The economic substance legislation was introduced in response to concerns expressed by the Council of the European Union about the absence of clear general legal substance requirements for entities doing business in and through these jurisdictions.
A summary of economic substance regulations
Bermuda’s Economic Substance Act 2018 (Bermuda Substance Act) and the Economic Substance Regulations 2018 (Bermuda Substance Regulations) became operative on 31 December 2018. The regime became applicable immediately to new registered entities incorporated or registered after that date. For existing registered entities, there is a six-month transition period and the first reporting will commence in 2020.
For purposes of the Bermuda Substance Act, Bermuda “registered entities” are:
- companies incorporated under the Companies Act 1981;
- companies formed under the Limited Liability Company Act 2016; and
- partnerships (exempted, exempted limited or overseas) which have elected to have separate legal personality under s.4A of the Partnership Act 1902.
There is currently no exemption from Bermuda’s substance requirements for entities which are tax resident outside of Bermuda.
Entities which are subject to Bermuda economic substance requirements
A Bermuda registered entity will be in scope of the Bermuda Substance Act if it conducts any of the following “relevant activities”:
- fund management;
- distribution and service centre;
- intellectual property; and
- holding entity.
Each of the above activities is defined in the Bermuda Substance Regulations. It is anticipated that guidance notes will be issued by the Bermuda Government in due course which should provide further clarity on the above activities.
Economic substance requirements in Bermuda
A Bermuda registered entity conducting a relevant activity (as outlined above) will satisfy the Bermuda economic substance requirements if:
- it is managed and directed in Bermuda;
- its core income-generating activities are undertaken in Bermuda with respect to the relevant activity;
- it maintains adequate physical presence in Bermuda;
- there are adequate full-time employees in Bermuda with suitable qualifications; and
- there is adequate operating expenditure incurred in Bermuda in relation to the relevant activity.
Enhanced substance requirements for intellectual property (IP) activities in Bermuda
A Bermuda entity is engaging in “IP activities” if it derives revenue from the exploitation of its IP assets.
“IP assets” includes (but is not limited to) patents, technical know-how, trademarks, brands and goodwill and will therefore be applicable to a broad range of businesses and not restricted to pure IP companies. The Bermuda Substance Act and the Bermuda Substance Regulations places enhanced requirements on entities that carry on intellectual property businesses.
Bermuda pure equity holding entities vs holding entities
A Bermuda entity will be classified as a pure equity holding entity if it only holds equity participations, and earns passive revenues from dividends, distributions, capital gains and other incidental income.
A Bermuda pure equity holding entity is subject to reduced economic substance requirements and will comply with Bermuda economic substance requirements if it:
- complies with (i) the applicable corporate governance requirements as set out in the Companies Act 1981, Companies Act, Limited Liability Company Act 2016 or applicable partnership legislation; and (ii) submits on an annual basis an economic substance declaration (Declaration) with the Bermuda Registrar of Companies (Bermuda Registrar); and
- can demonstrate that it has adequate people and premises in Bermuda to hold and manage equity participations.
A Bermuda entity will be classified as a holding entity if it engages in activities including holding or managing any assets or equity participations and will be within scope of the full Bermuda economic substance requirements as outlined above.
Bermuda economic substance reporting obligations
Bermuda entities that are subject to economic substance requirements will be required to file on an annual basis a Declaration and supporting information with the Bermuda Registrar confirming that the entity complies with the economic substance requirements.
The British Virgin Islands
The BVI’s Economic Substance (Companies and Limited Partnerships) Act, 2018 (BVI Substance Act) came into force on 1 January 2019. The BVI Substance Act is supplemented by the BVI’s Economic Substance Code (BVI Substance Code) which is currently in draft form and is expected to be finalised by May 2019. The regime applies to the following “legal entities”:
- companies and foreign companies incorporated/registered under the BVI Business Companies Act, 2004 (as amended), excluding companies which are not resident in the BVI; and
- limited partnerships and foreign limited partnerships formed/registered under the Partnership Act, 1996 or the Limited Partnership Act, 2017, excluding limited partnerships which are not resident in the BVI or do not have legal personality;
but does not include:
- an investment fund (within the meaning of applicable BVI legislation); or
- a non-resident company and a non-resident limited partnership.
An entity is a “non-resident company” or a “non-resident partnership” if the company/partnership is resident for tax purposes in a jurisdiction outside the BVI which is not on Annex 1 to the EU list of non-cooperative jurisdictions for tax purposes.
Entities which are subject the BVI’s economic substance requirements
The BVI Substance Act imposes economic substance requirements on all BVI legal entities carrying on “relevant activities”.
A legal entity incorporated or registered in the BVI will be in scope of the BVI Substance Act if it conducts any of the “relevant activities” as listed above under Bermuda relevant activities.
Details of “relevant activities” are defined in the BVI Substance Act and such definitions have been further clarified in the BVI Substance Code.
Economic substance requirements in the BVI
Each legal entity which is not tax resident outside the BVI (other than a pure equity holding entity) must, in relation to any relevant activity, carry out defined core income-generating activities in the BVI and demonstrate economic substance by reference to the following criteria, having regard to the nature and scale of the relevant activity:
- the relevant activity being directed and managed in the BVI;
- adequate numbers of suitably qualified employees who are physically present in the BVI (whether or not employed by the relevant legal entity or by another entity and whether on temporary or long-term contracts);
- adequate expenditure being incurred in the BVI;
- appropriate physical offices or premises in the BVI; and
- where the relevant activity is intellectual property business and requires the use of specific equipment, the equipment being located in the BVI.
