Substance requirements: what the EU, UK, and Switzerland actually mean

Why the substance debate has changed character

For two decades, substance requirements in international tax were largely a matter of self-assessment and audit risk management. A family holding company in Luxembourg or a Swiss finance subsidiary could, in many cases, satisfy local requirements with a registered address, a service provider, and a nominal director. The OECD's Base Erosion and Profit Shifting project changed the normative framework from 2013 onwards, but enforcement remained patchy and jurisdiction-specific. That period is ending. Three converging regulatory developments — the EU's proposed Unshell Directive (formally ATAD3), the maturation of UK economic substance doctrine, and the tightening of Swiss cantonal administrative practice — have transformed substance from a compliance checklist into a live enforcement variable. For families with multi-jurisdictional holding structures, the practical consequence is that entities which were passable under 2018 standards may now be materially non-compliant, not because the law changed, but because the threshold for what constitutes genuine substance has been revised upward by regulators and courts.

ATAD3 and the Unshell Directive: the EU's structural intervention

The European Commission published its proposal for a Directive laying down rules to prevent the misuse of shell entities for tax purposes — commonly called ATAD3 or the Unshell Directive — in December 2021, following the broader Anti-Tax Avoidance Directive lineage of ATAD1 (2016) and ATAD2 (2017). The proposal has been in qualified majority negotiation since then, with the Parliament's version diverging from the Council's on several critical points. As of early 2025, a revised compromise text is under discussion, but the core architecture is stable enough to plan around. Its significance for family offices is structural: unlike previous EU instruments that identified avoidance and then applied consequences, ATAD3 creates a gating test — the shell indicator screen — that, if failed, results in automatic denial of treaty benefits, parent-subsidiary directive access, and interest and royalty directive benefits. The denial operates at the source state level, meaning a Luxembourg holding entity classified as a shell would lose withholding tax exemptions on dividends from German or French operating subsidiaries before any litigation is required.

The three-tier gateway and what fails it

ATAD3's operative mechanism works through a sequential test. First, a relevance threshold: entities with more than 75% of revenues in the prior two years qualifying as 'relevant income' (broadly, passive income including dividends, interest, royalties, and income from immovable property) and that are cross-border in nature enter the screen. Second, a managed and administered test: entities that outsource their day-to-day operations and decision-making in full are presumed to lack substance. Third, an indicators test: the entity must demonstrate at least two of three indicators — own bank account in the EU, at least one own and active full-time equivalent director or employee who is resident in the member state of the entity, or premises in the member state. Crucially, these are minimum indicators, and the proposed directive permits member states to set higher bars. An entity that meets the minimum indicators can still be rebutted as a shell if the tax authority produces countervailing evidence. For family office structures, the relevance threshold is almost universally triggered: a Luxembourg SOPARFI or a Dutch cooperative holding passive equity stakes and receiving dividend flows will satisfy the 75% threshold without difficulty. The battle, therefore, is fought at the indicator and rebuttal stage.

The current Council compromise text has softened some provisions relative to the original Commission proposal. Notably, it has narrowed the automatic exchange of information obligations between member states — originally the directive would have required competent authorities to share shell classifications automatically — and it has extended the look-back period for the relevance test from two to three years. The practical implication is that families restructuring now should treat the three-year window as the operative planning horizon. An entity reconfigured in 2025 should be able to demonstrate substantive compliance by a 2028 reference date if the directive enters into force on broadly expected timelines. Several tax advisors in Amsterdam and Luxembourg have privately indicated that their clients are front-running the directive by adding genuine decision-making capacity now, rather than waiting for the final text.

ATAD3 does not primarily penalise aggressive tax planning. It penalises structural inertia: the family that built a holding layer for a legitimate historical reason and then never revisited whether that entity still does anything.

Interaction with the EU minimum tax and BEPS Pillar Two

The EU's implementation of the OECD's GloBE rules through the Minimum Tax Directive (Council Directive 2022/2523) introduces a parallel and reinforcing substance mechanism. The Substance-Based Income Exclusion carve-out allows a reduction in GloBE income proportionate to 5% of the carrying value of tangible assets and 5% of payroll costs attributable to the jurisdiction. For a pure holding entity with minimal payroll and no tangible assets beyond an equity stake, the SBIE carve-out is negligible — meaning the entity's effective tax rate calculation is exposed in full to the 15% global minimum. For families whose structures sit below the €750 million consolidated revenue threshold that triggers GloBE directly, this is currently academic. But the SBIE logic has already influenced how advisors think about substance: the question is no longer purely 'can we defend this to the local tax authority' but also 'does this entity generate real economic return justified by real economic inputs.' Those are different tests, and conflating them is a common error in family office advisory practice.

