Substance is tested at every layer, and fails at the one nobody staffed.

Every company in a holding chain makes a claim by existing: that it is resident where it sits, that decisions about its assets are taken there by its own board, and that it is the person the treaty, the licence or the ownership law treats it as. The claim is tested by tax authorities, by the regulators of the centres, by lenders' counsel and by buyers' diligence, and it is tested against facts rather than against the certificate of incorporation: who the directors are, where they meet, what they decide, what records show it, what the company owns and employs where it sits, and whether anybody in the jurisdiction would recognise the company as a thing that exists. A chain of four makes four claims, and the claim that fails is the one at the layer nobody staffed, because substance is produced by people and a layer without people produces none. The failure is found late, by a party with the power to redraw the chain, and the redrawing costs the position the layer existed to hold.

This note sets out who tests substance and what each tester looks for, where it fails and why, what holding substance at a layer actually consists of, the minute book as the chain's evidence, the management agreement and the line between recommending and deciding, the centres' own requirements, the source states' tests, the cost and the budget, a comparison, a worked chain as a type, cases, what each party holds, the sequence, questions, terms and what to read.

Who tests it

The centres require substance of the entities formed there and examine it. Both have regimes under which a company must demonstrate adequate presence, management and activity in the centre for the business it claims to carry on, and both regulators run reviews and require confirmations. A centre company with no directors present, no decisions taken there and no activity is a company the centre can find non-compliant.

The source states test it for treaty purposes. A treaty position that depended on a holding company's residence is lost when the company is found to be managed from somewhere else, and the principal-purpose test most treaties now carry asks, in addition, whether the company exists for any reason beyond the treaty. The source state's authority reads the board minutes, the bank account's operation, the employees, the office and the decisions, and it compares them with where the manager's team sits.

The tax authority of the country where the manager's team sits tests it in the other direction: a holding company whose every decision is taken by the team in that country may be resident there under that country's management-and-control test, with the consequences that follow, including a tax charge in a country the structure never intended to touch.

Lenders test it because security over a company's shares is worth what the company's decisions are worth, and a company whose board cannot be shown to have authorised the security has granted security a liquidator can question.

Buyers test it at exit because they are buying the chain, and a chain whose minute books show nothing is a chain whose every decision can be questioned and whose every position can be lost in the buyer's hands.

Where it fails

It fails at the layer nobody staffed. The fund has a manager, a board, an administrator and a regulator, and its substance is the manager's. The asset company has management on the ground, staff, a lease and a business, and its substance is its own. The two or three companies between them have directors who were appointed at formation, a registered office at a corporate services provider, a bank account, and a minute book that records one meeting a year, held by circular resolution, approving the accounts. Decisions about the asset were taken by the manager and implemented through the intermediate companies without their boards deciding anything. That is the fact pattern a look-through is built on, and it is the commonest fact pattern in private-markets chains, because the intermediate layers were formed for a position and not for a business, and a layer formed for a position is a layer nobody thinks of as needing to do anything.

What substance consists of

Substance at a layer means the layer actually does what a company in its jurisdiction does, and the list is concrete.

Directors who are resident where the company sits, who are not only the manager's employees, and who form a quorum the manager's people cannot make alone. Board meetings held in the jurisdiction, in person or in a form the jurisdiction's law accepts as held there, with papers circulated before, deliberation minuted, conflicts recorded and decisions taken rather than ratified. A registered office and a corporate services provider with staff present, or the company's own office and staff where the business requires it. A bank account operated from the jurisdiction by the company's own signatories. Accounts prepared and audited there and filed on the jurisdiction's calendar. Contracts in the company's own name, signed by its own directors on its own resolutions. For a treaty layer, the retention of what it receives and a board decision to distribute, so that it is the beneficial owner rather than a conduit. For a category layer, compliance with the state's conditions on the category, the registration and the filings. For every layer, a reason to exist that a reader can state without mentioning the treaty.

Each of those is a line in the layer's row of the structure paper's table, with a party who produces it and an annual cost, and a layer whose row is blank in the substance column is a layer that will be looked through.

The minute book as evidence

The minute book of each layer is the evidence that the layer existed in fact and not only on paper, and it is read by every party that tests the chain. The tax authority reads it for residence and beneficial ownership: did the board decide, where, on what papers, and did it decide to distribute or was it obliged to. The lender's counsel reads it for authority: did the board validly approve the security, within its powers, with a quorum. The buyer's counsel reads it for validity: was every acquisition, financing and disposal approved by the right body at the right time. The regulator reads it for substance. A minute book that shows an annual circular resolution approving accounts shows a layer that decided nothing, and every party that reads it reaches the same conclusion.

