Tax Tips (18) – The Final Days of Tax Haven

What would you do if every tax haven (e.g. BVI) company under your control is required by law to hire full-time qualified employees there and incur an adequate amount of operating expenditure to carry out the activities that they claim to be engaged in?


Harmful tax practice
BEPS Action in action

In Tax Tips (13), the issue of tax residency of tax haven companies was discussed.  Smart corporates will be able to ensure that the tax residencies of their tax haven entities are properly managed and thus would not create tax exposures.  That does not necessarily mean that these companies can continue to book un-taxed profits with no substance. The BEPS machine is not stopping.


Last month, the OECD Inclusive Framework on BEPS: Action 5 issued a paper called “Resumption of Application of Substantial Activities Factor to No or Only Nominal Tax Jurisdictions” (the “Paper”), which sets out the substance requirements for tax havens.  To the tax havens around the world, this Paper could be the last straw on the camel’s back (incidentally, tax havens such as the BVI, Cayman Islands etc are members of the Inclusive Framework).


The OECD issued the report “Harmful Tax Competition: An Emerging Global Issue” in 1998 (“the 1998 Report”) setting out a framework for approaching the perceived problem that certain no or only nominal tax jurisdictions (i.e., tax havens) and harmful preferential tax regimes “affect the location of financial and other service activities, erode the tax bases of other countries, distort trade and investment patterns and undermine the fairness, neutrality and broad social acceptance of tax systems”.  The 1998 Report called this “harmful tax practices,” and built a framework to assess these practices.  The aim was to deliver a level playing field between jurisdictions in a context where taxpayers can easily relocate their mobile activities in response to tax considerations.

The framework for assessing whether a jurisdiction is a tax haven is based on four criteria:

(a) whether a jurisdiction imposes no or only nominal taxes;

(b) lack of effective exchange of information;

(c) lack of transparency and

(d) the absence of a requirement that the activity be substantial.

Notwithstanding, in 2001 the Forum on Harmful Tax Practice decided to only determine whether or not a jurisdiction was considered uncooperative on the basis of the first three criteria, and focused on making them cooperative and transparent.

With the implementation of BEPS Action 5 and the peer review process to ensure tax breaks are only offered to substantive activities and only if they do not pose risks of harmful competition to others, the focus is now shifted to ensure that business activity does not simply relocate to tax haven in order to avoid the substance requirements.  Against this background, the Inclusive Framework has decided to apply the Substantial Activities Requirements for tax havens.

The Scope of the Substantial Activities Requirements

The types of activities that are within the scope of the Substantial Activities Requirements are geographically mobile activities such as the provision of intangibles (i.e., intellectual property (“IP”) related activities) and Non-IP activities which includes headquarters, distribution centres, service centres, financing, leasing, fund management, banking, insurance, shipping and holding companies.

What are the Substantial Activities Requirements


For income from income not related to IP (“Non-IP Income), tax havens would be required to introduce laws to:

(i) define the core income generating activities for each relevant business sector;

(ii) ensure that the activities are undertaken by the entity (or are undertaken in the jurisdiction);

(iii) require the entity to have an adequate number of full-time employees with necessary qualifications and incurring an adequate amount of operating expenditures to undertake such activities; and

(iv) have a transparent mechanism to ensure compliance and provide an effective enforcement mechanism of the laws.


For income related to IP (“IP Income) derived from patents or similar assets, the core income generating activities would be the conducting of research and development activities with an adequate number of qualified full-time employees and adequate amount of operating expenditures.  A similar requirement would apply where an entity is exploiting marketing IP assets such as trademarks, where the core income generating activities are branding, marketing, and distribution.

In other cases of IP Income, the entity would need to demonstrate that it is conducting strategic decision making, managing and bearing the principal risks relating to the development and subsequent exploitation of the IP asset, or carrying on the underlying trading activities through which the asset is exploited, with the adequate number of qualified full-time employees and an adequate amount of operating expenditures.  

IP Income – Higher risk scenarios

Higher risk scenarios would be cases that involve related parties outside of the tax haven where (i) the entity has acquired the IP asset from related parties or through the entity funding research and development activities which took place outside the tax haven; and (ii) the IP asset is licensed or sold to related parties, or the exploitation is conducted by related parties outside the tax haven (e.g. foreign related parties are paid to develop and sell a product in which the intangible asset is embedded).

