Cayman Islands Economic Substance Compliance

Cayman Islands Economic Substance Compliance | Bestar

Cayman Islands Economic Substance Compliance

To maintain annual compliance with the Economic Substance (ES) requirements in the Cayman Islands, you need to understand and adhere to several key obligations. The ES Act was introduced to ensure that entities carrying on specific activities have demonstrable economic presence in the jurisdiction. Here's a breakdown of the requirements and your responsibilities:

1. Determine if you are a "Relevant Entity" and conduct a "Relevant Activity":

• Relevant Entity: This generally includes all legal entities registered in the Cayman Islands, such as companies, limited liability companies (LLCs), limited liability partnerships (LLPs), and partnerships (including exempted limited partnerships and foreign limited partnerships). Certain entities are exempt, such as investment funds and entities through which they invest or operate (though they still need to file an Economic Substance Notification). Entities tax resident outside the Cayman Islands are also generally excluded, provided they can provide robust evidence of their foreign tax residency. Domestic companies (carrying on business locally) and not-for-profit companies are also typically outside the scope of the ES Test.

• Relevant Activity: These are specifically defined business activities under the ES Act:

  • Banking business

  • Insurance business

  • Fund management business

  • Financing and leasing business

  • Headquarters business

  • Shipping business

  • Intellectual property  (IP) business   

  • Distribution and service centre business

  • Holding company business (pure equity holding companies are subject to a reduced substance test).

• If your entity is a Relevant Entity and carries on a Relevant Activity, you are subject to the Economic Substance Test. If you are a Relevant Entity but do not carry on a Relevant Activity, you still have notification obligations.

2. Satisfy the Economic Substance Test (if applicable):

If your entity conducts a Relevant Activity, it must satisfy the ES Test concerning that activity. The test requires the entity to demonstrate that:

• Core Income Generating Activities (CIGA) related to the Relevant Activity are conducted in the Cayman Islands. The specific CIGA will vary depending on the type of Relevant Activity. For example:

  • For banking business: raising funds, managing risk, providing loans, managing capital.

  • For financing and leasing: negotiating funding terms, identifying and acquiring assets, setting terms, monitoring agreements.

  • For fund management: taking decisions on investments, calculating risk, preparing reports to investors.

• The entity is directed and managed appropriately in the Cayman Islands concerning that Relevant Activity. This includes having board meetings in the Cayman Islands with a quorum of directors physically present, and maintaining minutes of these meetings in the Cayman Islands.

• Having regard to the level of relevant income derived from the Relevant Activity in the Cayman Islands, the entity has:

  • An adequate amount of operating expenditure incurred in the Cayman Islands.

  • An adequate physical presence in the Cayman Islands (including maintaining a place of business or plant, property, and equipment).

  • An adequate number of full-time employees in the Cayman Islands with suitable qualifications.

The requirements for "adequate" are principles-based and depend on the nature and scale of the Relevant Activity. Pure Equity Holding Companies have a reduced substance test, primarily focusing on compliance with filing requirements under the Companies Law and having adequate premises and human resources for holding and managing equity participations. Outsourcing of CIGA to service providers within the Cayman Islands is permitted, but the Relevant Entity must be able to monitor and control the outsourced activities. Outsourcing CIGA outside the Cayman Islands is not permitted.

3. Meet Annual Notification and Reporting Obligations:

• Economic Substance Notification (ESN): All legal entities registered in the Cayman Islands must file an annual ESN by January 31st of each year, regardless of whether they conduct a Relevant Activity or are a Relevant Entity. This notification informs the Cayman Islands Tax Information Authority (TIA) whether the entity carried on any Relevant Activities and whether it was a Relevant Entity during its financial year that commenced in the prior calendar year. This is usually submitted via the entity's registered office to the Cayman Islands Registrar. Note that penalties may accrue if the notification is not submitted by March 31st.

• Economic Substance Return (ESR): If your entity is a Relevant Entity conducting a Relevant Activity, you must file an annual ESR within 12 months of the end of your financial year. This return provides detailed information about the Relevant Activity, relevant income, expenses, assets, the location of business premises, and details of employees in the Cayman Islands, demonstrating how the entity meets the Economic Substance Test.

• Tax Residency Return (TRO Form): If your entity claims to be tax resident outside the Cayman Islands and carries on a Relevant Activity, you must submit an annual TRO form to the DITC within 12 months after the financial year-end, providing documentary evidence of your tax residency in another jurisdiction. This evidence may include certificates/letters from the competent tax authority, tax assessments/demands, evidence of tax payments, tax returns, or rulings.

4. Maintain Adequate Records:

Relevant Entities must maintain records for at least six years that demonstrate compliance with the Economic Substance Test. These records should include the information provided in the ESR.

5. Be Aware of Compliance Deadlines for 2025:

Based on the current year (2025):

• January 1st: Deadline for full compliance with the new Beneficial Ownership Transparency Act.

• January 15th: Deadline for payment of annual CIMA fees (if applicable).

• January 31st: Deadline to file the Economic Substance Notification (ESN) with the DITC via the Registrar of Companies for all entity types.

• January 31st: Deadline to file the Annual Return and pay annual registration fees to the Registrar of Companies for all Cayman Islands entity types.

