has been introduced to provide for new substance requirements in Jersey. It came into effect on 1 January 2019, and has the potential to impact property holding structures that involve Jersey tax-resident companies.
Similar rules have also been adopted by other jurisdictions such as Guernsey, the British Virgin Islands and the Cayman Islands.
HSF: To whom do the substance rules apply?
BC: Companies (other than foundations) that are tax resident in Jersey (whether incorporated in Jersey or elsewhere) and that are carrying out a “relevant activity” are affected. Jersey-based (ie established or incorporated) unit trusts, limited partnerships, partnerships and LLPs are not caught by the rules.
The following businesses are considered relevant activities, to which the substance rules apply: banking, insurance, fund management (excluding companies that are collective investment vehicles), financing and leasing, headquartering, shipping, holding company business, intellectual property holding and distribution and service centre business.
HSF: The relevant activity most likely to apply in the case of property holding structures is “holding company business”. Would all companies in a typical holding structure be caught?
BC: Under the Law, a holding company is defined as a company that is a holding body (meaning that it holds a majority or controlling stake in another company), has as its primary function the acquisition of shares or other equitable interests in other companies and does not carry on any commercial activity – such as a holdco.
Propcos (ie companies directly holding interests in real estate assets), therefore, would not be caught. To be caught, a corporate’s primary function needs to be the holding of shares in companies – if it carries on other activities as well then a determination will need to be made as to what its primary function actually is. There also must be “gross income” arising (if not, then the company will fall outside the Law’s reach).
HSF: Is the Law intended to target property holding companies?
BC: Not specifically. The legislation is primarily intended to target profit shifting, but is wide enough to catch a holdco in a property holding structure.
However, where the company is administered by a professional Jersey trust company and the trust company adheres to good corporate governance standards and provides the necessary Jersey-based resources to the holdco, we would expect a holdco that is caught by the rules to be able to comfortably comply with them.
HSF: What does compliance with the substance rules entail?
BC: Companies to which the substance rules apply must demonstrate that they:
- are directed and managed in Jersey;
- are conducting core income-generating activities (CIGA) in Jersey; and
- have adequate employees, physical assets and expenditure in Jersey.
If they have not done so already, directors of companies in Jersey should carefully consider the Law to assess whether they may be affected by its requirements and, if so, what steps may be required to ensure compliance. It is worth remembering that the Law is only aimed at companies that are tax resident in Jersey (regardless of their jurisdiction of incorporation).
HSF: How can a company show that it is directed and managed in Jersey?
BC: Companies can demonstrate that they are directed and managed in Jersey by ensuring that the company’s board meets in Jersey with adequate frequency, having regard to the level of decision-making required by the board.
Companies should also ensure that:
- a quorum is physically present at the board meeting in Jersey (and it is expected that a majority of directors should be present);
- strategic decisions of the company are made in those meetings, with minutes recorded;
- the board of directors as a whole has the knowledge and expertise to discharge the duties of the board; and
- minutes and other records of the company are kept at the office in that jurisdiction.
Where the majority of a company’s board meetings are held with a quorum physically present in Jersey and a reputable professional Jersey trust company has been appointed to provide secretarial and director services (with emphasis on the latter) to the company, then we would expect that the high levels of corporate governance typically exhibited by such trust companies should mean that the substance requirements relating to direction and management will be satisfied.
HSF: Would having non-resident Jersey directors on
the board be a problem?
BC: Not necessarily, but a company which has non-resident Jersey directors on the board (eg those appointed by a client) needs to be careful that the activities of those directors do not inadvertently prejudice its compliance with the Law (eg by non-residents failing to attend Jersey board meetings or by those non-residents engaging in impromptu management/direction outside Jersey).
HSF: What constitutes CIGA and how can a company demonstrate it conducts CIGA in Jersey?
BC: The Law sets out a non-exhaustive list of what constitutes CIGA for each relevant activity to which the substance rules apply, and for “holding company business” all activities related to that business comprise CIGA.
Companies are able to outsource parts of their CIGA provided that the outsourcing is performed in and supervised from Jersey. Companies that outsource CIGA outside Jersey may risk a negative impact on meeting their substance requirements, but certain external professional advice provided from outside Jersey is permitted.
HSF: You mention that companies that are subject to these substance rules need to demonstrate that they have adequate employees, physical assets and expenditure in Jersey, but most companies in property holding structures do not actually have employees, physical presence or expenditure in Jersey other than through their corporate administrators. Is this enough?
BC: There must be an adequate level of appropriately qualified employees, expenditure and physical assets in Jersey, each of which is proportionate to the level of the relevant activity carried out.
