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Substance rules: Are we any clearer now?

Substance rules: Are we any clearer now?

Read the views of David Parsons, Tax Partner, on the latest economic substance guidance notes.

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David Parsons

Partner: Tax

KPMG in the Isle of Man

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Hot on the heels of the EU’s most recent blacklisting exercise in March, which saw the island completely removed from their “bad-boys” lists, the island’s Income Tax Division has now published guidance on the Isle of Man’s economic substance requirements legislation.  It is of course the introduction of our substance legislation in December last year – the rules that require Isle of Man companies with income from certain specific sectors to have adequate “substance” in the island - which has resulted in our removal from those lists.

It is probably worth pausing at this point – we should not underestimate the success achieved by our Income Tax Division – they secured our immediate removal from the EU’s lists, whereas the Governments of the grey listed Cayman Islands and British Virgin Islands, and blacklisted Bermuda, look on with a degree of envy.

Back to the substance guidance: whilst the publication of this guidance is to be welcomed, it does not purport to answer all of the difficult questions that have been asked in recent months.     

In particular, companies that hold intangible property, for example software, may be disappointed to note that no guidance is yet offered, albeit they should be in no doubt about the challenges that the legislation presents for that sector. Guidance is also yet to be published for the shipping and insurance sectors. Noting that the legislation is already in force for companies with a 31 December year end, and that the first year penalties for non-compliance can be as high as £50,000, simply sitting back and waiting for future guidance may no longer be a sensible approach (even if it ever was!).

There has been much debate about whether a company needs to carry out all of its “core income generating activity” on the island. Whilst the legislation does not state this to be a requirement, the guidance now states that the core income generating activity that generates the company’s income must be conducted in the island. This may seem a rather technical point, but it matters.

There will also be, quite understandably, frustration felt by some that the rules still do not contain carve-outs for “truly local” situations. For example, an Isle of Man company owned by a local resident that simply provides an interest bearing loan to another person is likely to be in scope as a financing and leasing company – quite how that type of company is of any concern to the EU or the OECD, goodness knows, but the requirements nevertheless apply.

The OECD are currently assessing our substance legislation (you didn’t think the EU’s assessment was the end of it, did you?) and it is to be hoped that any amendments arising from the OECD’s review will be minor:  after all, the EU’s requirements were themselves supposed to be based upon the work of the OECD in this area. This OECD involvement is in my view a largely positive development – whilst we (as an island) may not always be falling head over heels to welcome their initiatives, they do bring an academic rigour and fairness to processes. However, it must be borne in mind that guidance on the interpretation of the substance rules may emerge from the OECD that effectively ties the hands of the Income Tax Division in interpreting its own legislation.

So, overall, whilst the recently published local guidance does offer some further assistance on the substance rules, many will still be looking for more clarity.

The term Partner refers to a member of KPMG LLC / KPMG Audit LLC.

© 2019 KPMG LLC, an Isle of Man limited liability company and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ("KPMG International"), a Swiss entity. All rights reserved.

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