Jersey and Guernsey substance legislation comes into effect

Jo Huxtable, Tax Partner, Deloitte Guernsey

In response to concerns raised by the EU Code of Conduct (“the Code Group”) about profit shifting, Jersey, Guernsey and the Isle of Man (the Crown Dependencies, “CDs”), along with 10 other jurisdictions, committed to introduce new legislation by the end of 2018 requiring companies resident in their jurisdiction to demonstrate a link between the economic activity carried out there and the economic substance which supports that activity.

Despite a tight timetable, the CD governments have each developed their own new legislative framework which was in place by the end of 2018 and took effect in respect of all companies resident in the CDs for accounting periods starting on or after 1 January 2019.

Focus on businesses at risk of profit shifting

The Code Group’s focus is on so-called “geographically mobile” businesses carrying out “relevant activities” which are perceived to be at risk of profit shifting: intellectual property, banking, insurance, headquartering, shipping, finance and leasing, distribution companies and service centres and fund management. In practice, many holding companies should be subject to reduced substance requirements if they are passive and do not carry out any of the relevant activities.

Joint guidance from the CDs

In addition to the three pieces of legislation introduced at the end of 2018, the three governments have published a joint guidance document which provides an additional explanation of the key aspects of the legislation and is likely to be followed by more comprehensive guidance in due course.

New legislation for accounting periods on or after 1st January 2019

The rules have been introduced through new tax legislation requiring a company which generates income by carrying out relevant activities to certify on its annual tax return for accounting periods commencing on or after 1 January 2019 that:

• It is directed and managed in its territory of tax residence;
• It carries out its core income-generating activity (CIGA) in that territory; and
• There is an “adequate” number of employees, expenditure and physical presence (including, without limitation, offices and/or premises) proportionate to the relevant activity carried out by that company in that territory. Companies which are not able to certify in this way will face sanctions in the form of financial penalties, potential exchange of information with relevant EU tax authorities and the possible instigation of proceedings to have the company struck off.

The high-level guidance published to date sets out some key points, which are as follows:

• CIGA comprises the key essential and valuable activities that generate the income of the company and must be carried out in the territory.
• If all or some 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 requirement, that those activities are undertaken in the territory.
• Where CIGA is outsourced the resources of the service providers in the same territory will count towards meeting the people and premises test. However, there must be no double counting if the services are provided to more than one company.
• The new requirements will result in additional domestic reporting on the annual company tax return with the information required for companies carrying out relevant activities to include details of people, premises and expenditure, confirmation of CIGA, the financial statements and confirmation of whether any CIGA has been outsourced.
• Where companies outsource all or part of an activity outside of the island and that activity is not part of the CIGA, this will not affect the company’s ability to meet the substance requirement (for example, back office functions such as IT support). In addition, the substance requirement does not preclude companies from seeking expert professional advice or engaging the services of specialists in other jurisdictions.

A new approach based on existing international standards

The new requirements are based on existing international standards and so where a Guernsey, Jersey or Isle of Man company has been part of a transfer pricing study, it may be able to meet the substance requirements. However, it is worth noting that the rules and objectives of transfer pricing (profit attribution) are not aligned with those of the substance requirements (linking activity with substance) and so additional and specific work will be needed.