What is substance, and why does a “paper company” no longer work

Introduction

For many years, it was possible to register a company in a “convenient” jurisdiction, open a bank account, and operate almost entirely outside that jurisdiction. A legal entity on paper was often enough – it looked formal, it created an illusion of structure, and in many cases, it worked. But the world has changed. Compliance has matured, banking risk models have evolved, and regulators have shifted their focus from where a company is registered to where it actually lives.

Substance is not a single document or certificate. It is a combination of factual elements that, taken together, form the company’s real economic profile. It is about whether a business genuinely operates in the jurisdiction it claims to belong to – whether decisions are made there, people work there, services are delivered from there, and value is created there. Without this economic reality behind the corporate shell, a company risks being treated as a mere formality – a “paper company” – and modern financial and regulatory systems have little tolerance for that.

What does “substance” really mean?

In corporate law and international taxation, substance refers to a company’s real economic life—everything beyond registration forms and corporate addresses. A company has substance when it not only exists formally but also actually operates, makes decisions, generates value, and conducts its activities in the jurisdiction where it claims to be established.

From a practical standpoint, substance usually consists of several dimensions:

Decision-making and management – where directors and founders actually exercise control, hold meetings, and sign meaningful decisions.
People and functions – where employees or contractors perform daily work and deliver services.
Operational footprint – whether there are real expenses, infrastructure, suppliers, and ongoing business activity.
Commercial presence – whether clients, partners, and transactions are genuinely connected to that jurisdiction.

These elements do not need to be identical in every case. Different business models create substance in different ways. However, they must form a coherent and plausible picture. A company that claims to “operate” in one country, while all work, management, staff, and clients are located elsewhere, will inevitably raise doubts to banks, regulators, and tax authorities alike.

In essence, the key distinction lies between a registered entity, which meets legal requirements on paper, and a real business, which demonstrates genuine economic activity within its claimed jurisdiction. Substance is what transforms legal incorporation into the operational and economic reality that regulators and banks now demand.

Why did regulators start demanding substance?

For many years, international structuring often relied on companies that existed largely “on paper”: a registered address, a formal director, a corporate file, but little or no real business activity in the jurisdiction of incorporation. This approach was tolerated while regulatory systems focused mainly on formal legality. However, the evolution of global tax transparency, AML/CFT supervision, and risk-based banking compliance has shifted the emphasis from where a company is registered to where it actually operates and creates value. That is the context in which regulators and financial institutions began to require substance.

A major turning point was the EU Code of Conduct, which reinforced the idea that entities with no real functions, personnel, or decision-making in their place of incorporation may be treated as artificial arrangements. In parallel, a number of jurisdictions, including the BVI, Cayman Islands, Bermuda, Jersey, Guernsey, and the UAE, introduced economic substance regimes, obliging companies engaged in relevant activities to demonstrate local strategic management, adequate expenditure, operational footprint, and people performing core income-generating functions. Where such factors are missing, companies face penalties, disclosures to foreign tax authorities, or enhanced supervision.

At the same time, the banking sector strengthened its risk-based onboarding under AML/CFT frameworks (FATF standards, EU AML directives). Banks and payment providers increasingly assess whether a company has credible links to its claimed jurisdiction: real management involvement, staff or outsourced functions under control, contracts performed locally, and transactions consistent with declared activity. One of the most frequent outcomes of this shift is the refusal to open an account due to insufficient economic substance or an unclear business presence. In practice, this has affected sectors such as IT services, consulting, fintech, and crypto, where incorporation and operational reality are often in different countries.

Across tax, regulatory, and financial supervision contexts, the policy logic is the same. Incorporation proves that a company exists legally, but substance demonstrates that it exists economically. Substance enables authorities and financial institutions to distinguish genuine enterprises from letterbox entities created primarily for tax arbitrage or opacity. This is why substance is now a core indicator of credibility in cross-border business. That is why the “paper company” model no longer works.

What typically does not count as substance?

The first red flag is a registered address or virtual office with no operational reality behind it. A mailbox service, coworking address, or “corporate domicile” provider may satisfy the requirements of company law, but on its own, it does not demonstrate that business is actually conducted there.

Related is using a nominee director with no management role. If real decisions happen elsewhere, authorities use the “place of effective management” or “management and control” test. The company may be seen as controlled outside its claimed jurisdiction, regardless of its registry listing.

Another sign of a lack of substance is the lack of local staff or functions. If all employees, contractors, and activities are abroad, a nominal entity with no capacity for local services is likely to lack substance, especially in IT, consulting, fintech, or crypto. Many filings and reviews note companies claiming activity with no staff or real spending are high risk or must remediate.

Regulators and banks also treat with caution situations in which contracts are issued by the company but negotiated and performed elsewhere. If clients, partners, and transactions have no credible connection to the jurisdiction – and invoices merely pass through the entity – this is often viewed as a “letterbox” arrangement. Under banking AML/KYC onboarding standards, such structures frequently trigger enhanced due diligence or refusal of account opening on the grounds of insufficient economic substance.

Finally, purely formal expense trails without genuine business activity – accounting retainers, nominal office fees, minimal administrative spending – do not in themselves create substance. Supervisory bodies increasingly expect a coherent picture in which people, management, functions, expenditure, and business purpose align.

Conclusions

Substance is no longer a formal requirement – it is a test of whether a company truly exists beyond paper. Modern regulators, banks, and tax authorities assess where decisions are made, where people work, and where value is created, not just where an entity is incorporated. Structures that rely solely on a registered address, a nominee director, or administrative presence increasingly fail this test, while companies that align their legal form with real economic activity build credibility, resilience, and long-term viability. The difference between a registered entity and a real business is now defined by substance, and that is why the “paper company” model no longer works.

At Manimama Law Firm

At Manimama Law Firm, we help businesses navigate the regulatory landscape. We support documentation, manage applications, and develop compliance strategies for crypto-related companies.