The minute book that holds shows, for each decision the chain required, a meeting in the jurisdiction, the papers, the directors present, the deliberation, the conflicts declared, the decision and the authority under which it was taken. It is kept by the corporate services provider under an agreement that names what it must contain, and it is reviewed annually by the manager's compliance function against the table, because a minute book nobody reviews is a minute book that stops being kept in the second year.

Recommending and deciding

The management agreement between the manager and each layer draws the line between recommending and deciding, and the line is where substance lives. Under an agreement that holds, the manager identifies, evaluates and recommends; the layer's board receives the recommendation with the papers, deliberates and decides; the manager implements the decision. Under an agreement that does not hold, the manager has authority to act for the layer and the board ratifies. The first produces a board that decides in the jurisdiction; the second produces a board that records decisions taken elsewhere. The agreement is drafted to the first, and the board is run that way, with the directors understanding that a recommendation they always accept without deliberation is a recommendation the minute book will show they never considered.

Why substance became the test

Tax authorities and regulators moved from reading documents to reading facts because documents were cheap and facts were not. A treaty claimed by a company with a registered office and a nominee director cost nothing to assert and the source state nothing to lose by denying it once it learned to look. The principal-purpose test, the beneficial-ownership doctrine, the centres' economic presence rules and the onshore states' management-and-control tests are the same instinct in different instruments: a position is granted to a person who is really there, and "really there" is a matter of evidence. A structure that understands why the test exists produces the evidence as a matter of course, because the evidence is what a real company produces anyway; a structure that treats the test as a box produces a box, and an authority that has seen the box before opens it.

The corporate services provider's agreement

The provider is the party that produces most of a holding layer's substance, and its agreement is drafted to say so. The agreement names the registered office and the staff present; the directors the provider supplies and their residence; the meeting facilities and the calendar; the bank account's operation and the signatories; the accounts and the audit coordination; the filings and their dates; and the minute book's contents for each kind of decision. It names what the provider does not do: it does not decide, it does not take instructions from the manager in place of the board, and it does not sign what the board has not resolved. A provider's standard agreement, which offers "corporate services", names none of that, and a layer run on it has substance by accident.

The budget, by layer and year

A substance budget is a table: each layer, each line of substance, the party, the annual cost, and the total over the chain's expected life. For a chain of three holding layers the total over ten years is a number a manager should know before forming the first, because it is the cost of the positions the chain claims and the comparison against the positions' value is the comparison that decides the chain. The budget is approved at formation, paid as a running cost, and reviewed annually against what was actually produced, because a budget spent on a provider that did not hold the meetings is a budget spent on nothing.

Where it surfaces

At the source state's inquiry, when the minute book is read.

At the manager's home authority, when the manager's team is found to have decided everything.

At the lender's enforcement, when the board's authority for the security is questioned.

At the buyer's diligence, when the minute books show ratification.

At the centre's review, when the centre company's presence is tested.

At a change of provider, when the new one is not told what to produce.

The cost of getting it wrong

A position lost for want of substance costs the tax the position would have saved, for the years it is lost, with interest and penalties where the source state imposes them. A residence relocated to the manager's country costs a charge the structure never contemplated. Security whose authority is questioned costs the lender's confidence and a re-papering. A chain the buyer must re-paper costs the discount and the delay. The substance costs the budget, every year, and a manager that compares the two at formation staffs the layers it keeps and removes the ones it cannot afford to make real.

The centres' requirements

Each centre requires the entities it licenses and the companies it registers to have an adequate presence in the centre, expressed in rules on directors, on offices, on staff for licensed firms, on the place of decision-making and on records. Each examines compliance, by confirmation, by review and by inspection, and each can find a company non-compliant with consequences that reach its registration. A centre company formed as a layer is subject to those rules whether or not it carries on a licensed business, and the corporate services provider's arrangement is drafted to meet them.

The source states' tests

A source state tests a foreign holder's residence under its own law and under the treaty's test, which in most treaties turns on effective management; tests beneficial ownership against what the holder does with what it receives; and applies the treaty's principal-purpose test against the holder's reasons for existing. The state's authority reads the facts the structure produces, and a structure that produces them has a position, while one that does not has an opinion.

