Economic substance legislation was designed to protect the reputation of offshore jurisdictions. Industry experts discuss how Bermuda works to remain compliant
The Crown Dependencies have enhanced their commitment to meet the Organisation of Economic Co-operation and Development’s (OECD) principles for improving global tax transparency by introducing an Economic Substance Test.
This legislation, which came into effect 1 January 2019, was designed to protect the reputation of offshore jurisdictions by ensuring that income streams from certain activities are based on actual local activity to substantiate the use of low tax jurisdictions.
Those that have introduced this legislation include Bermuda, British Virgin Islands (BVI), Cayman Islands, Guernsey, the Isle of Man and Jersey.
Nicholas Miles, partner for Kennedys, says that this doctrine is applied to distinguish transactions by taxpayers with counterparties particularly related parties that are designed to exploit tax rate differentials and which lack ‘economic substance’.
In the context of recent global legislative reforms driven by the EU and the OECD, it refers to proof that the revenue of a company is sufficiently attributable to activity in its domicile.
In a huge proportion of jurisdictions, corporate profits are taxed at the domicile of the company.
Louise Charleson, partner at Ocorian, explains that Bermuda’s economic substance laws and regulations are enshrined in the Economic Substance Act 2018, the Economic Substance Regulations 2018 (both as amended, together with the ES Regime) and related Guidance Notes issued by the Minister of Finance on 18 September 2020.
One of the other aspects of global tax reform is tax transparency, including cross-border cooperation in identifying assets beneficially owned by taxpayers.
Miles states that Bermuda, for many decades, has gathered corporate beneficial ownership information in a central register, maintained by the Bermuda Monetary Authority (BMA) acting as Controller of Exchange.
He comments: “Pursuant to various Tax Information Exchange Agreements and its implementation of common reporting standards and country-by-country reporting, Bermuda shares and has shared its beneficial ownership data with authorities of a large number of foreign jurisdictions where required.”
“Unlike most other jurisdictions, including the UK, Bermuda actually vets its beneficial ownership data, by requiring beneficial owners to sign personal declaration forms and to provide proof of identity and residence (which is reviewed by the Controller of Exchange),” he adds.
Reflecting on how Bermuda works to remain compliant with economic substance legislation, Carol Feathers, director of client services at Ocorian, says that the Bermuda Registrar of Companies (Registrar) is responsible for implementing, monitoring and enforcing the economic substance regime. The registrar has the power to issue notices on an entity to comply with the economic substance requirements.
Feathers states: “If the entity fails to do so, the registrar can impose civil penalties of up to BD$250,000 in three stages. If, after the civil penalties have been exhausted, an entity continues to be non-compliant, the registrar may apply to the court for an order in such terms as it thinks fit, including an order for striking off the entity.”
“Additionally, there is an offence of knowingly making a false economic substance declaration with penalties up to BD$10,000 or imprisonment for two years or both,” she adds.
Impact on captives
Bermuda is one of the largest captive insurance domiciles in the world.
At the end of 2020, the domicile had 680 total captives on the small island.
On how this regulation affects the captive insurance market, Miles explains that the Insurance Act 1978 and associated codes of conduct already contain provisions requiring a substantial presence in Bermuda, captives benefit from a deeming provision in the Economic Substance Regulations 2018 (ESR), according to which they may comply with the economic substance requirements by complying with certain requirements applicable to economic substance.
Miles outlines that a captive must maintain a principal office in Bermuda and appoint a principal representative in Bermuda approved by the BMA.
He notes: “They must also comply with various rules relating to the outsourcing of regulated functions.
A captive must file an annual economic substance declaration (ES Declaration) within six months of the end of its financial year.”
For certain captives which require more intensive administration, such as industry group captives with multiple policyholders or those which write third party business including to clients of the onshore parent, Charleson adds these, by their nature, are more likely to have palpable substance evidenced by dedicated employees and premises.
“For other captives, such as those with a single policyholder (its onshore parent) which conduct their offshore operations exclusively through a specialist captive management company, a more mindful review of whether its substance requirements are met may need to be conducted to ensure that all key strategic decisions and core income generating activities (CIGA) are taking place in Bermuda,” Charleson highlights.
Understanding the challenges
Companies have often relied on conducting regular physical board meetings in Bermuda to demonstrate ‘mind and management’ and the carrying out of CIGA within the jurisdiction.
One of the biggest challenges over the last year has been the travel restrictions imposed as a result of the COVID-19 pandemic, which Feathers says has prevented entities from being able to conduct in-person board meetings locally. Physical board meetings are also essential for registered insurance entities to meet their regulatory obligations,” she adds.
On 20 March 2020, the registrar issued a notice, which acknowledged that business continuity is challenging during this time and as such, where meetings or other similar economic substance compliance measures are not possible due to travel or quarantine restrictions, this may be taken into consideration.
However, Charleson points out that the registrar also noted that entities must continue to act in good faith and maintain a careful record of all meetings affected, details of restrictions and steps taken.
A widely-held view is that companies should nevertheless ensure that they have personnel who are resident in Bermuda to conduct CIGA, whether this be directors, direct employees or employees of outsourced service providers. On 6 July 2020, the BMA issued a similar notice, confirming that in assessing compliance with the requirement to hold physical board meetings in Bermuda for the period ending 30 September 2020, it would consider all circumstances including registrants’ inability to hold such meetings due to logistical and health difficulties resulting from COVID-19.
However, Charleson also highlights that the BMA also noted that it expects registrants to continue to conduct their board meetings virtually, by telephone, video.
Developments
Currently, Bermuda’s economic substance law applies to exempted and local companies, exempted and local limited liability companies, overseas permit companies and partnerships that elect to have a separate legal personality that carries on a ‘relevant activity’.
Charleson says it is anticipated that the legislation will be revised to extend its application to all partnerships, not just those with separate legal personality.
She comments: “Bermuda’s economic substance legislation will continue to develop as needed to ensure ongoing compliance with the scoping paper issued by the European Union’s Code of Conduct Group (Business Taxation) in June 2018.”
“There may also be minor changes relating to ‘levelling up’ between all offshore jurisdictions to reduce any motivation to ‘island-hop’,” Charleson concludes.
