The international tax environment has seen momentous changes in the last few years. I could categorise these changes into two – transparency and substance.

The push for further transparency started by the US with the introduction of FATCA, whereby the rest of the world soon followed with the introduction of the Common Reporting Standards (CRS). Transparency today is the norm with the introduction of directives such as the Directives on Administrative Cooperation (DAC) at EU level, Beneficial Ownership registers and so much more.

This article will focus on the issue of substance and how this term became so important when it comes to corporate structuring in such a short period of time. Substance can be further sub-divided into two – the importance of the place of effective management (‘POEM’) and, possibly more important is the issue of where a company’s operations are carried out. These two matters help us understand in which jurisdiction a company should be taxed. The POEM (typically) determines the company’s tax residence and therefore the jurisdiction which will have primary taxing rights over the income of the company. This is also subject to the changes brought about by the signing of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS, some years ago. The issue of where the company’s activities are carried out, ultimately determines whether the company has a Permanent Establishment (PE) in another jurisdiction from the country where it is tax resident. If a company which is established and has its POEM in Rwanda doesn’t carry out any of its core operations from Rwanda, then it must have a PE in another jurisdiction.

In the last couple of years, we have seen several countries introduce minimum effective substance requirements. Other countries might not have specific legislation about minimum substance but have an implied requirement as a result of how tax authorities look at foreign entities owned by residents of that specific jurisdiction.

At the end of 2021, the EU released a draft Directive proposing measures to prevent the misuse of shell entities for tax purposes. This proposed directive is aimed at ensuring a minimum level of substance for companies which operate within the Union.

This latest proposal by the EU, which followed a number of similar proposals in various countries, is the latest piece of legislation which establishes a minimum level of substance by companies in the specific jurisdiction.

If one looks in detail at the OECD BEPS project, which was also followed by the European Union publishing the Anti-Tax Avoidance Directive, most of the proposals, whether relating to specific transactions, intangibles, or structuring, gave significant importance of the substance of the transaction or of the particular structure.

Whether as a result of more legislation or as a result of the direction which international tax planning is taking, the matter of substance will continue to become more important, and the cost of international structuring will continue to increase as companies will face these minimum substance requirement, written or implied.

The writer is a co-founding partner of Seed, an international research-driven advisory firm with offices in Europe and the Middle East.

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nicky@seedconsultancy.com