Economic substance requirements – a quandary for offshore investment managers

Many offshore law firms and other fund service providers have been publishing bulletins about the enactment by traditional offshore jurisdictions of economic substance (ES) requirements legislation, and its likely impact on fund structures using an investment manager in a no or low tax jurisdiction.

In a nutshell, offshore jurisdictions have been compelled to respond to initiatives by the Organisation for Economic Co-operation and Development and the European Union to address base erosion and profit shifting which are viewed as harmful tax practices. Entities which are in scope of the legislation and are conducting a relevant activity are required to report annually that they satisfy ES requirements, such as income generation, physical presence and full-time staff, in the relevant jurisdiction. Covered entities in existence on the legislation enactment date of 1 January 2019 have until 1 July 2019 to comply. Covered entities established after the enactment date must comply from the date it commences a relevant activity. Reporting obligations commence in 2020.

Of note in the funds world, an investment fund is not currently a relevant entity in the Cayman Islands (the predominant jurisdiction for offshore funds), whereas fund management is a relevant activity. 

We recommend that fund clients with an offshore manager speak to their Cayman counsel and their tax advisors to review their existing structure and plan a strategy for compliance. Options include creating sufficient ES in the offshore jurisdiction, changing the tax residency of the manager (which may give rise to licensing issues if the manager were to e.g. establish a presence in Hong Kong), or restructuring the fund to remove the manager and appoint an onshore investment advisor instead.

We are available to assist with Hong Kong licensing advice and fund restructuring should this be the preferred outcome.