Understanding ‘Economic Substance’​: What the rules mean for corporate tax compliance in Guernsey

Over the last 15 years or so, international tax compliance legislation has mushroomed. As the obligations on offshore companies have evolved, so tax authorities have gained access to far more insight about entities’ tax affairs than they ever had before.

From the EU Savings Tax Directive in 2003, to the US Foreign Account Tax Compliance Act (FATCA) introduced around a decade ago, to the OECD’s Common Reporting Standards more recently, the rules have become more far-reaching and there has been a clear trend towards information sharing between jurisdictions around the world.

Now we have ‘Economic Substance’ legislation which came into force in Guernsey in 2019 and affects many companies administered on the island.

What is ‘Economic Substance’?

Essentially, ‘Economic Substance’ is about an entity having a demonstrable presence in the jurisdiction in question. The legislation seeks to ensure that companies are not just a brass nameplate on a door, with nothing behind it – no people or operational premises in situ.

It has historically been the case that there are several offshore jurisdictions where companies can be registered that have no real presence on the ground, which is why five years back the EU’s Code of Conduct group started a review into the tax transparency of offshore locations. No issues were raised in respect of Guernsey’s standards of tax transparency and anti-Base Erosion and Profit Shifting (BEPs) – which came as no surprise to us: Guernsey is widely and rightly regarded as a leading ‘offshore’ jurisdiction with a very mature financial and professional sector and an internationally recognised legal system.

However, the group did conclude that there was a risk that some offshore jurisdictions could be used to attract profits artificially.

And so it was that the Economic Substance rules were born, to make sure that companies undertaking certain economic activities are properly directed and controlled in the jurisdiction where they say they are based. They must have adequate staff with the necessary qualifications operating out of registered premises, with visible local expenditure taking place that is proportionate to the level of business operations there.

How does this affect Guernsey-incorporated entities?

As a result, companies incorporated in the Bailiwick of Guernsey must submit an annual tax return which evidences that they have Economic Substance on the island if they generate income from nine specific activities: including banking, insurance, headquartering and finance and leasing. The Guernsey Revenue Service also require supporting documentation to be submitted, such as financial statements and details of premises, to demonstrate that there is sufficient activity on-Island.

Unlike other pieces of international tax compliance legislation, the Economic Substance rules do not necessarily require the automatic exchange of information between tax authorities in every instance. Nevertheless, it is still important to be aware that significant data-gathering powers exist and to recognise just how much information tax authorities have at their fingertips to cross-check and verify statements.

Getting it right first time

It is vital that even though gaining a tax advantage may not be the driver for using a particular structure, all the possible tax implications of doing so need to have been thoroughly thought through in advance. Getting it right first time matters. The last thing company owners want to do is unintentionally create a tax issue which could end up having significant negative financial repercussions.

None of this should be a major concern to clients that are properly managed. The key thing is that structures are well-maintained and robustly overseen, that the company has the right people with the right educational and professional credentials, working together with the right professional advisers and intermediaries, asking the right questions. If so, then the correct information will be declared. That’s the way to avoid falling foul of the law and adhere to best practice standards.

This is what sets Saffery Trust apart. We pride ourselves on having the best people, suitably qualified and experienced, so that we can manage the assets under our control effectively for the benefit of clients. For us, it’s all about having substance in the right places too.

Learn more about this issue in our New Horizons video interview with Mark Le Rayhere