• March 31st: Deadline for Economic Substance Notification for foreign companies.

• April 30th: Registration deadline for entities defined as Financial Institutions under CRS and FATCA legislation for the prior year ending December 31, 2024.

• June 30th: Deadline for filing the Fund Annual Return (FAR) and 2024 audited financial statements for all CIMA-registered funds with a December 31st year-end.

• July 31st: CRS and FATCA reporting due to the DITC for all Reporting Financial Institutions for the prior year ending December 31, 2024.

• Variable: The deadline for filing the Tax Resident in Another Jurisdiction form (TRO) or the Economic Substance Return (ESR) depends on your entity's financial year-end. It is typically within 12 months after the end of the financial year. For example, for an entity with a financial year ending December 31, 2024, the ESR/TRO would be due by December 31, 2025.

6. Understand Penalties for Non-Compliance:

Failure to comply with the ES requirements can result in significant penalties:

• Failure to satisfy the Economic Substance Test: Up to CI$10,000 for the first failure and up to CI$100,000 for subsequent failures.

• Failure to file the Economic Substance Return: Up to CI$5,000.

• There are also penalties for providing false or misleading information.

Staying compliant with the Economic Substance requirements is crucial for all Cayman Islands entities. Ensure you accurately determine your entity's obligations, maintain adequate substance if required, and meet all notification and reporting deadlines. Consulting with legal and financial advisors in the Cayman Islands can help ensure full compliance.

How Bestar can Help

Bestar plays a vital role in helping entities navigate and maintain compliance with the Economic Substance (ES) requirements in the Cayman Islands. Our expertise ensures that businesses understand their obligations, implement necessary measures, and avoid potential penalties. Here's how we can assist:

• Determining Applicability: Bestar can analyze your entity's structure and activities to determine if it qualifies as a "Relevant Entity" and conducts any "Relevant Activities" under the ES Act. We can provide clarity on the definitions and scope of the legislation.

• Interpreting the Law: The ES Act and related guidance can be complex. Bestar can provide accurate interpretations of the legislation, helping you understand your specific obligations and the nuances of the law.

• Structuring and Restructuring: If your current structure doesn't meet the ES requirements, Bestar can help you explore restructuring options to achieve compliance while considering your business objectives. This might involve establishing a physical presence, adjusting governance structures, or reviewing contractual arrangements.

• Advising on the Economic Substance Test: We can guide you on what constitutes "directed and managed" in the Cayman Islands, "Core Income Generating Activities" (CIGA), and the requirements for adequacy of resources (expenditure, physical presence, employees). We can help identify which activities are considered CIGA for your specific business.

• Documentation and Record-Keeping: Bestar can advise on the types of documentation required to demonstrate economic substance and help establish robust record-keeping processes to meet the six-year retention requirement.

• Board Governance: We can provide guidance on ensuring board meetings are appropriately conducted in the Cayman Islands, including quorum requirements, agenda setting, and minute-taking, to meet the "directed and managed" aspect of the test.

• Outsourcing Arrangements: Bestar can advise on the permissibility of outsourcing CIGA within the Cayman Islands and help draft or review outsourcing agreements to ensure they meet regulatory expectations.

• Tax Residency Claims: If you are claiming tax residency outside the Cayman Islands, Bestar can help gather and review the necessary documentation to support your claim and ensure it meets the requirements of the Tax Information Authority (TIA).

• Dispute Resolution and Appeals: In the event of a dispute with the TIA regarding ES compliance, Bestar can represent your interests and guide you through the appeals process.

• Keeping Updated: Bestar stays abreast of any amendments or updates to the ES legislation and guidance, ensuring you receive the most current advice.

• Financial Analysis: Bestar can analyze your financial data to assess the adequacy of operating expenditure incurred in the Cayman Islands relative to your relevant income.

• Substance Planning: We can help develop financial strategies to ensure you meet the economic substance test, including budgeting for appropriate levels of expenditure in the Cayman Islands.

• Reviewing Financial Records: We can review your financial records to ensure they accurately reflect your activities and presence in the Cayman Islands, preparing you for the Economic Substance Return (ESR).

• Assisting with the Economic Substance Return (ESR): Bestar can help compile the financial information required for the ESR, ensuring accuracy and completeness.

• Tax Implications: We can advise on the tax implications of the ES requirements and how they interact with other tax obligations.

• Liaising with Auditors: Bestar can work with auditors to ensure that your financial statements and related information support your ES compliance efforts.

• Cost-Benefit Analysis: We can help you evaluate the financial implications of different compliance strategies.

• Understanding "Relevant Income": Bestar can help you accurately identify and calculate the "relevant income" derived from your relevant activities in the Cayman Islands, which is a key factor in the adequacy test.

• Transfer Pricing Considerations: For multinational groups, Bestar can help ensure that the allocation of income and expenses aligns with the ES requirements.

In summary, Bestar provides expertise crucial for navigating the Cayman Islands' Economic Substance regime. Bestar focuses on the interpretation and application of the law, structuring, governance, and documentation, while concentrating on the financial aspects of compliance, including expenditure analysis, reporting, and tax implications. Engaging Bestar can provide a comprehensive approach to ensuring ongoing compliance and mitigating potential risks.

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