Isle of Man Substance Requirements 2018 (An Explanation)
The Income Tax (Substance Requirements) Order 2018 will amend our Income Tax Act 1970 to impose requirements on Isle of Man companies receiving income from certain so called “geographically mobile business sectors” to demonstrate that they have ‘substance’ in the Isle of Man.
Part 80C of the Order sets out a 3 part test which triggers the substance requirements where all 3 tests are passed…
Test 1 – is the Company Isle of Man Tax Resident ? Generally, all Isle of Man 2006 and 1931 Act companies are tax resident in the Isle of Man so this test is passed even where an Isle of Man Company is managed from elsewhere (eg IOM Company managed and controlled from Monaco).
In rare cases, Manx Companies can be non resident of the Isle of Man and resident elsewhere pursuant to the terms in a Double Tax Agreement. For example, under the terms of the UK/IOM treaty it is possible for an IOM incorporated company to be UK tax resident only and this might be useful in some circumstance.
Test 2 – Is there any income arising to the Company ? Where there is income in the accounting period the test is passed and substance requirements must be met. 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 Sectors’ covered by the requirements are:
(iii) Fund management – not fund vehicles themselves – so this also quite a narrow category
(iv) Shipping – This means commercial shipping business – and it excludes super yachts, fishing boats and anything smaller than 24m
(v) Headquarters – where strategy / coordination type services are provided to other group entities
(vi) Distribution and Services Centres – where goods are purchased from a group company and re-sold for a percentage of profit or where services are provided to group companies.
(vii) Financing and leasing.
(viii) Holding companies (not investment companies ie must hold more than 50% interest)
(ix) IP Companies and High Risk IP Companies.
As you can see from the list above, most companies do not operate in ‘Relevant Sectors’ and therefore the new substance requirements will not need to be met. For example, consulting companies, property companies, investment companies, telecoms companies, eGaming companies, manufacturing companies & general trading companies are entirely outside the scope of these provisions….
In terms of the relevant Sectors….Categories (i)-(iii) Banking, Insurance and Fund Management are licensable activities in the Isle of Man and will generally already have sufficient substance due to our licensing policies.
(iv)-(vi) Shipping, Headquarters and Distribution and Services Centres are pretty narrow categories which generally apply to large corporate groups. We don’t have any relevant clients so these seem like quite narrow categories too.
The rules relating to (ix) IP and High Risk IP Companies are more complex than the other sectors and the definition of IP & High Risk IP Company is not entirely clear from the legislation. However, as withholding taxes are generally imposed on royalty / licence income such companies are relatively rare in the Isle of Man. For this reason we will seek guidance from the Income Tax department over the definition and deal with these categories of companies in detail a future article.
(vii) Finance and Leasing companies & (viii) Holding companies seem to be the most relevant categories for the CSP sector.
Holding companies – are companies which own majority interests in underlying entities. Under 80E(3) (a)(b) a holding company is considered to have adequate substance in the Isle of Man if it :-
(b) has adequate people and premises for holding and managing the equitable interests or shares.
i.e. there is no overt requirement for a holding company to be directed and managed on the Island although of course care must be taken to ensure that point (b) is satisfied.
Finance and Leasing companies – are companies which provide a credit facility of any kind for consideration to any person (a “customer”).
For Finance and Leasing Companies and all other Companies with relevant sector income, the requirements are more onerous. In each case, (under 80E(1)) to have adequate substance an entity must ensure that:-
(a) it is directed and managed in the Island;
(b) there is an adequate number of qualified employees in the Island (whether or not employed by it or another person and whether on temporary or long-term contracts);
(c) it has adequate expenditure proportionate to the level of activity carried on in the Island; (d) it has an adequate physical presence in the Island; and
(e) it conducts core income-generating activity in the Island
The meaning of “directed and managed in the Island” is helpfully defined under 80E(4)(a)-(e) as follows:
A relevant sector company is “directed and managed in the Island” if —
(a) the company’s board of directors meets in the Island at an adequate frequency given the level of decision-making required;
(b) during each meeting in the Island, there must be a quorum of directors physically present in the Island;
(c) strategic decisions of the company must be set at meetings of the board of directors and minutes of the meetings must reflect those decisions;
(d) the board of directors, as a whole, must have the necessary knowledge and expertise to discharge its duties as a board; and
(e) the minutes of all board meetings and the company records are kept in the Island.
Verification and Enforcement.
It is anticipated that the new rules will come into force for accounting periods commencing on or after 1 January 2019 and 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, the corporate income tax form will be revised so that additional information required for evidencing compliance can be collected for resident companies which receive income from relevant sectors. Sections 80F 80H and 80I deal with collection of information and the application of sanctions for non compliance.
High Risk IP Companies are subject to special (stiffer) 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 – (a) Exchange information with owners home tax authority (if in EU) and (b) Fine of GBP10,000.
Next year – Failure in second accounting period – (a) Exchange information with owners home tax authority (if in EU) and (b) Fine of GBP50,000
Following year – Failure in third accounting period – (a) Exchange information with owners home tax authority (if in EU) and (b) Fine of GBP100,000
Continuing failure – Failure in fourth accounting period – (a) Exchange information with owners home tax authority (if in EU) and (b) Issue a notice to Registrar to strike off the Company.
Section 80J – deals with Avoidance matters and provides powers for the Assessor to impose a fine in the case of Avoidance with Fraudulent Avoidance being a criminal offence carrying a penalty of up to 7 years in jail.
Section 80K provides a mechanism for an appeal to the Income Tax Commissioners and gives them powers to reverse the decision of the Assessor.
Section 80L allows the Assessor and the Commissioners (on appeal) to reduce the penalties.
Section 80M empowers the Assessor to issue and revise guidance where thought appropriate.