In 2024, there has been a sharp increase in the number of enforcement actions initiated by the Cayman Islands Tax Information Authority (“TIA”) and fines levied against relevant entities (such as Cayman Islands exempted companies) for breaches of the economic substance test (“ES Test”) under the International Tax Co-operation (Economic Substance) Act (Revised) (the “ES Act”). Penalty notices have been issued by the TIA for, among other infractions, failure to conduct core income generating activities (“CIGAs”) in the Cayman Islands, failure to have adequate physical presence and personnel in the Cayman Islands and failure to file an Economic Substance Return (“ESR”) within the statutory deadline, being within 12 months of the financial year end of the relevant entity.

Civil and Criminal Penalties

Penalties imposed by the TIA pursuant to the ES Act and associated enforcement guidelines can range from fines of CI$5,000/US$6,098 for failure to file an ESR (and an additional penalty of CI$500/US$610 for each day during which the failure continues), to CI$10,000/US$12,195 for failure of the ES Test, up to CI$100,000/US$121,950 for a repeated failure of the ES Test in the subsequent financial year.

If a relevant entity fails the ES Test for two consecutive years, the TIA will report such non-compliance to the Cayman Islands Registrar of Companies who shall apply to the Grand Court which may make an order including, among others, (i) requiring the relevant entity to take a specified action, including for the purpose of satisfying such ES Test; or (ii) in the case of a relevant entity that is an exempted company, striking the company off the register pursuant to Part VI of the Companies Act (Revised).

In addition, a person commits an offence under the ES Act if they fail to provide the TIA with any requested information that is in that person’s possession or under that person’s control without lawful excuse, or knowingly or wilfully alters, destroys, mutilates, defaces, hides or removes any such information, and is liable on summary conviction to a fine of CI$10,000/US$12,195 or to imprisonment for a term of two years, or to both. A person also commits an offence if they knowingly or wilfully supply false or misleading information to the TIA, and is liable on summary conviction by a fine of CI$10,000/US$12,195 or imprisonment for a term of five years, or both.

How Can We Comply with the ES Test and the ES Act?

The ES Test can be satisfied in relation to a relevant entity carrying on a relevant activity if it (i) conducts CIGAs; (ii) is directed and managed in an appropriate manner in the Cayman Islands in relation to that relevant activity; and (iii) has adequate operating expenditure, physical presence and personnel in the Cayman Islands. Relevant entities must report their relevant activities on an annual basis to the TIA via the Department of International Tax Compliance (the “DITC”) portal and show “adequate substance” in the Cayman Islands.

All Cayman entities are required to file an annual Economic Substance Notification (“ESN”) with the TIA as a pre-requisite to filing their annual return. The ESN obligation is separate from the timing of compliance with the ES Test for entities that are relevant entities conducting relevant activities. Such entities are required to satisfy the ES Test and prepare and submit an ESR electronically via the DITC portal on an annual basis. An entity that is tax resident outside the Cayman Islands will need to file a TRO form on the DITC portal on an annual basis.

Compliance Assessment and Remediation Actions

As the TIA’s monitoring and supervision pursuant to the ES Act increases, it is anticipated that there will be a corresponding increase in the number of enforcement actions and imposition of penalties against relevant entities.

Relevant entities should take steps to ensure compliance with the ES Act requirements applicable to their specific operations in each financial year and attend to the appropriate filings with the TIA via the DITC portal within the prescribed deadlines. Relevant entities should bear in mind the potential for increased penalties for continued breaches of the ES Act and be wary of the impact regulatory penalties may have on commercial arrangements and contractual representations. Individuals completing economic substance filings with the TIA should also be mindful of the potential civil and criminal penalties which can be imposed against them.

Our dedicated and experienced Regulatory and Risk Advisory team, with members based in Asia and the Cayman Islands, can assist relevant entities with economic substance compliance assessments and implementation of appropriate remediation actions. Please contact [email protected] or any of our Asia Regulatory team members ([email protected]) should you require assistance with Cayman economic substance matters.

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