DEMPE Functional Analysis and Intangible Economic Asset Allocation Rules
Intangible returns belong to the entities controlling technical functions and bearing financial risks, overriding nominal title and passive capital financing.
Substance Requirements
Meaning
Regulatory standards dictate that a corporate entity must possess a physical presence and active business operations in a jurisdiction to qualify for tax benefits. These substance requirements aim to dismantle letterbox or shell companies that exist solely to exploit tax treaties. Tax authorities evaluate whether the entity has local employees, office space and local expenditures.
This review determines if the income allocation matches actual local activities and prevents artificial profit shifting across borders.
Operational Metric
Compliance involves demonstrating that the local board of directors possesses the technical expertise to make major business decisions. A company must maintain physical offices and show that its local managers actively supervise regional projects. If the board relies entirely on external advisors, the entity fails the test.
This evaluation focuses on actual operational control.
Tax Benefit
Meeting these criteria allows companies to access double tax treaties and avoid withholding taxes on dividends, interest and royalties. If a company fails to meet the threshold, the tax authority may deny treaty benefits and impose taxes at source. This penalty increases the overall cost of cross-border investments.
The company must then restructure its operations.
Audit Challenge
Tax audits increasingly focus on verifying that the employees of the foreign holding company perform high-value functions. Inspectors will demand to see employment contracts, travel logs and emails that show where strategic decisions were finalized. Relying on formal legal documents is no longer enough to satisfy modern tax departments.
The burden of proof rests on the corporate taxpayer.