Substance - Keep it real!

comment - 25 September 2012

Substance - Keep it real!

You can never have enough tax or regulatory substance or so the argument goes. This, however, is to misunderstand the point. To more effectively mitigate risk, promoters should focus on constructing something real with clear commercial logic. This will not only save a lot of time and money, but may also avoid accusations of artificiality.

It is generally accepted that businesses have the right to arrange their affairs in a way that makes most commercial sense.

Given the political implications though of establishing foreign vehicles that benefit from better operating environments elsewhere, authorities have sought to minimise any ‘loss’ of business by enacting special anti-abuse provisions and adopting restrictive practices when interpreting domestic laws. These anti-abuse provisions and practices often require that the foreign vehicle demonstrate real substance (as opposed to being simple postal addresses) in order to be recognised as genuine.

Precise substance requirements depend on whether they are regulatory or fiscal in nature (and if fiscal, whether they relate to direct or indirect taxes), but they all relate to demonstrating the existence of a real business presence in a foreign country. A real business presence does not consist though of simply insourcing the same-old administrative processes (as this adds nothing save cost), but rather in creating a real commercial enterprise. The enterprise itself should be value adding by nature and carried-out by those with appropriate experience, authority and discretion to do so. It should not be the disguised proxy of the promoter.

Unfortunately however, ‘demonstrating’ substance is often interpreted in a tick-the-box manner that lends towards artificiality. This is likely to be encouraged abroad, if anything, as it is used to promote local employment and service provision. Paradoxically, this combination of factors can result in promoters constructing exaggerated and inefficient business models that by nature undermine the existence of any credible commercial enterprise in the relevant jurisdiction. Taken too far, this approach could be construed as misrepresentative in an increasingly sensitive environment.

A properly considered and balanced approach should always be taken therefore to establishing foreign vehicles and a tick-the-box approach to substance should be avoided. These vehicles should carry on business independently in a way that is complimentary, efficient and value adding and does not misrepresent the commercial truth.

Aztec Group has developed an operating platform to facilitate business in each jurisdiction in an efficient, scaleable and accountable manner. This platform is totally flexible and includes all the components necessary to facilitate investment enabling our clients to focus on those core value adding processes that they are measured on. It is the valid performance of these processes that determines real substance.

previous comment / Edward Moore

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