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OECD FHTP moves to enforcement stage of new economic substance rules

Insight 23 November 2020

OECD FHTP moves to enforcement stage of new economic substance rules

In January 2021, the OECD Forum on Harmful Tax Practices (FHTP) will begin a move to the 'effective implementation' of its economic substance rules, with annual compliance monitoring of the financial sectors of the 12 jurisdictions affected.

The FHTP introduced its economic substance criterion in November 2018. It requires that jurisdictions operating a 'no or only nominal' business tax regime must impose a substance requirement on business entities based there. The requirement is that the entity conducts its core income-generating activities in the country, its staff and expenditures are adequate for this and the country's government enforces compliance. The aim is for companies to prove that they conduct genuine business activity in the jurisdiction rather than being there just for tax reasons.

The jurisdictions affected are Anguilla, the Bahamas, Barbados, Bahrain, Bermuda, the British Virgin Islands, the Cayman Islands, Guernsey, the Isle of Man, Jersey, Turks and Caicos Islands and the United Arab Emirates.

All these jurisdictions have now set up a satisfactory legal framework requiring companies to make economic substance reports, says the FHTP in its latest progress report. Its focus is therefore moving to the effective implementation of the standard, as set out in Action 5 of the OECD base erosion and profit shifting (BEPS) initiative.

From 2021, the 12 jurisdictions will therefore begin passing information on the activities and income of the entities based there to the jurisdictions where these entities' immediate parents, ultimate parents and beneficial owners are based. The aim is to enable the latter jurisdictions to assess whether these companies are arranging for their revenues to be diverted to low-tax jurisdictions.

Simultaneously, the FHTP will begin an annual monitoring process to ensure that the 12 jurisdictions are enforcing compliance with the economic substance standards imposed by OECD.

The FHTP’s progress report also states that its recent reviews of 49 tax regimes has resulted in significant legislative changes in 44 of them in 2020, with 37 having been redesigned or abolished and a further seven currently being amended. The other five regimes are considered not to pose profit-shifting risks.

The report notes that 18 jurisdictions are now in line with the BEPS Action 5 Minimum Standard: Aruba, Belize, the Cook Islands, Curaçao, Dominica, Dominican Republic, Georgia, Hong Kong, Jamaica, the Maldives, Mauritius, Morocco, North Macedonia, Qatar, Saint Kitts and Nevis, San Marino, Switzerland and Tunisia.