Economic substance in the Cayman Islands: what does it mean, how do we address it and what does BEPS mean? Victor Murray of MG Management explores the implications of economic substance for funds in the Cayman Islands.


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As concepts go, “economic substance” is not particularly descriptive nor helpful for a newcomer to this important aspect of international tax law. In short, subject to exceptions, economic substance (ES) dictates how certain offshore entities—based on their activities—must operate to maintain their favourable tax position.

The ES changes are driven by bodies such as the Organisation for Economic Cooperation and Development (OECD) and the EU, arising from their concern—rightly or wrongly held—about the possible erosion to the tax base in other jurisdictions. Here, I will explain some of the concepts and theories involved.


Alternative investment funds

Alternative investment funds formed in the Cayman Islands (not just those registered with the Cayman Islands Monetary Authority) are almost certainly exempt from the ambit of the International Tax Co-operation (Economic Substance) Law, 2018 (ES Law) which introduced ES requirements in the Cayman Islands.



BEPS stands for base erosion and profit shifting. The OECD has stated that: “BEPS refers to tax planning strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations where there is little or no economic activity.”


It is with this backdrop that the Cayman Islands in consultation with the OECD and the EU introduced ES via the ES Law.

As every financial services industry professional is aware, the fact that the Cayman Islands has no direct taxation system does not equate to profit shifting. In fact, the attraction of the Cayman Islands is to allow tax neutrality so that the fund manager in a taxable jurisdiction X can accept investors from a taxable jurisdiction Y (with the fund manager paying taxes in X and the investor paying tax in Y).

It is for this reason that investment funds are excluded from the ES requirements.


SIBL-registered person: relevant activity

Entities conducting other activities are potentially subject to the ES law, eg, advising a fund registered in the Cayman Islands as a Securities Investment Business Law (SIBL)-registered person (formerly known as the SIBL excluded manager); in these cases the application of ES requirements needs to be considered.

Under the ES Law, a Cayman entity will need to have certain notification, reporting and substance requirements under the ES Law if it is (i) a relevant entity; and (ii) carrying out a relevant activity.

Applying the ES Law guidance to the most commonly used structures would typically result in the analysis shown in Table 1.


Table 1: ES Law status of each entity

Entity/status under ES Law

Relevant entity

In scope or out of scope

ES Test & how ES Test may be met

Investment fund under the ES Law

An investment fund is not a relevant entity for the purpose of the ES Law and is not required to satisfy the ES Test. The definition of an investment fund is wider than just CIMA registration and includes funds not registered with CIMA

Out of scope


General partner (GP) typically to a master fund

As long as the GP is only acting as the GP of the Exempted Limited Partnership, the GP is not a relevant entity and will not be carrying out a relevant activity and, as such, is outside the scope of the ES Law

Out of scope


SIBL-registered person—fund manager under the

ES Law

A SIBL-registered person is undertaking relevant activity and is therefore subject to ES Law

In scope as of January 2020 (for 2019 out of scope) for 2019 it has not conducted relevant activity (see below)

See below for details

Holding company— under the ES Law

A Cayman Islands holding company both a relevant entity and conducting relevant activity is subject to the ES Law

In scope—subject to reduced ES Test for holding company activity

A relevant entity that is only carrying on a relevant activity that
is the business of a pure equity holding company is subject to a reduced ES Test which is satisfied if the relevant entity confirms that a) it has complied with all applicable filing requirements under the Companies Law (2020 Revision); and (b) it has adequate human resources and adequate premises in the Islands for holding and managing equity participations in other entities *

* This may be met by confirming it is in good standing with a registered office in the Cayman Islands and meets Companies Law requirements for two directors in the Cayman Islands

Table 2: ES Test requirements

Summary of the ES Test requirements


Conduct core income-generating activities (CIGAs)
in the Cayman Islands (the ES Law defines CIGAs as activities that are of central importance to a relevant entity in terms of generating income and that are being carried out in the Cayman Islands)

It is very important for the SIBL-registered person to conduct substantive activities in the Cayman Islands which can range from simply having responsibility for review and approval of investment decisions, to the payment of fees and arranging the audit process to making the investment management decisions, invoicing and operating bank accounts and placing trades

Be “directed and managed” in an appropriate manner in the Cayman Islands in relation to that relevant activity

Directed and managed:

1) Generally, two suitable qualified and experienced director(s) in the Cayman Islands;

2) The retention of responsibility investment decisions (as required);

  1. 3)  An employee who would undertake corporate administrative tasks;
  2. 4)  Operating a bank account to receive management fees and thereafter paying expenses and advisor fees, as well as reviewing and approving other invoices;
  3. 5)  Properly documenting the actions taken by the director(s) in the form of written resolutions and/or quarterly calls with the service providers

Having regard to the level of relevant income derived from the relevant activity carried out in the Cayman Islands:

  1. 1)  Have an adequate amount of operating expenditure incurred in the Cayman Islands;
  2. 2)  Have adequate physical presence (including maintaining a place of business or plant, property and equipment) in the Cayman Islands; and
  3. 3)  Have an adequate number of full-time employees or other personnel with appropriate qualifications in the Cayman Islands

An employee (not one of the directors) who can deal with day-to-day requests and emails.

The SIBL-registered person should not be listed simply as another client of the Cayman Islands service provider, they should actually establish an office presence in the Cayman Islands

There is no prescriptive list set out in the guidance notes—it is up to each entity to determine what is adequate to meet the ES Test, based on their own business activities and requirements


What it means to establish substance

In relation to the Cayman Islands manager who has also applied to become a CIMA SIBL-registered person it is in scope of the ES Law as at the date it becomes a SIBL-registered person.

The provision of discretionary investment management services is a relevant activity. As such, a SIBL-registered person will be a “relevant entity” and is carrying out a “relevant activity” and will have certain notification and reporting obligations. It will also need to have ES in the Cayman Islands.

An exception is if the SIBL-registered person is tax-resident outside the Cayman Islands. Therefore, it is important to determine tax residence as the initial step before proceeding to apply the ES Test to the Cayman Islands entity (Table 2).


The ES requirements should certainly not be a deterrent to the use of a Cayman Islands entity for the efficient investment of investor funds and pooling of assets. In fact, it reinforces the established position that investors should be taxed in their home jurisdiction and not where the fund is based. The Cayman Islands offers the optimum solution for that activity.

Likewise, the activities covered by ES should be taken as an opportunity to demonstrate for entities in scope that real business activities are being conducted in the jurisdiction.

The Cayman Islands is a jurisdiction with the infrastructure to support those activities. This is a developing area and no doubt there will be refinements to this area following the experience of its implementation