Kim Willey, senior legal counsel at ASW Law, breaks down the economic substance legislation adopted 1 January 2019, and explains why Bermuda’s captives are well-positioned to satisfy its requirements
A wave of economic substance legislation has been adopted, effective 1 January 2019, across the British Overseas Territories (including Bermuda, the Cayman Islands and the British Virgin Islands) and the Crown Dependencies (including Jersey, Guernsey and the Isle of Man). This legislation requires companies that are resident in such jurisdictions and carrying on certain relevant activities (which includes insurance) to evidence that they have adequate substance in their respective jurisdictions.
This new legislation will have significant implications for those doing business in these jurisdictions, particularly those entities that hold their intellectual property assets through entities resident in such jurisdictions. The impact on captive insurers is, however, moderated, as captive insurance business already generally has a substantive connection in its jurisdiction of regulation.
Pressure for greater economic substance
Economic substance legislation is the result of a commitment made in 2016 by the Council of the EU to prioritise policy efforts to combat tax fraud, evasion and avoidance, and money laundering both at an EU and a global level. The EU Code of Conduct Group was tasked by the EU Council in 2016 to undertake a screening process in which certain non-EU jurisdictions were comprehensively assessed against standards of tax transparency, fair taxation and compliance with anti-base erosion and profit shifting (BEPS) measures (the Organisation for Economic Cooperation and Development’s initiative to combat BEPS).
As a result of this assessment, the code group expressed concerns in 2017 that the jurisdictions assessed did not have a legal substance requirement for entities doing business in or through the jurisdiction. In 2017, the code group also published ‘The EU List of Non-Cooperative Jurisdictions for Tax Purposes’. In order to remain off of the list, governments in the jurisdictions assessed by the code group committed to adopting economic substance legislation by 31 December 2018.
As a result of this commitment, economic substance legislation has been adopted in many of the British Overseas Territories and Crown Dependencies which service the captive industry.
The code group is assessing the strength of this legislation and its implementation and failure to satisfy this assessment could result in a jurisdiction being placed on the list. Consequently, further refinements to the legislation adopted and the regulation and guidance provided in each jurisdiction is expected.
Bermuda–a leader in the captive world
As home to almost 750 captives at last count in 2017 (not including programmes run in segregated accounts of rent-a-captive structures), Bermuda is the largest captive domicile in the world. Bermuda, along with the Cayman Islands, Guernsey and the Isle of Man amongst others, have each adopted economic substance legislation.
Each act is slightly different, and this article focuses on the Bermuda legislation given its significance to the captive industry.
Application of economic substance to Bermuda captives
The Bermuda Economic Substance Act 2018 (ESA) provides that all registered entities, which includes Bermuda companies, limited liability companies and partnerships that have elected to have separate legal personality, engaged in relevant activities must maintain a substantial economic presence in Bermuda.
A relevant activity is defined in the ESA as “banking, insurance, fund management, financing, leasing, headquarters, shipping, distribution and service centre, IP and holding entities”. Insurance is specifically included in this list as a relevant activity.
To comply with the substance requirements in the ESA, each Bermuda captive (called a non-commercial insurer in Bermuda) will need to demonstrate that: it is managed and directed in Bermuda; its core income generating activities are undertaken in Bermuda; 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, which requirements are further expanded upon in the Economic Substance Regulations 2008.
The term ‘adequate’ has not been defined, however, the regulations further provide that the economic substance requirements are satisfied if the Bermuda captive complies with the corporate governance requirements in the Companies Act 1981, as amended and the Insurance Act 1978, as amended, and its related regulations (the Insurance Act) including the Insurance Code of Conduct (the Code).
Each Bermuda captive is already required to provide an annual statutory financial return including a declaration of compliance with the Bermuda Monetary Authority confirming that it is in compliance with the Insurance Act and the Code.
Bermuda captives are also required to file an annual declaration with the Registrar of Companies confirming compliance with the Companies Act. Consequently, Bermuda captives should, in practice, not need to adopt any significant changes to comply with the ESA, other than to file an additional annual declaration confirming compliance with the economic substance requirements.
The economic substance requirements apply immediately to any newly formed Bermuda captives, but existing captives have until 30 June 2019 to comply.
This would be an excellent opportunity for Bermuda captives to assess their governance and operational structures. There are significant penalties for non-compliance with the ESA, including civil penalties and/or the Bermuda captive being dissolved.
To ensure ongoing compliance, the Bermuda captives should ensure that:
The Bermuda insurance industry has long encouraged a substantive connection to the Island. As a result, Bermuda captives are well placed to meet the newly adopted economic substance requirements.
