LMKG Chartered Accountants

Economic Substance Test

The Economic Substance Test is a crucial evaluation employed to determine whether a business entity complies with the Economic Substance Regulations (ESR) in a given jurisdiction. Key elements of the test typically include:

  • Relevant Activities: Identification of activities subject to the Economic Substance Regulations within the jurisdiction, such as banking, insurance, and intellectual property.

  • Substance Requirements: Assessment of whether the business conducts substantial core income-generating activities locally, meeting criteria like having an adequate workforce and physical presence.

  • Compliance Measures: Examination of steps taken by the entity to ensure compliance with the specific requirements outlined in the ESR, including notification and reporting.

  • Periodic Review: Regular assessment of the business’s activities to ensure ongoing compliance with any changes in Economic Substance Regulations.

  • Documentation Verification: Verification of documentation supporting the business’s claims of economic substance, including details on employees, assets, and decision-making processes.

  • Risk Mitigation: Identification and implementation of strategies to mitigate any potential risks associated with non-compliance with the Economic Substance Regulations.

ESR is a regulatory framework implemented by various jurisdictions to ensure that businesses engaged in specific activities have substantial operations locally. Key features include:

  • Scope: Applicable to entities in specified sectors like banking, insurance, and fund management.

  • Substance Requirements: Entities must conduct core activities locally, meeting criteria like having qualified employees and physical assets.

  • Notification and Reporting: Mandates periodic reporting and notification of relevant authorities about activities.

  • Non-Compliance Consequences: Penalties, reputational damage, and potential removal from the register for non-compliance.

  • Review and Amendments: Ongoing reviews and potential amendments to align with international standards.

  • Expert Consultation: Businesses benefit from expert guidance to understand requirements, assess activities, and ensure compliance with ESR.

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