In which countries are companies required to have a substance?

Each year, opening a bank account or proving tax residency becomes increasingly difficult, especially for companies without a physical office or employees. EU and OECD tax authorities are placing growing scrutiny on businesses that exist only “on paper.” The absence of a real office, local staff, or management activity can lead to the loss of tax benefits, account closures, and allegations of tax avoidance. As global rules tighten, maintaining real economic substance has shifted from a best practice to a legal necessity. In this article, we explain what substance means, why it matters, and which countries have already introduced mandatory requirements.

What is substance and why is it important?

Companies registered in jurisdictions with favorable tax regimes are increasingly required to demonstrate their actual economic presence, commonly referred to as economic substance. Substance means having real business activity in the country of incorporation. This may include a physical office, employees, a local director, in-country management decisions, and maintaining local accounting records and corporate documents.

Unlike “paper” companies that exist only formally, structures with substance prove that they are conducting genuine commercial activity.

Where and why is substance assessed?

Substance requirements have become especially relevant following the adoption of international regulatory frameworks, such as:

• OECD BEPS (Base Erosion and Profit Shifting): targets artificial profit shifting and tax base erosion;
• CFC (Controlled Foreign Company) rules: apply to foreign entities lacking real operations;
• DAC6 (EU Directive on Mandatory Disclosure): requires reporting of aggressive tax planning schemes;
• CRS and FATF standards: mandate countries to identify beneficial owners and assess the economic rationale behind transactions.

Substance is a key requirement for recognizing a company as a tax resident and granting access to Double Taxation Treaties (DTTs).

Consequences of lacking substance

If a tax authority or bank deems a company to be a shell entity, this may lead to:

1. Loss of tax benefits;
2. Denial or closure of a bank account;
3. Automatic taxation of profits in the jurisdiction of the ultimate beneficial owner;
4. Fines or denial of VAT registration;
5. Ineligibility to participate in international transactions or holding structures.

In recent years, tax authorities in the Netherlands, Luxembourg, and Ireland have increasingly reviewed the residency status of companies that failed to demonstrate substance. Under EU and OECD pressure, these rules have been significantly tightened.

How do the tax authorities verify the existence of substance?

Companies claiming tax residency in a foreign jurisdiction must be prepared to prove it in practice. Tax authorities and international regulators increasingly request evidence that the business is genuinely operated at the declared address, not just on paper.

Who conducts substance checks and when?

Substance checks may be triggered by:

1. Tax authorities when filing tax returns or applying for Double Tax Treaty (DTT) benefits;
2. Banks when opening an account or receiving large payments;
3. EU competent authorities under automatic exchange of tax information frameworks (e.g., CRS, DAC6).

For example, the Dutch Belastingdienst requires companies applying DTT benefits to demonstrate real economic activity within the Netherlands and provide supporting documents.

What types of substance evidence are typically required?

The following documents are most commonly requested:

1. Minutes of board meetings with signed resolutions;
2. Office lease agreements and utility payment receipts;
3. Contracts with local suppliers and clients;
4. Employment agreements with local staff and payroll data;
5. Proof of local tax payments and registration with social insurance authorities.

What is considered insufficient and the risks involved

Common compliance errors include:

1. Board decisions being made entirely outside the country of incorporation;
2. No actual office or employees on the ground;
3. Use of a virtual address without physical presence;
4. Day-to-day management carried out from another jurisdiction.

If substance is found to be insufficient, the company may be denied access to DTT benefits, taxed in the country of effective management, or even listed in blacklists or sanction registers.

Which countries require substance?

A number of countries with favorable tax regimes have introduced clear requirements for companies to demonstrate economic substance. This comes in response to growing international pressure, particularly from the EU, OECD, and global banks.

Netherlands

The Netherlands has traditionally been one of the most attractive jurisdictions for international holding companies. However, since 2020, the Dutch Tax Authority (Belastingdienst) has revised the conditions for applying double tax treaties.

