Lots of jurisdictions worldwide have regulations about economic substance that companies incorporated there or doing business there must follow. These rules require entities to demonstrate real economic activity in the jurisdiction, not just be registered there on paper.
Many places recently updated and expanded their existing economic substance regulations. The amended rules widen the scope of impacted companies, stiffen reporting requirements, and enact harsher penalties for non-compliance.
This blog post will clarify the key changes in the revised economic substance regulations that businesses must now comply with. Clear guidance is provided on actions companies can take to meet the new standards and avoid risks of non-compliance.
Expanded Scope – More Now Comply
The amended economic substance regulations apply to a greater range of entities beyond what historical rules covered. In the past, regulations focused mostly on ring-fenced entities that claimed tax advantages abroad while not conducting local operations. But the updated rules capture many more types of entities across additional industries.
- Holding companies – Even pure equity holding companies without operations now must comply rather than being exempt
- Banking and insurance entities – Onshore and offshore banks, insurance firms, etc. must now meet economic substance requirements
- Shipping companies – Entities that provide international shipping services need to substantiate operations
- Investment funds – Managers & administrators of funds focused on foreign investments must now adhere to the regulations
- In summary, any type of company that derives income from banking, insurance, shipping, fund management or other mobile type activities must now comply with economic substance rules. Regulators have cast a wider net to cover more entity types.
Stricter Reporting and Filing Rules
In conjunction with the expanded scope to more entities, the new economic substance regulations also impose expanded reporting and documentation that companies must regularly submit to demonstrate compliance.
- Specific elevated reporting/filing requirements include:
- Annual reporting – Submitting detailed activity financials and operations data annually
- Company meetings – Keeping minutes and resolutions documenting key decisions and activities
- Core income generating activities (CIGA) – Providing proof to substantiate CIGA conduct locally
- Regulatory filings – Filing required paperwork on time to revenue authorities and regulators
- Entities must formalize compliance processes to collect and track all information needed for these regular submissions.
- Missing filings or reporting inaccurate data can trigger enforcement actions.
Increased Penalties for Non-Compliance
Alongside more entities needing to comply and stricter reporting rules, the consequences for violations of economic substance regulations also heightened significantly. Regulators now conduct more frequent audits and reviews to verify compliance.
- Financial penalties – Substantially larger fines, surcharges, back taxes
- Forced dissolution – Regulators can revoke licenses, demand winding down of non-compliant entities
- Jail time – In extreme non-compliance cases, individual directors & officers may face criminal prosecution
- This stricter enforcement incentivizes entities to urgently confirm compliance rather than risk severe implications. A minor administrative lapse could enable major fines or worse penalties.
Actions to Comply With Amended Regulations
Given the expanded scope, reporting obligations, and stricter penalties, entities must take proactive action to comply with revised economic substance rules:
- Execute core income generating activities (CIGA) locally
- Actually conduct activities like banking, lending, investing in the jurisdiction – not just record income there
- Collect and store detailed records to report
- Save meeting info, financials, employee data to submit annually
- Maintain real operations in good standing
- Have office space, employees, systems to execute CIGA locally
- Watch for updates and seek guidance
- Regulations frequently update, so monitor changes closely
Consequences of Ongoing Non-Compliance
Entities definitively need to monitor new economic substance regulations and implement changes to comply. The risks of non-compliance are now severe on multiple fronts.
- Specific repercussions for ongoing non-compliance include:
- Annual fines & back tax payments
- Increased likelihood of intensive audits
- Potential for forced dissolution of the entity
- Jail time in extreme non-compliance cases
- These substantial penalties for non-compliance in amended regulations necessitate immediate action to avoid risks.
Conclusion
Economic substance regulations exist so entities conduct meaningful business activities in jurisdictions where organized or operating, rather than unfairly exploiting tax advantages. Already strict regulations now updated to cover more entities, enact tougher reporting rules, and impose more stringent fines and penalties.
All companies must urgently review amended economic substance regulations to identify changes relevant to their structure and operations. Proactively executing compliance activities outlined above can spare entities from severe risks and penalties. Strategic legal and financial advice is recommended given the intricacies of varying international standards.
FAQs
For banking, that entails activities like lending, taking deposits, managing payments. insurance firms, that involves insuring and reinsuring local risks.funds, that means investing, administering or managing fund assets directly. Any activities that actively generate income.
Self-report the lapse to regulators, pay any penalties, and provide remediation plans for how to prevent reoccurrence. Judges may look more favorably on entities that proactively self-correct versus those trying to hide non-compliance.
economic substance regulations do not specify a fixed number of employees needed in a jurisdiction, entities should appropriately staff based on the nature and scale of their local income-generating activities.
All impacted entities must urgently review and comply with expanded economic substance regulations and reporting or risk severe enforcement actions from regulators and tax authorities.
