Establishing an economic substance in registered jurisdiction may be essential during inspection of local tax authorities. However, the process of establishing substance must be diligently evaluated prior to doing so, as under certain conditions it may go against your initial goals and business structure. Substance needs to be addressed in order to avoid a higher tax burden on your enterprises and to prevent big tax-disputes arising with your tax authority.

Businesses have for many years relied upon 'offshore' or non-resident structures to reduce or defer taxes and improve returns for investors. This has been particularly popular with private equity and real estate structures. But, increasingly, and particularly within the EU, tax authorities are demanding more, if the case for tax non-residence and\or relief from local taxes is to be given. Usually ‘more’ is interpreted as having more substance and physical presence in the stated jurisdiction.

Nowadays, there are still many structures established in such a way that there is so-called double non-taxation, implying that in both countries there is no effective tax levied on the overall proceeds realised within the structure. The ultimate goal is to prevent the granting of treaty benefits in the case of international corporate structures which are only set up to enjoy the beneficial terms of the applicable double taxation treaties.

When having a substance is beneficial
Having a substance is beneficial when you have planned on creating an offshore or onshore entity and want the highest protection possible in regards to it being recognized by international and regional tax authorities. In order to avoid problems, your international corporate structure must be set up as an actual and 'real' corporate structure.

Based on the actual role the company plays in your worldwide structure, there needs to be a relevant level of ‘real’ activity. In practice this means, for example, that the registered address of the company should not coincide with that of several hundred other companies and the director of the company should not be a director in hundreds of other companies simultaneously. In other words, your corporate address should at least be unique and the director should have a real function in the company.

Evaluation of company’s substance
It is extremely relevant to organise a sufficient level of substance for your international structure. There are two levels of substance for you to consider. They could be referred to as objective economic substance and subjective economic substance.

Objective economic substance is the level of economic activity and the actual setup of a foreign corporate entity. Subjective substance is the specific activities of the foreign corporate entity in correlation with the legal framework in the countries involved. It depends on the specific situation of your company, the actual international corporate structure, the applicable anti-avoidance tax regulations in your country of origin, jurisprudence on this issue in the jurisdictions involved and the rules of the applicable treaty for the avoidance of double taxation.

Generally, it is accepted by many jurisdictions that the Company qualifies as resident company if:

Decisions are taken in the jurisdiction of the company (including signing agreements, board meetings, etc.);
Directors of the company have major influence and control over company’s business (control bank accounts, control cash flow, conclude business contracts, etc.);
Directors are tax residents of jurisdiction of the company.
However, tax authorities normally would have more questions as they investigate presence of the company. The following FAQ (frequently asked questions by the tax offices) may help in planning your further steps of developing economic substance for your company:

Where do the Directors of the company reside?
Who has control over the corporate bank account?
Who actually signs contracts, resolutions, minutes, decisions and other company documents?
Where do the sales and operations actually take place?
How do your clients and suppliers communicate with your Company (by phone, e-mail)?
How can potential clients find information about your Company? (Do you have web-site? Do you use advertisement?)
How does your Company’s headquarters look like? Do you have a physical office? (Are there any employees?)
It might look like your Company’s substance really needs enhancement. Adding substance and establishing a management office is usually a tailored-made exercise. Confidus will help you fully evaluate your current situation and will offer step-by-step solutions on creating a Management Office.