Requirements:

1. At least one resident director making decisions within the Netherlands;
2. Lease of a physical office (virtual offices are not accepted);
3. Actual business activity: accounting, reporting, and correspondence must take place in the Netherlands;
4. Sufficient financial resources and staff proportional to the scale of business.

Companies lacking these elements may be denied treaty benefits and even fined up to €20,750.

Luxembourg

Due to increased scrutiny from the EU, Luxembourg has tightened the criteria for determining tax residency.

Requirements:

1. Presence of local management (director and secretary);
2. Employment contracts with staff or contractors performing functions within the country;
3. Board meetings must be held in Luxembourg;
4. Documentary evidence that decisions are made within Luxembourg.

In 2021, the Luxembourg tax authorities began denying DTT benefits to structures that fail to meet substance criteria.

Ireland

Ireland strengthened substance control following pressure from the EU and OECD over its low effective tax rate.

Requirements:

1. Presence of Irish directors and board meetings held within the country;
2. Leased or owned office space;
3. Actual management of the company from within Ireland;
4. Compliance with CFC rules and monitoring of controlled foreign structures.

Ireland requires substance for companies to be considered residents and qualify for the 12.5% preferential tax rate. Companies without substance may face a 25% rate and loss of treaty benefits.

Cyprus

As of 2022, Cyprus adopted a stricter approach to substance in response to pressure from the European Commission and efforts to eliminate "letterbox companies."

Requirements:

1. Physical presence in the country — office, employees, and local contracts;
2. Local director registered as a tax resident;
3. Active business operations and payment of taxes;
4. Regular submission of tax reports and proof of actual activity.

Without proven substance, a company risks losing its tax residency status and being denied bank account opening.

How to ensure the necessary level of substance?

To ensure a company is not classified as a shell company, it is essential not just to appear in a registry, but to demonstrate actual signs of economic activity in the country of incorporation:

1. Physical office — not a virtual address or coworking space, but a proper premises available for inspections and confirmed by a lease agreement;
2. Hiring employees — at least one employee formally registered under local law (or long-term contracts with contractors);
3. Local director — preferably with local tax residency and real involvement in management;
4. Regular management decisions — board meetings, signings, and reporting carried out locally;
5. Accounting and corporate records — must be maintained in the country of incorporation.

In many jurisdictions, having only one or two of these elements is no longer enough — a full combination is required.

Tax authorities, banks, and compliance teams verify substance when opening bank accounts (especially in the EU and UK), conducting CFC audits, applying for tax residency or treaty benefits, or during BEPS and transfer pricing reviews.

Acceptable evidence may include: office lease agreements, employment contracts and payslips, board meeting minutes signed on-site, invoices issued from a local IP address or location.

Practical recommendations

1. Assess the risks when choosing a jurisdiction. Substance is mandatory in most European countries with favorable tax regimes.
2. Do not rely on nominee services. A nominee director with no authority, a virtual office, and accounting done elsewhere offer weak protection during checks.
3. Document all actions. Management decisions, business correspondence, and contracts must originate from within the country of incorporation.
4. Engage regulatory and tax advisors. They will help structure your operations to meet substance requirements without the risk of being classified as a shell company.

How will Key2Law help your company meet substance requirements?

Without an adequate level of substance, companies risk losing tax benefits, facing account closures, and coming under scrutiny from regulators. The Key2Law team provides full regulatory support to help businesses establish and demonstrate substance in jurisdictions with increased regulatory oversight.

We can help you:

1. Conduct a full audit of your current structure: identify risks related to insufficient substance;
2. Develop and implement elements of real economic presence: including office lease arrangements, staff hiring, and appointment of a local director;
3. Prepare compliance and tax documentation confirming active business operations in the country of incorporation;
4. Support you during audits and reviews by tax authorities, banks, or compliance teams;
5. Reorganize your corporate structure if the existing setup no longer meets international requirements.

We work with both small businesses and international holding groups, providing practical and legally sound solutions in line with BEPS, CFC, AML, and FATF standards. If you want to prepare for a potential audit or are already facing regulatory risks, contact Key2Law. We will protect your structure and ensure stability for your business.