Substance, or formally the principle of substance over form, means the principle of the economic reality of a company’s situation.
This means that a company formed according to the laws of country A, but with no genuine relation with that country and thus the economic reality being elsewhere, lacks substance.
Why is substance important?
The place of effective management and substance are the main factors that tax authorities use to decide in which country the profits or a company or a group of companies are subject to taxes.
What means substance in practise?
The principle of substance over form was introduced to prevent abuse of companies, to prevent the use of mailbox companies, which don’t have a genuine relation with the country of registration. Such mailbox companies where often used in the passed to move profits to other countries, while there was no real substance in the company.
International business, outsourcing is still very well possible and even moving companies for tax purposes is perfectly legitimate, however a corporate structure shouldn’t be merely artificial to avoid taxes. A corporate structure should serve a rational purpose and should contribute to economic reality. Serious companies with genuine intentions will therefore have no problem complying with the substance requirements.
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