The Marshall Islands has adopted the Economic Substance Regulations ("ESRs") in relation to the compliance of legal entities which are tax residents or centrally managed and controlled in the Republic of Marshall Islands in order to ensure that profits are taxed where economic activity and value creation occurs.
Which entities are required to have economic substance?
The ESRs applies to the following entities:
- non-resident domestic entities (NRDEs) which are tax residents in the Republic of Marshall Islands; and
- foreign maritime entities (FMEs) centrally managed and controlled in the Republic
What is considered to be "relevant activities":
Entities that are tax resident in a jurisdiction outside of the Republic of Marshall Islands do not need to comply with the economic substance requirements but, satisfactory evidence of their tax residency must be provided.
What is considered sufficient objective evidence to show tax residency in another jurisdiction outside of the Republic of Marshall Islands?
An entity which claims to have tax residency in a jurisdiction outside of the Republic of Marshall Islands, must provide satisfactory evidence to the registrar in order to be deemed as tax resident, underlying in regime other than the applicable in the Republic of Marshall Islands.
The registrar will consider as satisfactory evidence the following documents:
- tax identification number
- tax residence certificate
- assessment or payment of a tax liability, or other proof that the entity is subject to the tax regime of another jurisdiction.
* A disregarded entity for the United States income tax purposes or other similarly treated entities in other jurisdictions may produce as objective evidence a signed statement under penalty of perjury from an external tax advisor or "C" level officer stating that all of that entity's income has been included on the corporate tax return of the parent company.
What activities are covered?
Relevant entities carrying on any "relevant activities" will be required to satisfy an economic substance test.
Relevant activities are limited to the following types of business activity:
- Distribution and service center business
- Financing and leasing business
- Fund management business
- Headquarters business
- Holding company business
- Intellectual property business
- Shipping business
- Banking business (Although banking business is listed as relevant activity, the Republic of Marshall Islands Associations Law prohibits all Non-Resident Domestic Entities and Foreign Maritime Entities from carrying on the business of banking)
- Insurance business (Although insurance business is listed as relevant activity, the Republic of Marshall Islands Associations Law prohibits all Non-Resident Domestic Entities and Foreign Maritime Entities from granting policies of insurance or assuming insurance risks).
*For more details of the "relevant activities" please contact us at email@example.com
When filing period starts?
Compliance with the ESRs is required for financial periods commencing on or after 1 January 2019, with reporting requirements commencing in July 2020.
However, as per the ERSs all Non-Resident Domestic Entities and Foreign Maritime Entities will need to file the Economic Substance Declaration to the Registrar. The reporting period will open on the annual anniversary date of the Non-Resident Domestic Entities or Foreign Maritime Entities and Economic Substance Declaration must be made within twelve (12) months thereafter. For newly formed entities, the reporting period will open on their first anniversary date. All Non-Resident Domestic Entities and Foreign Maritime Entities must report whether they are a relevant entity and, if so, whether they have derived income from a relevant activity.
Additional reporting requirements will apply to Non-Resident Domestic Entities and Foreign Maritime Entities determined to be "relevant entities" engaged in a "relevant activity".
Each relevant entity must prepare and file the following information for the relevant financial period:
- business type (to identify the type of mobile activity)
- amount and type (e.g: rents, royalties, dividends, sales, services) of gross income
- amount and type of expenses and assets
- number of employees, including the number of full-time employees
- information showing that it has conducted relevant core income-generating activities in the RMI.
*All reporting will be done through a dedicated secure web portal which is being developed by the Registrar.
What if an entity only performs a relevant activity as part of its business?
For each financial period in which an entity derives income from a relevant activity, it must have economic substance in the Republic of Marshall Islands only in relation to the relevant activity.
What if the entity does not derive income from the relevant activity?
If no income is derived from a relevant activity or no relevant activity is performed, then the entity is not required to have economic substance with regard to that portion of its business for that financial period. However, the relevant entity will still be required to meet any reporting obligations under the ESRs, such as submitting the annual report to the Registrar.
How would an entity meet the economic substance test?
An entity carrying on relevant activity in order to meet the three-part economic substance test must:
- be directed and managed in the Republic of Marshall Islands in relation to that relevant activity
1. Directed and managed test: The directed and managed test requires that the relevant activity or activities be directed and managed from the Republic of Marshall Islands. This requires board meetings to be held and attended by a quorum of persons physically present in the Republic of Marshall Islands with adequate frequency, considering the nature of the relevant activity and its importance to the overall business of the Non-Resident Domestic Entities or Foreign Maritime Entities. What constitutes an adequate frequency of meetings in the Republic of Marshall Islands will be dependent on the individual circumstances and facts of the relevant entity and its relevant activities. It is incumbent upon the governing body to make the determination in good faith with regard to whether there is an adequate frequency of such meetings. The minutes of relevant governing body meetings and appropriate records should be kept in the Republic of Marshall Islands. This may be satisfied by recording such meeting minutes and other records with the Registered Agent.
- have an adequate number of employees
- have an adequate physical presence
2. Adequate employees and presence test. The determination of what is an adequate number of employees, physical presence, and expenditure will be determined based on the level of relevant activity carried out in the Republic of Marshall Islands.
- have an adequate expenditure in the Republic of Marshall Islands
- carry out Core Income Generating Activities in the Republic of Marshall Islands ("CIGA")
3. CIGA test. CIGA are the activities of central importance to the relevant entity in terms of generating income of the entity which, if carried out by relevant entity in respect of a relevant activity, must be carried out in the Republic of Marshall Islands.
May a third party perform the CIGA on behalf of the relevant entity?
A relevant entity satisfies the economic substance test if another person conducts the CIGA in relation to the relevant activity so long as:
- the relevant entity is able to monitor and control the CIGA conducted by another person
- the CIGA are carried out in the Republic of Marshall Islands
- the economic substance of the other person will not be counted multiple times by multiple relevant entities when evidencing their own substance in the Republic of Marshall Islands.
The ESRs do not prohibit the use of service providers, other entities within the relevant entity's group of companies, or other third parties to perform all or part of an activity in the Republic of Marshall Islands. The relevant entity must be able to monitor and control the delegated activities and demonstrate it maintains adequate supervision of delegated activities. The resources of the service provider will be taken into consideration when determining if the test of the ESRs is met. The resources should be sufficient to prevent double counting of services provided to more than one relevant entity
Does compliance with the ESRs create a resident domestic entity?
A Non-Resident Domestic Entities or Foreign Maritime Entities does not become a resident domestic entity as defined in the Associations Law merely by complying with the requirements of the ESRs. In no event, including claiming tax residency status or obtaining an Employer Identification Number (EIN) in the Republic of Marshall Islands, will a Non-Resident Domestic Entities be construed to be a resident domestic entity.
Do pure equity holding companies have a lower threshold to show economic substance?
Yes, pure equity holding companies may satisfy the economic substance test by compliance with all applicable filing requirements of the Business Corporations Act, Revised Partnership Act, Limited Partnership Act, or Limited Liability Companies Act, including the payment of all fees. Additionally, a pure equity holding company must have adequate human resources and premises in the Republic of Marshall Islands for holding and managing participations in other entities. "Adequate" will be determined based on the circumstances of each pure equity holding company. However, a pure equity holding company may be able to satisfy these reduced substance requirements by maintaining a registered agent in the RMI in accordance with the Associations Law. A pure equity holding company is not required to be directed and managed in the Republic of Marshall Islands.
What are the heightened requirements for relevant entities engaged in high risk intellectual property (IP) business?
Relevant entities engaged in the business of high risk IP must be able to demonstrate that a high degree of control over the development, exploitation, maintenance, enhancement, and protection of the intangible asset is, and historically has been, exercised by full time highly skilled employees that permanently reside and perform their core activities within the Republic of Marshall Islands.
"High risk IP business" means an IP business carried on by an entity that:
- did not create the IP in an IP asset that it holds for the purposes of its business
- acquired the IP asset: from an entity in the same Group or in consideration for funding research and development by another person situated in a country or territory other than the Republic of Marshall Islands
- Licenses the IP asset to one or more entities in the same Group or otherwise generates income from the asset in consequence of activities (such as facilitating sale agreements) performed by entities in the same Group or an entity that does not carry out the core income-generating activities in the Republic of Marshall Islands as specified in the ESRs.
What to do now?
Where a legal entity is subject to the economic substance regime, it will need to demonstrate that it adheres to the Republic of Marshall Islands Law. Full details on the requirements for compliance is available at www.register-iri.com/corporate/esr. In the interim, the first step is to consider whether a legal entity is a relevant entity or whether it has its tax resident in another jurisdiction. If it is not a tax resident in another jurisdiction, the next step is to consider if it is carrying on a "relevant activity". If not, appropriate action, which will depend on the particular facts and circumstances, needs to be taken.
Originally published 21 July 2020.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.