Substance and virtual office

Please note that the below is merely a summary and is not a substitute for specific professional tax or legal advice.

The terms “tax substance” or “economic substance” refer to the requirement for an entity to have an actual economic presence in the jurisdiction where it is established to qualify for the benefit(s) of a tax treaty.

Substance attached to structures has become a key theme in regulatory tax circles at all levels – domestic (anti-avoidance provisions), regional (EU’s aggressive tax planning and harmful tax competition) and global (OECD’s base erosion and profit shifting, or BEPS). While the concept of substance has yet to be formally implemented in any treaty, it stands behind related concepts of residence and beneficial ownership, and in practice constitutes the safeguard tool of choice of governments wishing to prevent treaty- shopping.

It is therefore important for companies involved in international operations to be aware of the notion of “economic substance”, to prevent and counter the risk of a potential challenge over tax residency.

The level of substance required may vary depending – among others – on the nature of the company’s activities (i.e. substance requirements for a non-operational holding company are lower than for an operational financing or trading company) and the jurisdiction(s) involved (e.g. several EU member countries have implemented anti-abuse rules requiring a higher level of economic and physical substance). In this context, key issues to be considered when setting up an entity with the aim of it being considered as tax residence from a foreign tax perspective notably consist of the following:

  • To maintain a permanent, dedicated and identifiable office in the jurisdiction;
  • To employ qualified personnel working physically in the company’s local premises;
  • To have a dedicated telephone, fax, internet lines, as well as a website and e-mail address(es);
  • To make use of local providers (e.g. bank(s), accounting firm, audit firm, law firm, IT firm, marketing firm);
  • To be effectively managed in the Cayman Islands – e.g. board meetings should be held regularly and minutes of meeting duly documented, and all key decisions should be taken in the jurisdiction;
  • To document the operations at the company’s local premises (e.g. books of accounts, minutes’ books, banks accounts, commercial contracts).

How can Bell Rock Group Help?

The notions of “tax substance” or “economic substance” are fundamentally subjective. Many countries have their own substance requirements and one should be fully aware of those requirements before determining appropriate tax substance solutions. Careful planning and sophisticated tax advice is therefore paramount in order to determine the extent of enhancing the substance of a company. We can discuss with you the requirements you have based on the tax advice you have been given. Please contact us for further information:

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