The cost and the budget

Substance costs money at every layer, every year, and that is why the question of whether a layer is needed is asked first. Resident directors who are not the manager's staff charge for their time and their liability. Meetings in the jurisdiction cost travel or the provider's facilities. The provider charges for the office, the records, the filings and the account. The audit is a cost. Staff, where the business requires them, are a cost. A chain that is short has fewer places to fail and more money for each of the places that remain. A chain of four with substance at every layer costs what four real companies cost; a chain of four with substance at none is a drawing that a regulator or a tax authority will eventually redraw, and the redrawing costs the position.

By layer · by test	Who tests	What they read	What fails it	What holds it
Centre company	The centre's regulator	Presence, directors, decisions, records	Staff-director quorum; no meetings; no activity	Resident directors; meetings; a provider with staff; filings
Treaty company	The source state's authority; the manager's home authority	Residence; beneficial ownership; purpose	Conduit flows; decisions elsewhere; no function beyond the treaty	Retention and decision on receipts; a function; a resident board
Category holder	The asset state's registry and regulator	Compliance with the category's conditions	Lapsed registration; unnotified changes	The calendar of conditions
Blocker	The source state's authority; the buyer	The same as a treaty company, more closely	The same	The same, budgeted
Any layer	The lender; the buyer	Authority and validity of decisions	Circular resolutions; no papers	The minute book

A timeline, as a type

Month one: the chain is read as a whole and reduced to the layers with functions; the substance budget is drawn by layer and year. Month two: resident directors appointed at each layer; the provider's agreement drafted to name the minute book's contents; the management agreement drafted to recommend and decide. Month three: the acquisition approved at each layer's board, in the jurisdiction, on papers, minuted. Year one: four quarterly meetings at each layer; a dividend received by the treaty layer, retained for a quarter, distributed on a board decision. Year three: a change of provider; the new agreement names the minute book's contents; the handover reviewed. Year four: the source state's inquiry; the minute books produced; the position stands. Year six: exit; the buyer's counsel reads the books; the chain is priced at no discount.

The structure paper's page

The structure paper's substance page is the table: each layer, its directors and their residence, its quorum, its provider and office, its meeting calendar, its account and signatories, its audit and filings, its minute book's required contents, its budget, and the party responsible for each line. Beneath it, the management agreement's line between recommending and deciding, quoted. Beneath that, the annual review's checklist. The page is signed by the manager's compliance function each year, and a year without a signature is a year the chain may not have existed.

Substance and the feeder

A feeder is a layer above the master rather than below it, and its substance is tested for the same reasons by the same testers: the feeder's own regulator, its investors' source states for the treaty position the feeder claims for them, and the master's manager's home authority. A feeder whose board consists of the master manager's staff and whose minutes record annual accounts is a feeder its investors' source states look through, and the position the feeder existed to give them is lost in the feeder's own minute book.

The director's own position

A resident director of a holding layer takes on the duties the jurisdiction's companies law imposes and the liabilities that go with them, and a director who understands that is a director who deliberates. The best resident directors ask for the papers early, read them, ask questions the manager did not anticipate, and decline to resolve what they do not understand; their questions are the deliberation the minute book records and the substance the authority reads. A director who signs what is put in front of them is a director whose signature evidences nothing, and a manager that wants compliant directors has chosen directors whose minute books will show compliance and nothing else. The director's cost is the price of deliberation, and deliberation is the substance.

Substance in the onshore states

The onshore states test substance in their own ways. The Kingdom examines a registered investor on its conduct and its activities. Qatar's foreign investment approval carries conditions on the company's activity. Kuwait's licensed scheme has a Kuwaiti manager whose presence is the scheme's substance. India's place-of-effective-management test and its authority's appetite for applying it make the chain above an Indian asset a chain whose every board must be real, and the treaty positions chains into India rely on are positions about residence. A category layer in an onshore state produces the substance its state's conditions require, and the structure paper's table has a row for it beside the treaty layers'.

