Updated
GL-E-06
Glossary · Structures and trusts
ESR - when a company in a low-tax country must prove real presence
01 / In 30 seconds
The short answer
- What it is
- National rules requiring companies to evidence their economic substance
- What is required
- Passing the substance test and filing regular reports
- Who they apply to
- Companies carrying on certain kinds of relevant activity
- What is checked
- Staff, expenses, premises, management, alignment of activity
- Consequences
- Penalties, exchange of information with other countries and, in serious cases, striking off the register
02 / In plain words
What Economic Substance Regulations means
Economic Substance Regulations are national rules requiring companies to evidence real economic substance in their jurisdiction of registration. They were introduced by a number of countries, above all low-tax ones, under pressure from international transparency requirements — as an alternative to being placed on lists of non-cooperative jurisdictions.
The rules apply not to all companies but to those carrying on so-called relevant activities: certain categories such as holding, finance, insurance, leasing, intellectual property, distribution and service centres. Each category has its own substance criteria.
The practical mechanism has two parts: passing the substance test — having sufficient staff, expenses and premises and conducting management in the jurisdiction — and filing reports regularly. Non-compliance results in penalties, and information on such companies is passed to the tax authorities of other countries, including the owner’s country. That is why empty companies in such jurisdictions have ceased to be a workable tool.
A case from practice
A client had a holding company in a jurisdiction with such rules, with no staff and no reports filed. When preparing for the programme, the structure was reviewed: some elements were wound up, and substance and reporting were put in order for the rest.
Who it concerns
- Holding companies
- Companies with financial activities
- Holding intellectual property
- Distribution and service centres
- Old structures in low-tax jurisdictions
- Preparing to apply for a programme
03 / What it covers
What needs to be ensured
Staff
- A sufficient number
- The right qualifications
- In the company’s jurisdiction
Management
- Board meetings held locally
- Decisions taken in the jurisdiction
- Minutes and documents
Costs
- Operating expenses in the country
- Premises
- Proportionate to the activity
Reporting
- Regular filing
- Timelines
- Accuracy of the information
04 / How it works
How to comply
Establish whether the activity is relevant
Whether the company falls under the rules' categories.
Assess the substance requirements
The substance criteria for your category.
Provide staff and expenses
Staff and spending in the jurisdiction.
Conduct management locally
Decisions are taken by directors locally.
File reports on time
The substance report is filed on time.
05 / Key facts
What you need to know
01What they are
National rules
They require proof of economic substance and regular reports. Mainly introduced by low-tax jurisdictions.
02Who is affected
Relevant activities
Holding, financial, insurance, leasing, IP, distribution and service centre activities.
03What is checked
People, costs, premises, management
Adequate staff and spending, premises and decisions taken in the jurisdiction.
04Consequences
Penalties and information exchange
The information goes to other countries' tax authorities, including the owner's. In serious cases the company is struck off.
Common mistakes
Assuming the rules do not apply to you
Check whether the company's activity falls into a relevant category.
Not filing because there was no activity
File anyway if the law requires it.
Providing substance on paper only
Have real staff, spending and management on the ground.
06 / Expert advice
How to prepare in advance
First establish whether the company’s activity falls into the relevant categories. If it does, assess the requirements and calculate objectively the cost of meeting them: staff and premises in the jurisdiction cost real money. If ensuring substance is not worthwhile, the structure is reviewed rather than left in limbo.
What we do for you. We check old structures in low-tax jurisdictions first: whether they comply with the substance rules and whether reports are being filed. They are what most often raise questions both at the bank and in due diligence.
Dmitry NagyTax consultant, international taxation and compliance (ex-Big4)
07 / Questions
Frequently asked questions
National rules requiring companies to evidence real economic substance in their jurisdiction of registration.
Companies carrying on relevant activities: holding, finance, insurance, leasing, intellectual property and a number of others.
Pass the substance test — staff, expenses, premises and management in the jurisdiction — and file reports regularly.
A report is still filed. The absence of transactions does not exempt the company from reporting on its status.
It is passed to the tax authorities of other countries, including the owner’s country of tax residence.
Significant penalties, exchange of information with other jurisdictions and, for systematic breaches, up to striking the company off the register.
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