Enhanced substance requirements for intellectual property (IP) activities in the BVI
A BVI entity is engaging in intellectual property business if it is holding intellectual property assets which includes (but is not limited to) copyright, patents, technical know-how, trademarks, brands and goodwill and will therefore be applicable to a broad range of businesses. The BVI Substance Act places enhanced requirements on entities that carry on intellectual property businesses .
BVI pure equity holding entities
BVI pure equity holding entities are those entities that fall within the scope of the BVI Substance Act, but which carry on no other relevant activity other than holding equity participations in other entities and only earn dividends and capital gains. Pure equity holding entities are subject to reduced substance requirements under the BVI Substance Act.
BVI pure equity holding entities have adequate substance within the BVI if they:
- comply with their statutory obligations under the BVI Business Companies Act, 2004 (as amended) or the Limited Partnership Act, 2017, whichever is relevant (including, for example, requirements to pay annual fees and to make certain filings following corporate events); and
- have, in the BVI, adequate employees and premises for holding equity participations and, where they manage those equity participations, have in the BVI, adequate employees and premises for carrying out that management .
BVI economic substance reporting obligations
All entities must file information on their tax residency and activities to ensure that the BVI International Tax Authority has sufficient information to monitor compliance with the BVI Substance Act. Such filings will be made through the BVI entity’s registered agent in the BVI, who will then input the information to the BVI’s existing Beneficial Ownership Secure Search System.
The Cayman Islands
The Cayman Islands’ International Tax Co-operation (Economic Substance) Law, 2018 (Cayman Substance Law) and The International Tax Co-Operation (Economic Substance) (Prescribed Dates) Regulations, 2018 came into force on 1 January 2019. The regime became applicable immediately to new relevant entities incorporated or registered after that date. For existing relevant entities, there is a six-month transition period and the first reporting will commence in 2020. The Cayman Substance Law is supplemented by the Cayman Islands guidance for economic substance for geographically mobile activities (Cayman Guidance Notes) which is currently in draft form.
For the purposes of the Cayman Substance Law, Cayman “relevant entity” means (with some exceptions):
- a company, other than a domestic company, that is incorporated under the Companies Law or registered as a limited liability company under the Limited Liability Companies Law;
- a limited liability partnership registered under the Limited Liability Partnership Law; and
- a company that is incorporated outside of the Cayman Islands and registered under the Companies Law,
but does not include:
- an investment fund (within the meaning of applicable Cayman Islands legislation); or
- an entity that is tax resident outside the Cayman Islands.
An entity is “tax resident outside the Cayman Islands” if the entity is subject to tax in another jurisdiction by reason of its domicile, residence or any other criteria of a similar nature.
Entities which are subject to the Cayman Islands economic substance requirements
A Cayman relevant entity is only in scope of the Cayman Islands economic substance requirements if and to the extent that it conducts any “relevant activity”.
A legal entity incorporated or registered in the Cayman Islands will be in scope of the Cayman Islands Substance Law if it conducts any of the “relevant activities” as listed above under Bermuda relevant activities.
Details of “relevant activities” are defined in the Cayman Substance Law and such definitions have been further clarified in the Cayman Guidance Notes.
Economic substance requirements in the Cayman Islands
A Cayman Islands relevant entity will satisfy the Cayman Islands economic substance test in relation to a relevant activity if the relevant entity:
- conducts Cayman Islands core income-generating activities (any activity that is of central importance to a relevant company in terms of generating income that is being carried out in or from within the Cayman Islands) in relation to that relevant activity;
- is directed and managed in an appropriate manner in the Cayman Islands in relation to that relevant activity;
- having regard to the level of relevant income derived from the relevant activity carried out in the Cayman Islands:
- has an adequate amount of operating expenditure incurred in the Cayman Islands;
- has an adequate physical presence (including maintaining a place of business or plant, property and equipment) in the Cayman Islands; and
- has an adequate number of full-time employees or other personnel with appropriate qualifications in the Cayman Islands.
Enhanced substance requirements for intellectual property (IP) activities in the Cayman Islands
A Cayman Islands entity is engaging in intellectual property business if it holds, exploits or receives income from intellectual property assets which includes (but is not limited to) copyright, design right, patents and trademarks and will therefore be applicable to a broad range of businesses. The Cayman Islands Substance Law places enhanced requirements on entities that carry on intellectual property businesses.
The Cayman Islands’ pure equity holding entities
A Cayman Islands “pure equity holding company” means a company that only holds equity participations in other entities and only earns dividends and capital gains.
A Cayman Islands pure equity holding entity is subject to reduced economic substance requirements and will comply with the reduced Cayman Islands economic substance requirements if it:
- confirms that it has complied with all applicable filing requirements under the Companies Law (2018 Revision); and
- has adequate human resources and adequate premises in the Cayman Islands for holding and managing equity participations in other entities.
Cayman Islands holding companies that hold something other than pure equity interests, or that earn income other than from dividends and capital gains, do not fit into the definition. If their other activities amount to another relevant activity as defined in the Cayman Islands Substance Law, they will be caught within scope of the full Cayman Islands economic substance requirements as outlined above.
The Cayman Islands’ economic substance reporting obligations
Cayman Islands entities that are subject to economic substance requirements will be required to file a notice with the Cayman Islands Tax Information Authority (TIA) stating whether or not they are carrying out relevant activities.
Twelve months after the last day of the end of each financial year commencing on or after 1 January 2019, a relevant entity carrying out any relevant activity will be required to file a basic return setting out particulars as to income, expenses, assets, management, employees, physical presence and other matters.
What Can Appleby do to Help?
We recommend that Bermuda, BVI and Cayman entities give consideration to whether or not they meet the definition of relevant entity. Those that appear to be in scope of the new regime should undertake an internal review to determine if they undertake relevant activities. Appleby can help with this analysis.
This article is current as at 14 May 2019. Appleby continues to monitor further amendments and will provide updates in due course.