Economic Substance – guidance notes

The Revenue Service, along with the other Crown Dependencies, have updated their Guidance Notes on Economic Substance. This follows further discussions with the Code of Conduct Group (Business Taxation) (“COCG”) regarding the application of elements of the economic substance rules (see: ). The key changes in version 2.0 of the guidance notes are:


Changes with general application:

  • In a number of circumstances it is the making of decisions that is the Core Income Generating Activity (“CIGA”) that the company needs to undertake.  In light of this, there has been concern regarding the applicable analysis where a decision is made outside of the Island and whether this would be enough to result in the CIGA being undertaken outside the Island; it is welcome therefore that guidance notes v2.0 state: “The taking of decisions outside the Island would generally indicate performance of CIGA outside the Island.  However, isolated decisions may be taken outside the Island provided that it can be evidenced that the decisions taken and the CIGA undertaken in the Island are of a quality and quantity to clearly outweigh the question that the CIGA involving the decisions is undertaken outside the Island.” (original emphasis).
  • Further information on the sanctions (penalties, exchange of information and company strike-off) available to the revenue authorities has been outlined – making it clear which competent authorities information will be exchanged with and that financial penalties will be increased in cases of repeated failure to meet the test.  Guidance notes v2.0 also makes it absolutely clear that information will always be exchanged with relevant competent authorities in respect of high-risk IP companies, irrespective of whether they have passed the test.
  • The treatment of Protected Cell Companies (“PCCs”) and (“ICCs”) under the economic substance rules is clarified – PCCs being treated as a single company under the rules, whereas an ICC and each of its incorporated cells will be treated as individual companies.


Pure equity holding company relevant activity:


  • The definition of pure equity holding company is narrowed in the guidance notes to companies whose “sole function” is to acquire and hold shares – this being narrower than the legislative provisions (and the previous version of the guidance notes) which refer to the “primary function” of acquiring and holding shares.
  • Guidance notes v2.0 also utilise a sentence from the OECD’s Action 5 2017 update report – we understand that this sentence has been included to clarify the point that if a company is undertaking another relevant activity (in addition to the activity of being a pure equity holding company) it must meet the economic substance test in relation to that other relevant activity (i.e. a company which is a high-risk IP company cannot avoid the rules applicable to high-risk IP companies by claiming it is a pure equity holding company).


IP holding relevant activity:


  • Guidance on IP holding is now included in v2.0; although the specific guidance provided in respect of high-risk IP companies is a reproduction of the guidance previously provided in the “key aspects document”.
  • In terms of the general guidance on IP holding, guidance notes v2.0 provides a number of examples which seek to explain the different types of IP and the various forms of associated CIGA.
  • There is a statement that where companies seek to manipulate their income to fall outside of scope this will be addressed and clarification is provided that where, for accounting purposes, IP assets are aggregated within “goodwill”, the company will still be regarding as undertaking IP holding.


Other Activities


  • Guidance in relation to the relevant activity of insurance has been provided, including further details of the insurance CIGAs have been provided – critically these focus on oversight of the determination of risk and strategic decisions in relation to the provision of client services.  Four examples are provided which outline cases which both pass and fail the insurance CIGA tests.
  • Guidance in relation to the relevant activity of shipping has also been provided. The key element is that to be within the scope of this relevant activity the company must operate one or more ships in international traffic.  Therefore the other shipping activities mentioned in the legislation (e.g. management of crew, sale of tickets) are only in scope where the company meets this gateway condition.  As guidance notes v2.0 state: “A company which undertakes any of these other activities where the company does not also operate a ship, or ships, in international traffic is not within the shipping relevant sector.”
  • In the context of the relevant activity of “distribution and service centre” the sentence in the previous version of the guidance notes that the definition did not extend “to cases where [such] activities are not the main activity of a company” has been clarified with the inclusion of the following words: “…but only if that other activity is recharged at cost or less.  (For example, where a company seconds staff for a limited period recharging at cost rather than for a profit.)”  The revenue authorities have then warned that they will take appropriate action where companies seek to manipulate their income to fall within this exclusion.


In light of the challenges of agreeing the wording with the various stakeholders engaged in this process, it is not believed that further versions of the guidance notes are likely to be released in the near future and hence entities should progress on the basis that this is the maximum amount of guidance that is going to be released.