The Income Tax (Substance Requirements) Order 2018 has amended the Isle of Man Income Tax Act 1970 to impose requirements on Manx tax resident companies who receive income from geographically mobile business activities to demonstrate they have adequate substance in the Isle of Man (IoM).
Aim of the legislation
The proposed legislation has been designed to address concerns that companies could be used to artificially attract profits that are not commensurate with economic activities and substantial economic presence in the IoM. For accounting periods starting on or after 1st January 2019 the legislation requires certain companies to demonstrate they have substance in the IoM by:
- being directed and managed in the IoM
- conducting Core Income Generating Activities (CIGA) in the IoM
- having an adequate number of qualified employees and people in the IoM (whether or not employed by it or another person and whether on temporary or long-term contracts)
- Having adequate physical presence/premises in the IoM
- Having adequate expenditure proportionate to the level of activity carried on in the IoM
The Order sets out a three part test which can be used to assess the substance requirements of a company – all three parts must be passed to trigger the requirement to demonstrate substance.
Test 1 – is the Company IoM Tax Resident?
Generally, all IoM 2006 and 1931 Act companies are tax resident in the Isle of Man, by virtue of their incorporation, so this test is passed even where an IoM Company is managed from elsewhere.
However it is possible in rare cases for a Manx company to be non-resident in the IoM for tax purposes pursuant to the terms in a Double Tax Treaty Agreement with another jurisdiction (e.g. the UK).
Test 2 – Is there any income arising to the Company?
Where there is income in the accounting period the test is passed – note the test is an income rather than profit test so the test is still passed by a loss making company with turnover.
Test 3 – does the Company receive its income from a relevant sector?
The relevant geographically mobile business sectors are:
- Shipping (this does not include yachts)
- Fund management (but not the fund entities)
- Financing and leasing (excludes leasing of land or interests in land)
- Headquartering – where strategy / coordination type services are provided to other group entities
- Distribution and service centre business
- Operation of a holding company (owning more than 50% of subsidiaries)
As an exception, to demonstrate it has adequate substance a pure equity holding company need only (a) comply with its statutory obligations under whichever of the Companies Act 1931, Companies Act 2006 or Foreign Companies Act 2014 is relevant and (b) have adequate people and premises for holding and managing the equitable interests or shares.
- Holding intangible property (“IP”)
There is a rebuttable presumption that a high risk IP company has failed the substance requirement as the risks of artificial profit shifting are considered to be greater. A high risk IP company is one where either:
(a)It owns an IP asset that has been acquired from related parties or obtained through the funding of overseas research and development activities and is licensed to related parties or monetised through activities performed by foreign related parties
(b)It owns an IP asset and does not carry on the core income-generating activity specifies in the IoM
As a result the Assessor will exchange all of the information, provided by the company, with the relevant foreign tax official where the immediate parent company, ultimate parent company and/or ultimate beneficial owner is resident. Such exchange of information will be in accordance with any existing international tax exchange agreements and will occur irrespective of whether the substance requirements are met.
To rebut this presumption and avoid further sanctions a high risk IP company will have to produce relevant materials to explain how the key development and maintenance of the IP has been under its control and that it has involved people who are highly skilled and perform their core activities in the IoM.
More detail of the specific sectors can be found within the Order itself.
Implementation & Verification
The Assessor of Income Tax in the Isle of Man will be responsible for enforcing the new requirements and for imposing the penalties due. In practice corporate tax returns will be amended to collect the information needed to monitor compliance with the substance requirements.
The Assessor may, in respect of any accounting period, request any additional information in order to satisfy them that a relevant sector company meets the substance requirements.
The proposed legislation includes robust and dissuasive sanctions for failure to meet the substance requirements. The sanctions are progressive and include financial penalties, with the ultimate sanction leading to the striking off of the company from the Companies Register. As stated the Assessor will also spontaneously exchange relevant information with the EU Member State competent authority where the immediate parent company, ultimate parent company and/or ultimate beneficial owner is resident, if the substance requirement is failed (and in all high risk IP cases).
As noted high risk IP Companies are subject to special sanctions; however all other resident companies with income from relevant sectors are subject to the following sanctions for failing to meet the substance requirements:
- Initial Sanction – Failure in first accounting period – Exchange information with owners home tax authority (if in EU) and fine of GBP 10,000 (High Risk IP company GBP 50,000)
- Next year – Failure in second accounting period – Exchange information with owners home tax authority (if in EU) and fine of GBP 50,000 (High Risk IP company GBP 100,000)
- Following year – Failure in third accounting period – Exchange information with owners home tax authority (if in EU) and fine of GBP 100,000 (High Risk IP company strike off)
- Continuing failure – Failure in fourth accounting period – Exchange information with owners home tax authority (if in EU) and issue a notice to Registrar to strike off the Company.
If the Assessor finds that in any accounting period a company has avoided or attempted to avoid the application of this Order, the Assessor may:
- Disclose information to a foreign tax official
- Issue to the company a civil penalty of £10,000A person has fraudulently avoided or seeks to avoid the application is liable to:
- On conviction: custody for a maximum of 7 years, a fine or both
- On summary conviction: custody for a maximum of 6 months, a fine not exceeding £10,000, or both
- Disclosure of information to a foreign tax official
Any appeals will be heard by the Commissioners who may confirm, vary or reverse the Assessor’s decision.
This new legislation will have a significant impact on many companies within the IoM who must now consider whether they will be caught by the substance legislation three part test. If so then there is only a short amount of time to demonstrate to the Assessor that they are compliant with the substance requirements to avoid the substantial sanctions listed. Many companies will easily be able to identify whether or not they fall within one of the relevant sectors. Companies managed by corporate service providers may need to assess whether they have the necessary substance, particularly in respect of physical presence and personnel. Steps must also be taken to ensure that the evidence to support substance demonstration is appropriately documented.
Where there are any difficulties with meeting the requirements consideration will need to be given to what restructuring can be undertaken.
How can Crowe Isle of Man help?
If you feel your business may be affected by this legislation then it is important that you act quickly and begin to take the appropriate steps now. Please contact the Crowe team for advice or to discuss.
If you would like to know more then please contact:
+44 (0)1624 627335 firstname.lastname@example.org
+44 (0)1624 627335 email@example.com
+44 (0)1624 627335 firstname.lastname@example.org