UK economic substance: from offshore regime to mainland posture

The UK's formal economic substance rules originated not in the UK mainland but in the Crown Dependencies. Following OECD Forum on Harmful Tax Practices pressure, the British Virgin Islands, Cayman Islands, Bermuda, Jersey, Guernsey, and the Isle of Man all enacted economic substance legislation in 2018 and 2019, modelled on a common template developed in coordination with the UK. The International Tax Enforcement (Disclosable Arrangements) Regulations 2017 and subsequent HMRC guidance made clear that the mainland HMRC was watching the offshore compliance story closely. Since 2019, HMRC's Large Business and High Net Worth units have materially intensified transfer pricing and controlled foreign company inquiries in which substance is a central factual issue. The statutory framework has not changed dramatically, but the inquiry posture has.

What HMRC actually looks for in practice

HMRC's published guidance on transfer pricing and the taxation of multinationals, found in the International Manual (INTM), makes the core test explicit: does the entity perform the functions, own the assets, and bear the risks that its claimed profit allocation implies? This is the OECD's authorised approach applied domestically. In the family office context, the most commonly challenged structures are: UK-resident families holding non-UK investment vehicles that claim non-UK management; UK-connected trusts with offshore trustees who exercise nominal rather than genuine discretion; and operating businesses with offshore holding or finance companies that claim arm's-length margins on intra-group services or financing. HMRC's Connect data analytics system, which cross-references self-assessment returns, Companies House filings, Land Registry data, and information exchanged under CRS and FATCA, has significantly lowered the cost to HMRC of identifying mismatches between reported substance and observable economic reality.

A 2023 HMRC annual report noted that the department's compliance yield from wealthy individuals and their associated entities exceeded £5 billion for the year, with offshore structures constituting a disproportionate share of open enquiries in the High Net Worth Unit (threshold: £10 million or more in assets) and the Ultra High Net Worth Unit (£100 million or more). While HMRC does not break out substance-specific yields, advisors in London's private client tax community report that the proportion of enquiries touching on entity substance and management and control questions has increased materially since 2020. Post-Brexit, the UK is no longer bound by the EU's state aid constraints or the parent-subsidiary directive, meaning HMRC has more legislative freedom to deny treaty benefits unilaterally when it concludes an entity lacks genuine residence — a power it exercises under the UK's domestic anti-avoidance provisions and the general anti-abuse rule introduced by the Finance Act 2013.

The management and control test in family structures

For families specifically, the UK management and control test — which determines corporate residence under Section 5 of the Corporation Tax Act 2009 — is the sharpest instrument. A company is resident in the UK if it is incorporated there or if its central management and control is exercised in the UK. The converse risk for offshore structures is that a nominally Cayman or BVI entity whose investment decisions are made by a UK-resident family principal is, in HMRC's analysis, UK-resident and subject to corporation tax. The test is fact-intensive: it looks at where board meetings are held, who has real authority over major decisions, and whether offshore directors exercise independent judgment. The standard that emerged from Wood v Holden [2006] EWCA Civ 26 requires that directors genuinely superintend and control the company, not merely rubber-stamp decisions made elsewhere. Family offices should conduct periodic management and control reviews — at minimum every three years, and whenever a key family member changes residence — and document the results in a formal memorandum.

Swiss substance practice: cantonal pragmatism with federal teeth

Switzerland's approach to substance is partly federal — anchored in the 2019 Federal Act on Tax Reform and AHV Financing (TRAF), which abolished the preferential cantonal holding and domicile company regimes that had been on the OECD's harmful tax practices list — and partly cantonal, reflecting the administrative cultures of individual cantons. Zug, Geneva, and Zurich, which together account for the majority of Swiss family office and private holding company registrations, each apply the federal principles with distinct emphases. The federal framework requires that all entities taxed at ordinary cantonal rates — now typically between 11.9% and 14.6% all-in for Zug and 13.5% to 24.5% for Geneva, depending on the municipality — meet substance expectations proportionate to their claimed functions.