An entity in a higher risk scenario could meet the substantial activities requirements by providing evidence that there was, and historically has been, a high degree of control over the development, exploitation, maintenance, enhancement and protection (the DEMPE functions) of the intangible asset, exercised by an adequate number of full-time employees with the necessary qualifications that permanently reside and perform their activities in the tax haven. This would need to be demonstrated by providing additional information including:

  • detailed business plans which demonstrate the commercial rationale for holding the IP assets in the jurisdiction;
  • employee information, including the level of experience, type of contracts, qualifications,
    and duration of employment; and
  • evidence that decision making is taking place within the jurisdiction, rather than
    periodic decisions of non-resident board members.

Ensuring Compliance

To ensure compliance, tax havens would need to:

  1. Set up a mechanism to collect various information from entities including details of the core income generating activities, the amount and type of gross income and expenses, the assets and premises held in the course of carrying out the business, and the number of full-time, qualified employees.
  2. Set up a sanction mechanism that is rigorous, effective and dissuasive to take action in the event an entity failed to meet the substantial activities requirements. Sanction mechanism could include striking an entity off the register. The tax havens would also need to continue enforcement efforts and remedy any shortcomings in the enforcement process.
  3. For any entities that do not comply with the substantial activities requirements, tax havens would be required to spontaneously exchange all relevant information with the jurisdictions of residence of the immediate parent, ultimate parent, and ultimate beneficial owner.

The effectiveness of the information collection and exchange mechanism is to be reviewed in 2022.  

What about Holding Companies?

As discussed in Tax Tips (13), tax haven company is the ideal type of vehicle for investment holding, i.e. holding equity participations and earn only dividends and capital gains.  Such companies are recognised in BEPS Action 5 that they may not require much substance in order to exercise their main activity of holding and managing equity participations, and therefore is less of a concern from BEPS’ perspective.  The Substantial Activities Requirements on investment holding companies are that they respect all applicable corporate law filing requirements and have the substance necessary to engage in holding and managing equity participation (for example, by showing that they have both people and the premises necessary for these activities).   

The Mauritius Example

Mauritius imposes nominal tax on companies with Category 1 Global Business Licence (“Cat 1 GBL”, commonly used as holding companies with access to the Mauritius tax treaty network).  In the recent months, the Mauritius authorities issued new rules to bring about changes with effect from 1 January 2019. Under the new rules, Cat 1 GBL will be replaced by a new licence called Global Business Corporation (“GBC”) and the licensing conditions for GBC include, inter alia, carrying out of its core income generating activities at all times in, or from, Mauritius by:

  • Employing, either directly or indirectly, a reasonable number of suitably qualified persons to carry out the core activities; and
  • Having a minimum level of expenditure, which is proportionate to its level of activities.

In addition, the regulations provided the indicative core income generating activities and the minimum annual expenditure and employees (direct or indirect).  For an investment holding GBC, the indicative minimum annual expenditure is USD12,000 and there is no minimum employee specified.

The Mauritius rules could be an example of what is forthcoming in other tax havens.

Tax Tips

Subject to the actual regulations to be introduced by the tax havens, the requirement that the entities in tax havens should maintain “an adequate number of qualified full-time employees and adequate amount of operating expenditures” and the threat of information exchange is likely sufficient to kill most tax haven entities earning IP or Non-IP Income (except for investment holding companies).  Corporates that have not already restructured the activities to “normal tax jurisdictions” should speed up their review process and take action.

As to investment holding, which probably is a major business activity of most tax havens, corporates should follow the development closely and react to that accordingly.  It is foreseeable that the OECD may accept more lenient substance requirements in order not to hurt the economies of the tax havens too significantly. The introduction of requirements on annual minimum expenditure even full-time employees will reduce the attractiveness of tax haven.  As these are real additional costs of setting up investment holding companies, corporates should consider consolidating the group holding structures to eliminate duplicated costs, if not pulling out completely. The days of letterbox and brass plate companies appear to be limited.


Contact Us


(This is an English translation of the Chinese article published in the Hong Kong Economic Journal Forum on 10 December 2018:


The Paper:

Members of the Inclusive Framework on BEPS:   

Mauritius Circular CL1-121018: