Having substance in international tax planning is critical because it helps to ensure that a company is not simply taking advantage of tax loopholes but is actually conducting real business operations in the countries where it operates. Substance refers to the tangible elements of a company, such as its employees, office space, and equipment, that demonstrate that it is a genuine, operating entity rather than a shell company designed solely to minimize taxes.
Substance can take various forms, including having a physical office, employees, and assets, as well as conducting real business activities such as generating revenue, incurring expenses, and engaging in negotiations with customers and suppliers. The level of substance required can depend on the specific country and the type of business activity being conducted.
Different countries may apply different rules and standards when it comes to substance, and it is important for companies to understand the requirements in each jurisdiction where they operate. For example, in some countries, it may be sufficient to have a virtual office and a few employees, while in others, a company may need to have a significant physical presence with many employees and significant assets.
In the right way, creating substance means running real business operations and making sure that the company has the employees, office space, and equipment it needs to support those operations. This can mean making investments in the local infrastructure, like opening a real office, hiring local workers, and buying equipment.
Fraud can occur when a company has no substance, as it may be engaged in tax evasion or other illegal activities. For instance, a “shell company” that doesn’t do any real business but is used to move money through places with lower taxes can be seen as fraudulent. Companies must ensure that they have substance in order to avoid these types of issues and to comply with the tax laws in the countries where they operate.
Some examples of how to create substance in a proper way.
- Physical presence: Establishing a physical office in the country where a company operates is one way to demonstrate substance. This could include having a physical location where employees work, conduct business, and interact with customers and suppliers.
- Local employees: Hiring local employees who have expertise in the industry or market and who can conduct business on behalf of the company can help to establish substance.
- Equipment and resources: Having the necessary equipment, resources, and infrastructure in place to support business operations is another way to demonstrate substance. This could include having necessary technology and equipment, as well as sufficient working capital to support ongoing business activities.
- Business activities: Conducting real business activities, such as generating revenue, incurring expenses, and engaging in negotiations with customers and suppliers, is another way to establish substance. It’s important to have documentation to support these activities, such as contracts, invoices, and other financial records.
- Economic substance: Demonstrating that a company has economic substance, or that it has the ability to generate profits through its own activities, is another way to establish substance. This could involve demonstrating that the company has its own employees, management, and expertise, and that it is not simply relying on contracts or arrangements with other entities to generate profits.
It’s important to keep in mind that different countries may have different requirements when it comes to substance, and companies should always consult with local tax and legal advisors to understand the specific requirements in each jurisdiction where they operate.
