Updated
GL-E-04
01 / In 30 seconds
The short answer
- What it is
- A requirement for a company to actually carry on business where it is registered
- What is checked
- Employees, an office, expenses, the place where decisions are taken, alignment of activity
- Why it was introduced
- So that companies are not registered in a jurisdiction solely for its tax regime
- Consequences
- Penalties, loss of benefits, refusal by banks, questions from another country’s tax authority
- The practical conclusion
- An empty company in a convenient jurisdiction no longer works
02 / In plain words
What Economic substance means
Economic substance is the requirement for a company to actually carry on business in the jurisdiction where it is registered rather than exist there only on paper. The concept has become central to international taxation in recent years and has changed the approach to structuring.
Very specific things are checked: whether there are employees with the right qualifications, whether there are premises, whether the company incurs real expenses, where management decisions are actually taken, and whether the declared activity matches the real one. The requirements usually depend on the type of activity: they are lighter for a holding company and stricter for a trading or financial company.
The consequences of non-compliance are multi-layered. The jurisdiction of registration may impose penalties and withdraw the preferential regime. A bank may refuse to open an account or close an existing one. The tax authority of the country where decisions are actually taken may treat the company as its tax resident, with everything that follows. That is why the question of substance is settled before registration, not after.
A case from practice
A client had a company in a jurisdiction with a preferential regime, but with no employees and decisions being taken from another country. When preparing for the programme, the structure was reviewed: some elements were simplified and real substance was provided for the rest.
When it is critical
- Registering a company abroad
- Applying a preferential regime
- Opening a bank account
- Using tax treaties
- Reviewing old structures
- The owner moving to another country
03 / What it covers
What is assessed
People
- Employees in the jurisdiction
- Qualifications for the activity
- Genuine employment relationships
Place
- Office or premises
- Operating expenses
- Infrastructure
Management
- Where decisions are taken
- Board meetings
- Directors’ residence
Activity
- Alignment with what is declared
- Income from real operations
- Reporting
04 / How it works
How to ensure substance
Establish the requirements for the activity
Provide people and premises
Take decisions locally
Document the activity
Complete the reporting
05 / Key facts
What you need to know
01
Requirements depend on the type of company activity
02
A registered address does not equal economic substance
03
The place where decisions are taken may determine tax residence
04
Banks check substance when opening an account
05
Non-compliance leads to penalties and loss of benefits
Common mistakes
- Treating a nominee director as sufficient substance
- Taking all decisions from another country
- Registering a company without a plan for substance
- Not keeping records of the activity
- Leaving old structures unreviewed
06 / Expert advice
How to prepare in advance
Substance requirements are established before registration and built into the budget: staff, premises and local management are real costs. Board meetings are held and documented in the company’s jurisdiction. And an objective assessment is made: if substance cannot be ensured, it is worth choosing another jurisdiction or another structure.
What we do for you. We review the client’s structure before filing: where the companies are registered, whether they have real substance and how this will look after your change of residence. Empty companies raise questions both at the bank and in the check.
Dmitry NagyTax consultant, international taxation and compliance (ex-Big4)
07 / Questions
Frequently asked questions
The requirement to actually carry on business in the jurisdiction of registration: to have employees, premises and expenses and to take decisions locally.
No. An address is a formality. Substance is assessed by people, expenses, activity and the place where decisions are taken.
No, they depend on the type of activity: usually lighter for holding companies and stricter for trading and financial ones.
Penalties, loss of the preferential regime, refusal of banking services and sometimes the company being treated as tax resident in another country.
As a rule, no. What is checked is where decisions are actually taken, not who is formally listed in the register.
Before the company is registered. Ensuring substance means real costs that need to be built into the structure’s budget.
INITIAL ASSESSMENT
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