What Zug and Geneva cantonal authorities expect

In Zug, the cantonal tax administration has published guidance — reinforced through informal rulings practice — that a holding or finance entity claiming ordinary taxation and treaty residence should demonstrate: at least one director with Swiss residence and genuine decision-making authority (not merely signature authority); documented board minutes for all material investment or financing decisions, held in Switzerland; a physical office address that is not purely a registered office service; and employment or service agreements with local staff or advisors proportionate to the entity's balance sheet. The minimum local payroll expectation for a holding entity managing assets of CHF 50 million or more has been informally described by Zug cantonal advisors as at least one full-time equivalent with relevant qualifications, though this is not a published statutory threshold. Geneva is more explicitly document-intensive: the Geneva cantonal tax administration (AFC-GE) routinely requests three years of board minutes, employment contracts, lease agreements, and correspondence demonstrating that decision-making authority actually resides locally when conducting ordinary audits of international holding entities.

The post-TRAF environment also interacts with Switzerland's expanded treaty network. Switzerland has bilateral double tax treaties with over 100 countries, many of which include limitation on benefits or principal purpose test provisions as a result of the OECD's Multilateral Instrument (MLI), which Switzerland signed in 2017 and ratified in 2019. Under the MLI's Article 7 (principal purpose test), a treaty benefit can be denied if one of the principal purposes of an arrangement was to obtain that benefit, unless granting the benefit would be in accordance with the object and purpose of the treaty. For a Swiss entity receiving dividends from an Indian operating subsidiary, for example, the principal purpose test means the entity must be able to demonstrate that its Swiss residence reflects a genuine business rationale, not merely access to Switzerland's favourable withholding rates. Substance documentation is the primary defence against a principal purpose test challenge, and Swiss advisors have noted a material increase in withholding tax challenges from India, Brazil, and South Africa — all BRICS jurisdictions that have adopted aggressive PPT positions — against Swiss intermediate holding entities whose substance is thin.

The MLI principal purpose test has given source-country tax authorities a tool that bypasses the treaty network entirely when substance cannot be demonstrated. Switzerland's treaty advantages are only available to entities that can show they genuinely belong there.

The nexus with Swiss private banking and family office registration

Switzerland's Financial Institutions Act (FinIA), which entered into force in January 2020, introduced a new licensing category for asset managers and trustees, including family offices managing third-party or single-family assets above defined thresholds. The supervisory authority FINMA oversees this regime through the Supervisory Organisations (SO) framework. The FinIA licensing requirement is not itself a substance rule, but it has had a collateral substance effect: entities seeking FinIA authorisation must demonstrate organisational adequacy, qualified leadership, and risk management infrastructure proportionate to their activities. Several family office structures that relied on a Swiss address but conducted actual portfolio management from outside Switzerland have found the FinIA authorisation process difficult precisely because local substance is operationally insufficient. The regulatory and tax substance expectations are therefore now mutually reinforcing: an entity that satisfies FinIA organisational requirements will generally also satisfy the AFC-GE's substance expectations, and vice versa.

How families should calibrate substance to actual operating activity

The most durable compliance error in family office substance planning is designing substance to match the legal structure rather than the economic activity. A family might create a Luxembourg SOPARFI, recognise that ATAD3 requires a local director and premises, install both, and believe the matter is resolved. The error is that the substance package must reflect what the entity actually does. A holding entity that actively manages a portfolio of 15 operating businesses across multiple sectors requires different substance than a passive holding entity that owns one real estate asset and receives an annual distribution. Regulators are increasingly sophisticated about this distinction: the question is not only whether the minimum indicator boxes are ticked, but whether the substance is proportionate to the claimed function.

A four-indicator substance matrix

A practical framework for family offices is to assess each entity against four indicators and then calibrate the intensity of each indicator to the entity's function. The first indicator is local decision-making authority: who actually makes decisions about the entity's key functions, and can that be documented? For an active investment holding entity, this means board resolutions and investment committee minutes signed locally, with evidence that the local directors reviewed analysis and exercised independent judgment. For a passive holding entity, it means at minimum an annual review by a locally-resident director with documented consideration of the entity's performance and any distributions. The second indicator is qualified local staff or directors: what is the human capital proportionate to the entity's balance sheet and activity level? An entity with €100 million in assets and annual transactions should not be operated by a single part-time nominee director. Many Swiss and Luxembourg advisors now recommend a minimum of 0.5 full-time equivalent qualified staff per CHF or EUR 50 million in assets managed, though this is a rule of thumb, not a regulatory standard.

