The International Tax Co-operation (Economic Substance) Law, 2018 (the “ES Law”) came into effect in the Cayman Islands on 1 January 2019, requiring in-scope entities that carry on particular activities to have demonstrable economic substance in the Cayman Islands.

This guidance note summarises the main elements of the ES Law as it relates to investment funds, fund managers and other entities registered as excluded persons under the Securities Investment Business Law (2019 Revision) (the “SIBL”). The ES Law as it relates to SIBL registrable persons (previously exempted persons) as it relates to fund managers only relates to companies which are “managing securities belonging to another person in circumstances involving the exercise of discretion” (i.e. entities carrying on discretionary fund management under the SIBL).

Overview

The ES Law defines which Cayman Islands entities are regulated by the ES Law (“Relevant Entities”). Relevant Entities must report annually as to whether or not they are carrying on one or more of a defined list of activities (“Relevant Activities”). These entities must satisfy an economic substance test in the Cayman Islands in respect of such Relevant Activities.

Relevant Entities

Entities that are not Relevant Entities fall outside the scope of the ES Law, therefore the first step is to determine whether an entity is considered a Relevant Entity. The following are not Relevant Entities:

Any entity claiming to be tax resident outside the Cayman Islands will be required to produce satisfactory evidence to substantiate the same, such as a tax ID number, tax residence certificate together with an income tax return, assessment or payment of a corporate income tax liability on its gross income arising in Cayman from a Relevant Activity.

Investment Funds

The ES Law excludes investment funds altogether. The ES Law defines an "investment fund" as "an entity whose principal business is the issuing of investment interests to raise funds or pool investor funds with the aim of enabling a holder of such an investment interest to benefit from the profits or gains from the entity's acquisition, holding, management or disposal of investments and includes any entity through which an investment fund directly or indirectly invests or operates (but not an entity that is itself the ultimate investment held), but does not include a person licensed under the Banks and Trust Companies Law (2018 Revision) or the Insurance Law, 2010, or a person registered under the Building Societies Law (2014 Revision) or the Friendly Societies Law (1998 Revision)".

Guidance issued by the Cayman Tax Information Authority (“Guidance”) confirms that mutual funds licensed or registered with the Cayman Islands Monetary Authority are considered investment funds for the purpose of the ES Law.

For entities not registered or licensed as mutual funds it will be necessary to assess the individual circumstances of each entity to determine if it is out of scope as an investment fund. In the absence of additional guidance, and subject to such a case by case analysis:

It is crucial to consider all the circumstances, particularly where an entity has only one investment; has only one investor; has no third-party investors; or does not instruct a fund manager.

Fund Managers

For entities that carry on any form of fund management, the first step is to assess if the entity is a Relevant Entity. Of the entities that are most commonly used for fund management activities, most exempted companies, Cayman LLCs and foreign entities registered in Cayman as foreign companies will be Relevant Entities, unless in each case they are tax resident outside Cayman.

The Guidance provides that “The principles are that (a) those individuals who in fact conduct a relevant entity’s Cayman Islands CIGA that generates the relevant income must do so in the Islands, not elsewhere, and (b) the relevant entity must be directed and managed in the Islands”.

As a result, we will need to consider each discretionary fund manager’s circumstances on a case by case basis to determine how in practice the manager takes decisions on the holding and selling of investments.

Relevant Activities

Entities that are Relevant Entities will then need to determine if their activities are Relevant Activities. A Relevant Entity carrying on more than one Relevant Activity is required to satisfy the economic substance test in relation to each Relevant Activity.

In relation to funds, it is likely that the Relevant Activities of greatest relevance will be "fund management business" and "holding company business ". Again, a fact-specific analysis will be required and each of the Relevant Activities must be considered. Particular care will need to be taken if a Relevant Entity holds, exploits or receives income from intellectual property assets.

Fund Management Business

The ES Law defines fund management business as "the business of managing securities as set out in paragraph 3 of Schedule 2 to the SIBL carried on by a relevant entity licensed or otherwise authorised to conduct business under that Law for an investment fund". Three elements of this definition should be noted:

Under the ES Law then neither entities whose activities are limited to providing non-binding investment advice nor investment management entities currently registered as SIBL excluded persons are conducting the Relevant Activity of fund management business. The latter category will, however, need to plan for compliance with substance requirements by 15 January 2020.

Economic Substance Test

The economic substance test (“ES Test”) can be satisfied in relation to a Relevant Entity carrying on a Relevant Activity if it (i) conducts Cayman Islands core income generating activities (“CIGAs”); (ii) is directed and managed in an appropriate manner in the Cayman Islands; and (iii) has adequate operating expenditure, physical presence and personnel in the Cayman Islands.

Core Income Generating Activities

Fund management business CIGAs include:

In respect of licensed fund management business (not registered/exempted persons), the Guidance provides that:

“Given the stringent regulatory requirements in the Cayman Islands, which result in significant overlap with the substance requirements, it is expected that relevant entities licensed to carry on… licensed fund management business will already generally be operating in the Islands with adequate resources and expenditure. However, those relevant entities will still be subject to the ES Law (i.e. filing requirements, Cayman Islands CIGA performed in the Islands and monitoring by the Authority)”

Reporting

All corporate entities required to file an annual return with the General Registry will be required to file a declaration as to whether or not they are Relevant Entities and if so, what type of Relevant Activities, if any, they are carrying on; and if not, the basis of the exemption they are claiming (e.g. investment fund or foreign tax residence). Relevant Entities that do carry on a Relevant Activity shall, no later than 12 months after the date of their financial year end, prepare and submit a detailed report regarding their Relevant Activities.

Key Dates

The ES Law and accompanying Regulations provide a timetable for compliance, notification and reporting:

Next steps

Although some issues remain to be further refined in the Guidance, the deadlines for compliance with the ES Law require that clients with Cayman Islands entities (or non-Cayman entities registered in Cayman as foreign companies) address the new requirements now.

All Relevant Entities conducting fund management business will need to undertake their own internal review and analysis to determine what measures, if any, they might need to take in order to demonstrate substance in the Cayman Islands and achieve compliance with the ES Law. Clients should therefore consult Stuarts to determine:

if they are Relevant Entities carrying on Relevant Activities:

Framework Services

In order to facilitate our clients to meet the ES Law requirements, Stuarts is able to offer the following services as a framework upon which our clients can build a physical presence in the Cayman Islands:

Additional Services Include:

As a minimum, we would suggest that fund managers put in place the following:

The services set out above are not intended to be a comprehensive solution to the economic substance requirements in the Cayman Islands but are instead intended to offer a framework upon which our clients can build, to meet the requirements of the ES Test. A quote or any services can be provided on request. Fees for legal services, if required, would be charged on a time spent basis.

Read the PDF guidance note on EEconomic Substance Requirements - Fund Managers.