The first economic substance declarations have been made, and while firms are now thinking about this year’s declarations, the regulators are just getting started with last year. Are you in their crosshairs? Read on for the common issues being cited.

Financial Services businesses around the globe have in the early part of this year submitted their first filing as to their compliance with economic substance obligations for tax resident companies conducting relevant activities in 2019.

Take the Channel Islands as an example, however, concerns are being expressed by the Tax Authorities over the quality and accuracy of the information submitted. Requests have been circulated to Financial Services Businesses seeking additional confirmations recently, to be made in short order, as to the quality and completeness of their business procedures and subsequent filings made on behalf of companies under their control.

In a recent communication from Revenue Jersey, it was highlighted that answers to questions, or combinations of questions, submitted alongside the tax return were representative of ongoing misunderstanding by Industry as to how the rules would be applied.

Whilst Revenue Jersey are seeking a primary point of contact within regulated administrators and CSPs to work through the errors, the States of Guernsey Revenue Service has issued a compliance questionnaire to those regulated / licensed fiduciary businesses, again seeking a confirmation of their overall compliance and the effective operating controls around the economic substance determination and onward reporting of their administered entities.

With such a wide outreach, it is important to understand who in your business has received this communication and the actions that they are taking to explore those issues with the Tax Authorities in each Island.

Common Issues

As well as instances where relevant activities may have been overlooked or misidentified entirely, thereby removing any substance compliance determination from the filings, there are themes and patterns emerging even where companies have indicated themselves to be within the scope of the rules that suggest inconsistency of how businesses have approached the economic substance analysis.

Typical examples include:

  • The company has confirmed itself to be outside of the scope of economic substance, owing to its primary purpose being something other than a relevant activity, but the financial statements include activities and income streams expected to be caught within the definitions;
  • The company has reported combinations of multiple relevant activities that should not co-exist;
  • The income reported does not represent that shown within the accounts;
  • The company has reported large whole numbers of full-time equivalent employees, not easily aligned with the very low activity, income and expenditure shown;
  • The company has stated that it has complied with its obligations of adequate substance, but has reported information surrounding the requirements that appears to contradict this view.

Exposure and Risk

Whilst economic substance is not itself part of the tax computation, the accuracy of the data reported and the correct application of the legislation and guidance by tax residents is vital for demonstrating to the EU Code of Conduct Group that jurisdictions have a fully equipped and effective system of monitoring in place to support these new Regulations, and are taking the appropriate enforcement actions against those who do not comply.

The penalties for a company failing its individual economic substance obligation are £10,000 per company. So, for administrators of large corporate books of business, the potential for having misinterpreted the requirements and reported incorrectly could be substantial, both in terms of financial penalty and the time and resources required to rectify any inaccurate reporting.

The initial commentary from Revenue Jersey includes a desire to apply risk ratings against administrators as a means to target audit of substance and tax compliance procedural effectiveness. It would be expected that this outreach and review of first year issues will feed that rating process, so early remediation will be important.

How can you do it better?

It’s clear that the economic substance regulations are not just a box-ticking exercise and firms need to take them as seriously as regulations like AML.

Our Economic Substance Advisory Service, with a decision engine built in collaboration with PwC, is uniquely designed to leverage the data points already held on the accounting ledgers, staff time records and statutory registers within your software, to remove the need to identify and rekey substance information.

Your existing data and the decision engine integrate seamlessly to provide an end-to-end audit trail surrounding the economic substance decision-making process, producing an output report for each entity (irrespective of whether or not the entity is in scope), and built-in checks during the day-to-day administration that flag change events where substance might be impacted.

With data points and substance information centralised, our reporting functionality could aid in early identification of any tax office queries, as well as demonstrating the robust business controls over your substance decision on administered entities.

To find out more about how we can make economic substance reporting more efficient and robust, get in touch with us or speak with your account manager.

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About the Author

Nina Mileksic

Nina is Compliance Product Manager at TrustQuay