Creating business Substance
Business or Economic Substance defines the economic reality of a company that avoids a high tax burden on your business and serious tax challenges from multiple tax authorities.
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Why is economic substance so important?
Since beginning of 2016 the requirements on economic substance by banks and tax authorities have increased significantly. Under the new OECD action plan on Base Erosion and Profit Shifting (BEPS) companies and transactions are under permant threats of missing substance.
There are today still many company structures with a double none-taxation where no taxes are levied on the proceeds of a multinational transaction.
BEPS has the goal to prevent the use the treaty benefits when international corporate structures exists only to enjoy the benefits of the applicable double taxation treaties.
BEPS uses multiple instruments to prevent treaty mis-use including
- Substance requirements to allow benefits under double taxation treaties
- anti-abuse rules under double taxation treaties
- anti-abuse instruments in home country legislation
- "Controlled Foreign Company (CFC) rules
All measurements relate to the level of genuine business activities of company structures and transactions.
In case of missing substance corporations will face high tax risks and financial transactions questioned or blocked by financial institutions.
What are the risks of missing substance?
Companies and transactions with missing economic substance run the risk of:
- Missing out on tax deductions (transactions are not tax deducatable in the country of payment but are taxable in the destination country
- Double taxation of income within a cross country value chain
- Challenges from tax authorities with the risk tax audits, penalties and court cases
What is the right level of economic substance?
The right level of economic substance depends on the size and complexity of the underlying business transactions.
Some red flags are:
- Director is not sufficient qualified to conduct the business transactions and the work time does not correspond to the reasonable work load
- Missing tools like computer, phone lines etc. in the balance sheet of the company indicating a fake substance approach
- Location and transaction type do not match (illogical transaction) where the purpose of the transaction / company are obviously tax based and not related to value added
Director WESP Consulting
The ultimate business substance reflects all business aspects and commercial activities related to genuine business where the optimisation of tax benefits are a pure side-effect but not the primary goal of the business structure.
Artificial business substance does not provide sufficient protection against tax authorities in high taxation countries.
Country to country, FATCA and CRS data exchanges effectively take away the protection of bank secrecy and expose tax planning structures.