What is economic substance and which rules apply in the Cayman Islands?

Economic substance legislation is intended to ensure that income received by certain Cayman Islands entities from certain activities is substantively based on local activity in the Cayman Islands. Local activity specifically refers to appropriate activities, management, expenditure, physical presence and personnel. The relevant legislation is the International Tax Co-operation (Economic Substance) Act (“Act”) which came into force in the Cayman Islands on 1 January 2019 and broadly stems from OECD global standards applicable to low tax jurisdictions.

What types of entities and activities are caught?

“Relevant entities” which receive “relevant income” from “relevant activity” must have economic substance in the Cayman Islands – each such term as further described below.

“Relevant entity” means any entity incorporated or registered, and tax resident in, the Cayman Islands.

“Relevant income” means all of a “relevant entity’s” gross income from its “relevant activities” recorded in its books and records under applicable accounting standards. For the avoidance of doubt, “gross income” means gross receipts/gross revenue (rather than accounting income/profit) whether in the form of cash or property.

“Relevant activities” means:

(a) banking business;

(b) distribution and service centre business;

(c) financing and leasing business;

(d) fund management business;

(e) headquarters business;

(f) holding company business;

(g) insurance business;

(h) intellectual property business; and

(i) shipping business.

What is the economic substance test and what are the penalties for failing it?

Generally the economic substance test will be met if a “relevant entity”, in relation to each individual “relevant activity”, (i) conducts its “core income generating activities” in the Cayman Islands, (ii) is managed and directed in an appropriate manner in the Cayman Islands, and (ii) has adequate operating expenditure, physical presence and employees/personnel in the Cayman Islands.

Significant penalties including fines of up to US$122,000, removal from the Companies Register, or imprisonment of up to 5 years, may be applied where a “relevant entity” fails the test.

What does this mean in practice for my Cayman Islands entity?

All Cayman Islands entities must submit an annual economic substance notification to the Companies Registry as a prerequisite to making their annual return filing by 31 January in each year, confirming whether they fall within the scope of the Act. 

Entities which are in scope must file an annual economic substance report, within 12 months of financial year end, providing detailed information to the Tax Information Authority to support the economic substance test being met. The specific requirements as to local substance, in particular the nature of the “core income generating activities”, depend on the type of “relevant activity” being conducted and the level of “relevant income” being received.

Priestleys would be very happy to advise you regarding whether your entity is subject to the economic substance test, whether substance requirements are being met, submission of any substance notifications and reports, and any related issues. Please do reach out to David Cottle or Daniel Priestley.