26th March 2020

How Covid-19 threw Economic Substance Rules out of the Window

<span id="hs_cos_wrapper_name" class="hs_cos_wrapper hs_cos_wrapper_meta_field hs_cos_wrapper_type_text" style="" data-hs-cos-general-type="meta_field" data-hs-cos-type="text" >How Covid-19 threw Economic Substance Rules out of the Window</span>

We are in a new era.

Covid-19 pandemic has instigated the biggest social changes seen in a few generations, but understandably, in this hyper-connected, globalised world with more complex dependencies than ever before, business is contemplating the short, medium and long term impact.

One of the more important of these is the impact on regulation and compliance.

As a result of Covid-19 pandemic, many companies became concerned about whether travel restrictions or changes to normal working practice, such as the need for self-isolation and working from home, could have an impact on their ability to comply with certain regulations. Economic Substance rules being a key case in point.

Economic Substance rules have been introduced widely in response to concerns raised by the EU Code of Conduct Group with the purpose of ensuring that companies incorporated in international financial centres have sufficient substance either in the jurisdiction in which they are incorporated, or another jurisdiction where they are tax resident. These measures were designed to discourage the use of ‘brass plate’ companies and nominee directors.

One of the specific requirements is that board meetings must take place in the jurisdiction of incorporation or tax residency. For that purpose, an adequate number of board meetings need to occur physically in the relevant jurisdiction.

This would in theory create an expectation to have directors of a company physically present in the relevant jurisdiction most of the time considering current and likely future travel restrictions.

Earlier this week however, both the Jersey and Guernsey tax authorities have put out an advisory note to allay industry concerns that where board meetings are not able to occur physically in the relevant jurisdiction, that in itself will not be enough to fail the tax residency or economic substance test ‘directed and managed’ requirements.

In the guidance provided by GIBA (Guernsey International Business Association), they do remark that companies should maintain and retain records that show what travel policies were in place and for how long in order to demonstrate that Covid-19 measures prohibited them from holding the required number of board meetings in that jurisdiction or required them to be temporarily held virtually.

While this will come as a relief to many firms, it does uncover a couple of cracks in the system.

Firstly, it sheds light on how current business models are vulnerable in a crisis, be it a pandemic, or a natural disaster which fundamentally alters the way the society and business operates.

Secondly, and perhaps more unpleasant for regulators, this relaxation of the rules raises a question: how effectively will they achieve their objectives if one of the main criteria cannot be met?

Whilst the issue of Economic Substance rules is a specific issue, the general observation is that our core operating assumptions are being challenged. Fortunately, technology and communications infrastructure are not currently affected, but all industry participants should be considering how to operate as effectively and efficiently as possible via digital means, with videoconferencing, online chat, workflow, cloud-based document management, mobility solutions, electronic signature solutions, interactive dashboards and collaboration platforms and of course email being key tools as we all adapt to the new environment.