The third indicator is adequate physical presence: does the entity have genuine premises, or merely a registered address? Regulators across the EU, UK, and Switzerland have become familiar with the shared-office model in which dozens of entities nominally occupy the same floor of a professional services firm. Genuine premises means a dedicated space, a local telephone number, and evidence of regular use — meeting records, utility bills, access logs. The fourth indicator is proportionate operating expenditure: does the entity's cost base make sense for its claimed function? An entity claiming to manage a complex multi-asset portfolio with annual operating costs of CHF 15,000 is implausible on its face, and tax authorities know it. Operating expenditure should include local advisory fees, director remuneration at market rates, local professional services, and any regulatory costs — not merely filing fees and a registered address.

Documentation practice and the audit readiness standard

Substance is ultimately a factual claim, and factual claims require contemporaneous evidence. The single most common failure in substance audits is not the absence of substance but the absence of documentation of existing substance. A director who genuinely reviews investment proposals, travels to board meetings, and exercises real authority but keeps no records of having done so is, from an evidentiary standpoint, no better positioned than a nominee who signs papers remotely. Family office governance practices should include: board calendars maintained in the entity's jurisdiction with attendance records; investment or financing decision memos prepared locally or reviewed and annotated locally before approval; annual tax residency certifications prepared by local counsel and retained for a minimum of seven years; and periodic substance reviews by external counsel that produce a written opinion on whether the entity's substance profile remains proportionate to its activities. The seven-year retention standard mirrors the standard applicable under DAC6 (Council Directive 2018/822) and most national limitation periods for tax assessment.

The audit readiness standard is simple: assume a tax authority will request, within 30 days, all documentation demonstrating that this entity is genuinely managed and controlled from its claimed jurisdiction. If assembling that file would take longer than a week, the substance practice is inadequate.

Restructuring versus remediation: a cost-benefit discipline

Not every entity with thin substance should be remediated. Some entities exist for historical reasons — a structure set up in the 1990s that once had operational logic and now merely holds a minority stake in a family asset — and the cost of building genuine substance may exceed the tax benefit of maintaining the entity in its current jurisdiction. The discipline here is to conduct a binary assessment: can this entity be given genuine substance proportionate to its function at reasonable cost, or should it be collapsed, migrated, or restructured? Collapsing an entity involves its own risks — triggering crystallisation of gains, loss of thin capitalisation history, restructuring of credit facilities — and these should be modelled explicitly. Migration to a jurisdiction with lower substance requirements may be appropriate in some cases, though the set of jurisdictions offering both credible treaty access and low substance expectations is shrinking materially as OECD and EU pressure propagates. The honest advice to many family clients is that structures built before 2015 should be reviewed with the presumption that they require significant remediation, and that the review should be conducted by tax counsel with direct experience of current enforcement practice, not merely treaty analysis.

CRS, FATCA, and the cross-referencing risk

Common Reporting Standard data, now exchanged among over 110 jurisdictions annually under the Multilateral Competent Authority Agreement, provides tax authorities with financial account information that can be cross-referenced against corporate registry data and tax return filings. A Luxembourg entity holding a financial account in Switzerland, with a Cayman ultimate beneficial owner and a family member resident in the UK, generates CRS reports flowing to Luxembourg, Switzerland, and the UK simultaneously. HMRC's Connect system and equivalent data analytics infrastructure in the Dutch and German tax authorities are designed precisely to identify cases where the CRS data and the corporate filing data tell inconsistent stories about where an entity is genuinely based. FATCA, which operates on US persons' accounts globally and flows to the US Internal Revenue Service, creates a parallel information thread that has been used by the IRS in combination with FBAR and Form 5471 filing data to identify cases where offshore entity substance is inconsistent with claimed non-US management. The convergence of CRS, FATCA, and BEPS Pillar Two information exchange infrastructure means that family office structures are now subject to multilateral cross-referencing at a level of granularity that was operationally impossible as recently as 2016.

Practical priorities for family office principals and their advisors

The operational priorities for families with international holding structures in 2025 are, in order of urgency: first, conduct a jurisdiction-by-jurisdiction substance audit of every entity in the structure that receives passive income or claims treaty benefits, using the four-indicator matrix described above; second, identify entities that would fail ATAD3's minimum indicator test if the directive were applied today, and begin remediation now rather than waiting for the final text; third, review all management and control documentation for UK-connected structures, particularly where UK-resident family members are involved in investment decisions; fourth, confirm that Swiss entities have proportionate local decision-making documented in contemporaneous board minutes; and fifth, ensure that the CRS and FATCA reporting profile of each entity is consistent with the substance position being maintained for tax purposes. These are not one-time exercises: they require annual review and periodic external validation. The families that navigate the new substance environment successfully will be those that treat it as an ongoing operational discipline rather than a compliance project to be completed and filed.