Substance-Vereisten
Substance Requirements
Substance requirements ensure that entities claiming treaty benefits, holding exemptions, or other favourable tax treatment have genuine economic presence in their jurisdiction of residence. Insufficient substance is the most common basis for challenging international tax structures.
What Constitutes Substance?
Substance is not defined by a single factor but assessed holistically based on the entity's activities, governance, personnel, and physical presence. Tax authorities examine whether the entity has the capacity to perform the functions attributed to it and to bear the risks it assumes.
The concept is relevant across multiple areas of international tax: treaty benefit entitlement (beneficial ownership, limitation on benefits), CFC exemptions, transfer pricing (functional analysis), anti-abuse provisions (GAAR, PPT), and state aid assessments.
Board and Management
Effective management and control must reside in the jurisdiction where the entity claims residence. Key indicators include:
Board Composition
A majority of directors should be resident in the jurisdiction. Directors must have genuine expertise and authority — nominee or rubber-stamp directors undermine substance.
Board Meetings
Regular board meetings held in the jurisdiction with documented agendas, minutes, and evidence of substantive decision-making (not pro-forma approvals).
Strategic Decisions
Key business decisions — investments, financing, contracts, risk management — must be made locally, not dictated by the parent company or head office.
Personnel Requirements
The entity must employ qualified personnel who have the expertise to perform the functions generating its income. Outsourcing core functions to the parent or to management companies weakens the substance position.
Qualified Employees
Staff with relevant professional qualifications (finance, legal, technical) who are locally employed and compensated at market rates.
Decision-Making Authority
Employees must have the authority to execute transactions and manage risks — not merely implement instructions from abroad.
Proportionality
The number and seniority of employees should be commensurate with the scale and nature of the entity's operations and the risks it assumes.
Premises
Physical office space in the jurisdiction serves as evidence of genuine operational presence. Virtual offices or registered-agent addresses are generally insufficient. The premises should be:
Dedicated Space
A permanent, dedicated office (not a shared desk or mailbox) with the entity's own signage, IT infrastructure, and telecommunications.
Operational Use
The office must be used for day-to-day business activities — staff should be physically present and reachable during normal business hours.
Economic Activity Test
The ATAD CFC rules provide an exemption for entities that carry on "substantive economic activity supported by staff, equipment, assets, and premises." This test is also referenced in the EU's UNSHELL Directive proposal (Directive on shell entities) which introduces minimum substance indicators:
Own Premises
The entity has premises available for its exclusive use in the jurisdiction.
Active Bank Account
The entity has at least one own active bank account in the EU.
Qualified Directors / Employees
At least one director is resident in the jurisdiction, or a sufficient number of employees with relevant qualifications are resident and active in decision-making.
EU Holding Structures
Holding, IP, and financing structures in the EU face heightened substance scrutiny. Each type of structure has specific considerations:
Holding Companies
Must demonstrate active management of participations — attending subsidiary board meetings, making investment decisions, and performing shareholder functions. Pure passive holding without governance involvement is a red flag.
IP Companies
Must have employees with the technical capability to manage, develop, and exploit the IP. DEMPE functions (development, enhancement, maintenance, protection, exploitation) should be performed locally.
Financing Companies
Must demonstrate independent treasury management, credit risk assessment, and decision-making authority over lending terms. Capital adequacy and genuine risk-bearing capacity are critical.
Important
Substance requirements are assessed holistically — no single factor is determinative, but the absence of qualified personnel is a significant red flag.