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Cayman Islands Tax Law Raises Questions Amid July Deadline
Three months after enacting a new law aimed at combating cross-border tax avoidance, the Cayman Islands remains unclear on what it means for companies to have “economic substance” in the territory. The International Tax Co-Operation (Economic Substance) Law, implemented in January, requires firms registered in the Cayman Islands to undertake activities of “economic substance” or face fines and potential defunction.
What Does “Economic Substance” Mean?
Companies must demonstrate that they are:
- Managed and directed from within the Cayman Islands
- Conducting core income-generating activities
- Maintaining an “adequate” physical presence on the islands
- Having “adequate” operating expenditures and human resources
Lack of Clarity Causes Concerns
The legislation failed to provide detailed thresholds for what constitutes:
- An “adequate” physical presence
- Operating expenditures
- Human resources
The government’s guidance in February also left many questions unanswered. Lawyers predict that the deadline may be delayed as companies struggle to meet the new requirements.
Impact on Chinese Companies
The Cayman Islands has long been a popular destination for Chinese companies looking to set up offshore subsidiaries, including internet giants like Alibaba Group Holding Ltd., Baidu Inc., and Tencent Holdings Ltd. However, under the new law, these companies must demonstrate “economic substance” or face potential penalties.
Other Tax Havens Follow Suit
Other tax havens, such as the British Virgin Islands, Bermuda, and Guernsey, have also enacted similar legislation to comply with the EU’s fair taxation principle and avoid being listed as non-cooperative jurisdictions. The Cayman Islands’ law takes in companies from sectors including:
- Banking
- Distribution
- Service centers
- Financing and leasing
- Fund management
- Holding companies
- Insurance
- Intellectual property
- Shipping
Consequences for Chinese Companies
Experts say that Chinese companies may need to restructure their variable-interest entity (VIE) structures if they fail to meet the economic substance test. The VIE structure is designed to skirt Chinese rules restricting foreign investment and ownership in certain sectors, including internet businesses and value-added telecommunications services.
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