It is expected that affected companies will be able to rely on outsourced resources (eg employees of the appointed corporate administrator rather than of any holdco itself) provided that the company has adequate supervision of the outsourcing and the outsourcing is carried out in Jersey.
The term “adequate” is often used as a threshold for meeting these substance requirements; however, the Law does not provide a definition of its meaning. Preliminary guidance references the dictionary definition of “enough or satisfactory for a particular purpose”, but further guidance is expected to follow.
HSF: Will complying with the Law involve additional filings/disclosure requirements?
BC: Yes. Companies that are caught by the substance rules are required to disclose additional information in their annual tax return.
Tax-resident companies will be required to include the following additional information in their income tax filing to demonstrate to the taxation authorities how they have met the substance requirements:
- business/income details in order to identify the type of relevant activity;
- amount and type of gross income;
- amount of operating expenditure;
- details of premises;
- number of (qualified) employees, specifying the number of full-time equivalents;
- confirmation of the CIGA conducted for each relevant activity;
- financial statements; and
- confirmation and details of any CIGA that has been outsourced.
Companies without an income for an accounting period that would otherwise have been caught by the rules are not required to comply for that period.
HSF: Which body will monitor compliance, and at what point will it start to investigate whether a company meets the substance requirements?
BC: The relevant body is the Comptroller of Taxes in Jersey. The Law took effect from 1 January 2019, so the first tax return that will need to incorporate the new reporting will be that return submitted in respect of the 2019 tax period. Reporting will need to demonstrate substance compliance throughout the reporting period, not just at the end of it.
Directors should look at the whole business operation throughout the financial period before forming a view as to whether the company has complied with the Law during that financial period.
HSF: What happens if a company does not comply with the new substance rules?
BC: Initially, non-compliant companies to whom the substance rules apply may be fined for a breach. Subsequent breaches may result in further fines and, ultimately, the non-compliant companies being struck off the Jersey Companies Register. Any such breach will be subject to disclosure to the relevant foreign tax authorities.
HSF: Is there a “two strikes and you’re out” policy?
BC: Article 9(3) of the Law provides that: “If, for the financial period following a financial period in which a notice of non-compliance has been issued, the Comptroller determines the resident company has failed to meet the economic substance test, then the Comptroller must issue a further notice to the resident company notifying it […] that the Comptroller may make a report to the Minister for Treasury and Resources.”
The Law then provides that on receipt of such report from the Comptroller of Taxes, the Minister for Treasury and Resources may then apply to the court for an order which, on our reading of all guidance notes issued to date, may include an order for the striking off of the offending company. So it’s not necessarily two strikes and you’re out… but it could be!
The Law is clear that a company cannot be penalised twice for two breaches during the same financial period, and on a strict reading of the Law a company would only be subject to the enhanced punishments if the subsequent breach occurs in the next financial period (ie the one following a period for which the first punishment was imposed).
The Comptroller’s office has confirmed as much and that, where a company is compliant for that next financial period, if it subsequently breaches the Law in a subsequent financial period then it shall again be treated as a first offence.
HSF: Is there a publicly available register of those companies that are the subject of penalties for substance non-compliance?
BC: The Comptroller’s office has confirmed that there is no policy for naming companies (and that this could, in any event, be a breach of the taxpayers’ confidentiality rights). However, if a company was to appeal any such fine, the Comptroller’s office makes no guarantees that such an appeal process will not result at some point in public disclosure.
HSF: How do the substance requirements interact with the determination of residency for taxation purposes?
BC: The economic substance requirements are designed to sit alongside the tax residence requirements (rather than overlap with them). Meeting the residency requirements for tax purposes (as an election or by way of management and control) will not necessarily mean that you meet the economic substance requirements, and vice versa. So it’s possible to be Jersey tax resident but not meet the substance requirements and, again, vice versa.
HSF: What happens where a company is incorporated in Jersey but is tax resident in a different jurisdiction (eg Guernsey) where economic substance legislation has also been introduced?
BC: The company would need to comply with the economic substance legislation (if any) in force in that foreign jurisdiction. As it is not Jersey tax resident, it would not be caught by the Law.
HSF: And finally, where can I access more information?
BC: Additional information and access to the Law and guidance on it are available here.
Tom Davies and Bruce Scott are partners in Bedell Cristin’s London office and Guy Westmacott is a partner in its Jersey office. Paul Chases is a partner and Micky Yang is an of counsel in the corporate real estate team at Herbert Smith Freehills LLP