7 May 2019
Kevin O’Loughlin explains the Isle of Man’s new Substance Requirements Legislation
In 2016, the Council of the European Union committed to coordinated policy efforts in the fight against tax fraud, evasion and avoidance. In 2016, the EU Code of Conduct Group (Business Taxation) (the Group) undertook a screening process whereby jurisdictions, including the Isle of Man and the other Crown Dependencies, were assessed against standards of tax transparency, fair taxation and compliance with anti-base erosion and profit shifting (BEPS) measures.
No issues were raised in respect of the Isle of Man’s standards of tax transparency and anti-BEPS compliance. The Group, in a letter to the Isle of Man government dated 6 November 2017, expressed concern that the Isle of Man did not have a ‘legal substance requirement for entities doing business in or through the jurisdiction’. The Isle of Man made a commitment to address these concerns by the end of December 2018.
INCOME TAX (SUBSTANCE REQUIREMENTS) ORDER 2018
Consequently, the Isle of Man has introduced the Income Tax (Substance Requirements) Order 2018 (the Order). The Order has effect in respect of accounting periods commencing on or after 1 January 2019. A corporate taxpayer that is a resident company must, for each accounting period in which it derives any income from a relevant sector, have ‘adequate substance’ in the Isle of Man. A company that does not have adequate substance will be subject to escalating sanctions, including civil penalties and being struck off the register of companies. Companies must include in their tax returns information relevant to the substance requirements.
A company is deemed not to be resident if it satisfies certain conditions:
- its business is centrally managed and controlled in another country;
- it is tax-resident in that country; and
- a double taxation agreement tiebreaker clause applies, or a specified level of tax applies in that country.
The substance requirements apply to companies that are tax resident in the Isle of Man, and that derive any income from a relevant sector (a relevant sector company). Relevant sectors are banking, insurance, shipping, fund management, financing and leasing, headquartering, operation of a holding company, holding intellectual property (IP), and distribution and service-centre business.
For a relevant sector company to have adequate substance, it must ensure that specific requirements are met. Other than for a pure equity holding company (PEHC), these requirements are that:
- it is directed and managed in the Isle of Man;
- there is an adequate number of qualified employees in the Isle of Man (whether they are employed by it or another person);
- it has adequate operating expenditure proportionate to the level of activity carried out in the Isle of Man;
- it has an adequate physical presence in the Isle of Man; and
- it conducts core, income-generating activity in the Isle of Man.
The Order sets out how these requirements are to be met, covers the ‘directed and managed’ requirement in terms of the need to hold board meetings and take strategic decisions in the Isle of Man, and sets out core income-generating activities. The Order does not prohibit a company outsourcing some or all of its activity.
PEHCs AND IP
A PEHC only holds shares or an equitable interest in, and controls the majority of the voting rights or composition of the board of, other companies. A PEHC is considered to have adequate substance in the Isle of Man if it complies with its statutory obligations under the relevant companies legislation and has adequate people and premises for holding and managing the equitable interests or shares.
The Order has additional requirements in relation to high-risk IP companies. IP assets are defined to include patents, trademarks and copyright, and an IP company is one that holds or receives income from an IP asset. An IP company is considered high risk if it:
- either acquired its IP asset from related parties and the IP asset is licensed to, or monetised through, activities performed by foreign related parties; or
- does not carry on research and development, marketing, branding and distribution in the Isle of Man (it is presumed that the company does not do so unless the company provides rebutting evidence).
The Order requires the Isle of Man tax authority to disclose information about high-risk IP companies to the relevant EU tax authority, in accordance with the international tax arrangement with that country, irrespective of whether the substance requirements are met (subject to the General Data Protection Regulation). Additionally, there are greater sanctions, including civil penalties, for high-risk IP companies that do not satisfy the substance requirements.
The Order will ensure the Isle of Man continues to meet all international standards as a responsible member of the international community.