There has been a number of changes in the international tax legislations, for instance, the G20 countries have endorsed the final Organisation for Economic Cooperation and Development (OECD) recommendations relating to the Base Erosion and Profit Shifting (BEPS) project and the Common Reporting Standard has moved into implementation phase.
The new legislation is in line with the international efforts to counter tax evasion and fraud; it aims at making it more difficult for companies that have legal entities registered in low-tax jurisdictions to take advantage of the favourable rates. These companies must now meet the minimum 'substance requirements' in order to be considered taxable in the host country.
A proper understanding of the minimum substance requirements is key to fully grasping the implications of the changes in international legislation. The Managing Director of Cim Tax Services, Gary Gowrea, shares some insight into the topic.
1. Compliance with substance requirements is laid out in various tax legislation worldwide. Could you tell us what this term means?
There are concerns that have been raised with regard to structures which have been set up as conduit companies for the sole purpose of enjoying tax treaty benefits. These are also known as 'postbox' offices or shell companies. The OECD proposes certain measures to address the issue under Action 6 (Preventing the granting of treaty benefits inappropriate circumstances) of the Base Erosion and Profit Shifting (BEPS) Action Plan as endorsed by the G20.
From a layman's point of view, substance would relate to the activities that are carried out in a jurisdiction or how the presence of an entity can be substantiated. In Mauritius, a company is deemed to be tax resident if it is incorporated or has its central control and management in the country. The Financial Services Act sets out six mandatory and one optional requirement that must be satisfied to demonstrate that the company is controlled and managed from Mauritius. The most obvious one would be for a company to have an office in the jurisdiction with its employees performing administrative or technical functions that support the activities of the company.
It should be noted that from a tax perspective, substance is a moving goal post; the more you have the better it is. It takes more than merely prescribing a specific set of rules to ensure adequate substance. Interview of Gary Gowrea on “substance requirements”
The OECD seeks to address the issue form an international perspective by requiring the inclusion in all treaties of principal purpose and limitation on benefits (LOB) tests demonstrating the tax residency of companies to be eligible to tax treaty benefits. This in itself is a mammoth task, which can have an impact on 3,500 tax treaties in place.
2. Will the changes to international tax legislation put an end to the practice of companies having subsidiaries in low-tax jurisdiction?
It should be recalled that many companies use intermediary jurisdictions for a whole range of commercial reasons and not only for tax purposes. For instance, a company will invest in Africa through Mauritius due to its proximity to the countries on the continent, the absence of foreign exchange control, its investment promotion and protection agreements, its rule of law with an independent judiciary and the Privy Council in the UK as ultimate court of appeal, to name a few reasons.
Thus if a company is engaged in substantive business operations in Mauritius with activities such as procurement, marketing, sales, treasury functions, etc., it would be hard to say that it does not have bona fide commercial operations. Personally, I think that 'postbox' companies are set to disappear.
3. How can we help our clients meet the substance requirements if such is not already the case?
Cim as a group is well-positioned to assist our clients. Cim Property has a stock of office space to offer with a suite of services such as IT support and conference rooms for board meetings. Cim Forex can assist in foreign currency transactions. For example, if a shareholder has sent US dollars and wants to invest in India, we can convert his dollars into Indian rupees at a favourable rate. For staff recruitment and payroll management as well as other associated HR matters, our Human Resources Department team could extend their assistance. Our asset management company can help in fund management as well as investment acquisitions in the local market or placing excess cash in high-yield products.
Over the years, our in-house legal team has also developed expertise in drafting constitutive documents as well as preparing the particulars for listing on the Stock Exchange of Mauritius, and the list goes on and on.