A chain, as a type

A fund holds an onshore asset through a centre company and a treaty company. The structure paper names, for each, the directors, two resident and not the manager's staff and one the manager's, with a quorum of two residents; the provider and its office; the quarterly meeting calendar in the jurisdiction; the bank account's signatories; the audit; and the budget. The management agreement has the manager recommending and the board deciding. The treaty company receives a dividend in year two, retains it for a quarter, and its board decides to distribute on papers that show the decision was its own. The source state inquires in year four; the minute books show quarterly meetings, papers, deliberation and decisions; the treaty position stands. The buyer's counsel in year six reads two minute books and finds every acquisition, financing and distribution approved by the right body.

Four cases, as types

A fund holds an onshore asset through a centre company and a treaty company. The treaty company's directors are the administrator's staff; its minutes are annual; the acquisition was decided in the manager's office in a third country; the dividend it received was paid up within a week under a loan agreement. The source state denies the treaty benefit on the footing that the company is neither resident nor the beneficial owner, the manager's own country asserts the treaty company's residence there, and the fund pays twice for a layer that existed to pay once.

A fund's chain is tested by a buyer at exit. The intermediate companies' minute books show circular resolutions approving accounts and nothing else. The buyer's counsel asks for the board approval of the original acquisition and of the lender's security, and finds neither; the price reflects a chain the buyer must re-paper, and the lender, asked to confirm its security, asks its own counsel the same question.

A fund collapses its chain to the layers with a stated function, appoints resident directors at each who are not the manager's staff, holds quarterly meetings with papers, and minutes deliberation. The treaty position survives the source state's inquiry because the facts the opinion was conditional on are in the minute book, and the buyer's counsel at exit reads two books in a day.

A fund staffs its layers at formation and lets the substance lapse in year three when the provider is changed and the new one is not told what the minute book must contain. The lapse is found at the year-five inquiry, which reads the first two years as substantive and the last three as not, and the position is lost for the years it matters most.

What each party holds

The manager holds the decision to staff each layer, the budget, the management agreement's line and the annual review of the minute books.

The directors of each layer hold the substance: their residence, their meetings, their decisions and their records.

The corporate services provider holds the office, the records, the filings and the minute book under an agreement that names its contents.

The tax adviser holds the opinion and its conditions, which are the substance the structure must produce.

The lender holds the authority of each layer's decisions, read from the minute book.

The buyer at exit holds the minute books, which it reads and prices.

The sequence

1. The substance each layer must produce is named in the structure paper, with the party who produces it and the annual cost, before the layer is formed.
2. Resident directors are appointed at each layer with a quorum the manager's staff cannot make alone.
3. The management agreement is drafted so that the manager recommends and the board decides, and the board is run that way.
4. The provider's agreement names what the minute book must contain.
5. The minute book is kept as the evidence: papers, deliberation, conflicts, decision, authority.
6. The substance at each layer is reviewed annually by the manager's compliance function against the table, and on every change of provider.

Questions a manager asks

Can the manager's own staff be directors. Some of them, with a quorum the residents make alone and a record that the residents decided; a board of the manager's staff alone is the manager's board wherever it meets.

Are circular resolutions ever acceptable. For routine matters the jurisdiction permits to be resolved in writing, with the papers attached; not for the decisions the chain exists to take.

How much substance is enough. Enough that a reader in the jurisdiction would recognise the company as a thing that exists there and decides there, which for a holding company is a resident board that meets, a provider with staff, an account operated there and a reason to exist.

Does substance reach the centre company above. The centres require it and examine it; a centre company is not exempt because it is in a centre.

What if a provider is changed. The new provider's agreement names the minute book's contents, and the handover is reviewed; a lapse at a change of provider is the commonest lapse.

Who bears the cost of substance. The fund, as a running cost of the chain, budgeted at formation; a manager that did not budget it has a chain it cannot afford to make real.

Terms used

Substance: the facts, directors, meetings, decisions, records, presence, that make a layer what it claims to be.

Look-through: an authority's or a buyer's treatment of a layer as transparent, for want of substance or purpose.

Effective management: the treaty test of residence, turning on where the company's key decisions are taken.

Beneficial ownership: the condition that the layer holds what it receives for itself rather than as a conduit.

Recommend and decide: the line in the management agreement between the manager's advice and the board's decision.

Minute book: the record of each layer's meetings, papers, deliberation, conflicts, decisions and authority.

What to read

Each centre's substance and economic presence requirements; the source states' residence and beneficial-ownership tests and the treaties' principal-purpose provisions; the management agreement; the provider's agreement and the minute books. On this site, the holding chains room under Structures and the ADGM and DIFC rooms under Jurisdictions.