Background
In 2019, the countries listed below enacted the Substance Requirements Regulations (“SRR”), due to pressure from the G20 and the OECD. The substance requirements under the SRR do not apply to entities that are directly or indirectly owned by local individuals or local entities that are tax residents of a foreign country.
In addition to the necessity of local physical offices and expenditures, the SRR also require local employment of adequate full-time employees. For example, an offshore IP software company may be required to employ local executive software engineers. This requirement also applies when using local outsourcing service providers.
The SRR include reporting requirements and penalties if the substance requirements are not met. The fines range from US$10k – US$400k, to the extent that the company will be struck out from the local Register of Companies, which may trigger material impacts on the underline assets held by the offshore entity.
Currently, the list of offshore countries that enacted SRR includes the Bahamas, Bermuda, BVI, Cayman Island, Guernsey, Isle of Man, Jersey, Mauritius, and Seychelles. We believe that the trend will continue, and more offshore countries will enact similar legislation in the near future.
Considerations
There are some solutions to manage the exposure bloomed from the SRR, which need to be considered on a case-by-case basis. Such considerations include the sale of intellectual property to a related foreign party (while protecting the entity, its parent or subsidiaries from an adverse tax consequence). In other cases, for example, where the offshore entity is merely a holding company, the alternative of substantiating and strengthening the local substance should be considered. Lastly, the domestication of the offshore entity to a foreign jurisdiction (excluding the OECD’s blacklist) so the entity will be regarded as having a foreign (non-offshore) tax residency. In such case, the offshore entity will need to demonstrate a formal approval of the foreign tax residency to the local offshore authorities.
Our team can assist in analyzing the situation, developing the strategy and implementing it.
