As many are now aware, all companies with activities and income in a relevant sector in an accounting period will be required to demonstrate that they have adequate substance in the Island.
The adequate substance requirements will generally require that a company:
is directed and managed in the Island;
has an adequate number of (qualified) employees proportionate to the level of activity carried on in the Island;
has adequate operating expenditure proportionate to the level of activity carried on in the Island;
has an adequate physical presence in the Island; and
conducts core income-generating activity (‘CIGA’) in the Island
A range of sanctions will be enforced by the Income Tax Division where they consider that a company is not meeting the substance requirements. These include fines, exchange of information with appropriate tax authorities and ultimately, the company being struck off the Isle of Man register.
High-Risk Intellectual Property (“IP”)
Where a company receives income from IP, it will also have to consider if it is a “high-risk IP company”, which is defined in the legislation as an IP company that owns an IP asset that:
has been acquired from related parties or obtained through the funding of overseas research and development activities; and is licensed to related parties or monetised through activities performed by foreign-related parties; or
owns an IP asset and does not carry on research and development (rather than acquiring or outsourcing) or marketing, branding and distribution in the Island.
Rebuttable Presumption
There is a rebuttable presumption that a high-risk IP company has failed the substance requirement as the risks of artificial profit shifting are considered to be greater. As a result, the competent authority will exchange all of the information, provided by the company, with the relevant EU Member State competent authority where the immediate parent company, ultimate parent company and/or ultimate beneficial owner is resident. Such exchange of information will be in accordance with the existing international tax exchange agreements.
To rebut the presumption, a high-risk IP company will have to produce materials which will explain how the DEMPE (Development, enhancement, maintenance, protection and exploitation) functions have been under its control, and that this has involved people who are highly skilled and perform their core activities in the Island.
The high evidential threshold requires:
Detailed business plans which clearly lay out the commercial rationale for holding the Intellectual Property asset(s) in the Island;
Concrete evidence that the decision making is taking place in the Island, and not elsewhere; and
Information on employees in the Island, their experience, the contractual terms, their qualifications, and their length of service.
Periodic decisions by non-resident directors or board members, or local staff passively holding intangible assets, cannot rebut the presumption.
Substance Specific to High Risk Intellectual Property
is directed and managed in the Island
has an adequate number of (qualified) employees proportionate to the level of activity carried on in the Island
has adequate operating expenditure proportionate to the level of activity carried on in the Island
has an adequate physical presence in the Island
conducts core income-generating activity (‘CIGA’) in the Island
CIGA
CIGA for a company with income from holding the intangible property is defined as follows with my notes in-line:
(a) the company’s board of directors meets in the Island at an adequate frequency given the level of decision-making required; (b) during each meeting in the Island, there must be a quorum of directors physically present in the Island; (c) strategic decisions of the company must be set at meetings of the board of directors and minutes of the meetings must reflect those decisions; (d) the board of directors, as a whole, must have the necessary knowledge and expertise to discharge its duties as a board; and (e) the minutes of all board meetings and the company records are kept in the Island.
Directed and managed
A relevant sector company is “directed and managed in the Island” if:
(a) research and development (rather than acquiring or outsourcing); (b) marketing, branding and distribution; (c) taking the strategic decisions and managing (as well as bearing) the principal risks relating to the development and subsequent exploitation of the intangible asset; (d) taking the strategic decisions and managing (as well as bearing) the principal risks relating to the third-party acquisition and subsequent exploitation of the intangible asset; and (e) carrying on the underlying trading activities through which the intangible asset is exploited, and which lead to the generation of revenue from third parties.
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