Economic substance in the post-pandemic era: the truth of the matter.

As the world moves into a greener and more tax conscious climate in 2022, the OECD has already paved the way for implementation of the Base Erosion and Profit Shifting (“BEPS”) Pillar II and a global 15% corporate tax rate on the profit of multinational enterprises (“MNEs”).

In a press release in late December 2021, disclosing the set of rules which governments are expected to follow and implement as part of BEPS Pillar II, OECD’s director for Tax Policy and Administration Mr. Pascal Saint-Amans stated: “the model rules released today are a significant building-block in the development of a two-pillar solution, converting the foundations of a political agreement reached in October into enforceable rules.” (

The topic of “economic substance” is gaining more and more traction in the new year, as it is developing in economies wounded by the pandemic, influenced by the attention to environmental and social governance requirements, at the backdrop of new realities in the employment sector that adapt to remote work as a permanent feature.

Economic substance is hardly a new concept however, it is certainly one worth re-visiting with fresh eyes.

  1. What does “economic substance” mean?

It’s a tax concept developed in EU and non-EU countries in response to the OECD’s initiative for more transparency in transactions in combating harmful tax practices. It drives attention to the substance of a transaction which should be undertaken for purposes other than tax avoidance.

  • Drive for substance?

The EU and international tax framework applying the OECD standards for transparency, BEPS, FATCA, Common Reporting Standards and country-by-country reporting made it imperative for MNEs to structure their business in a way that adopts economic substance practices. This way corporations can legitimately enjoy taxation benefits offered by double tax treaties; while contributing to the real economies of the jurisdictions in which they choose as headquarters.

  • From concept to application -how do we do this?

Economic substance can take the form of the following:

  1. Real presence with bricks-and-mortar offices at the company’s chosen place of business;
  2. Fully-functioning offices, with all facilities required for the conduct of business;
  3. Persons dedicating their time into actually conducting the business (employees);
  4. Persons qualified and capable of building strategy and directing the management of the business (directors);
  5. Internal handbooks setting out the company’s policies or business development objectives, applied by its directors and employees;
  6. Accounts with banks or other credit or fintech institutions that are managed by the company’s employees or directors;
  7. Depending on the company’s activities at its chosen place of business, local investments realised can be an indicator of substantial economic activity;
  8. Consultants engaged locally, who will be professionally able to advise the directors and employees of the business (legal, accounting, tax advisors);
  9. Proper record-keeping at the company’s chosen place of business (books and records);
  10. Independent committees which will support the board of directors adding to knowledge and experience;
  11. Any step which reflects that a group of qualified, available and capable persons spearhead the activities and presence, at the company’s chosen place of business.
  • Are there any preferred economic substance practices?

The question of whether a company has or applies economic substance, is an objective of one, for the Cypriot and international tax authorities. Ultimately, a review of the company’s business conduct, through its corporate structure, corporate documents, agreements and books and records, reveals the level of substance (if any), applied.

  • Are there any practices that should be avoided when aiming for proper economic substance?

Absolutely. Many practices involving the appointment of nominee persons, rental of over-shared office spaces, over-reliance on powers of attorneys issued to persons abroad or who have no knowledge of expertise in the company’s affairs, are now long outgrown by the Cypriot or international tax authorities.

If a company is willing to invest in its business, it is well-advised to invest in building real presence at its headquarters, for proper taxation of its corporate profits. To achieve this, it will require structuring its activities in a way that reveals the economic substance it adopts. It would ideally:

  Avoid Choose
1 Appointing persons as employees who actually work for someone else and are only just nominees. Persons who will dedicate time and effort promoting the company’s objectives.
2 Renting offices that are really just empty or used by someone else. Real or virtual offices that are actually occupied by the company’s employees, directors and staff.
3 Appointing directors who are unqualified for the position, and really, appointed in too many other companies as well. Persons who are academically and professional qualified and share the company’s vision while having the ability to add value to its business targets.
4 Appointing only directors who are located out of Cyprus. Persons who are qualified, available and located in Cyprus. A Board may consist of directors based abroad, while majority is located in Cyprus.
5 Operating company’s bank accounts from a place other than the company’s chosen place of business and by persons who are not located at the company’s chosen place of business. Bank account opening and operating them from the company’s chosen place of business. There are numerous ways to do this, efficiently and safely, in Cyprus.
6 Issuing general or wide-powers of attorney for business decisions that should be made and executed by the company’s directors or employees. Trust the company’s directors or employees to represent the company in transactions they have been monitoring and are fully informed of, even where closing takes place abroad.
7 Putting up signs with the company’s name on a door, when really, there’s no one behind it. Create proper headquarters entrusting the company’s staff with operating real office space.
8 Creating a landing page for the company on the internet with no noteworthy content or purpose. Engage professionals to build a website for the company which explains its activities and informs about its team. Tax authorities read content too.
9 Using template agreements for multi-million worth transactions. Engage professionals and give instructions including what the real business objectives are, and allow them to draft proper agreements addressing all key legal and tax points between two independent parties.
10 Using devices abroad, with phone numbers maintained in the company’s chosen place of business. Operating devices using phone numbers at the user’s actual location which matches the company’s chosen place of business.
11 Allowing in-house counsel to advise on matters of law that are outside their knowledge, or practice. Engage professionals practicing in the chosen jurisdictions that will give up to date advice which can then be evaluated by the company’s directors before a decision is reached.
12 Investing solely abroad and not at all at the company’s chosen place of business. Evaluate notable investment opportunities in the company’s chosen place of business.
13 Skipping board of directors’ meetings and replacing them with a template resolution or minutes of a meeting. Hold board meetings with physical or virtual presence, which are recorded and which set out the reasoning behind the decisions reached.
14 Skipping shareholders’ meetings and replacing them with a template resolution or minutes of a meeting. Hold shareholder meetings which are recorded and which set out the shareholders’ concerns, business targets, and objectives.
15 Over-simplifying multi-million worth transactions by using instruments that jeopardise the ‘independence’ or legality of the transaction. Engage professionals who can advise on the possibilities and benefits available through listing in MTFs, or creating and operating vehicles such as alternative investment funds in Cyprus and across the EU.

First and foremost, proper review of existing economic substance initiatives taken by the company over the years. An evaluation of whether these initiatives require an update is a crucial exercise for directors at the helm. Proper advice from tax professionals is paramount. Choosing the right professional should entail a background check of advice given, a track record of clients’ applying that advice. Even better, if professionals have experience defending challenges to companies’ tax residency.

Above all, it is important that businesses understand the evolving economic climate. It is no longer proper or sustainable to ‘disguise’ harmful tax practices. Economies have really moved on to more tax conscious practices (our 2014 article on tax consciousness still relevant this day can be found here Governments are more accountable, and tax authorities more educated. The new generation of uber-wealthy entrepreneurs is younger, raised in the digital age with a different set of values, and a lot more demanding.

For more information on the ways we can assist in building an appropriate level of economic substance for your corporate structure, feel free to contact Stella Koukounis or Chara Paraskeva at [email protected]

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