Economic Substance Requirements in Bermuda, the British Virgin Islands and the Cayman Islands

Each of the governments of Bermuda, the British Virgin Islands (BVI) and the Cayman Islands has passed legislation that will require certain entities carrying on any “relevant activity” to have “economic substance” in its jurisdiction.

The legislation was introduced in response to concerns expressed by the Council of the European Union about the absence of economic substance requirements for entities doing business in and through these jurisdictions.

Below is a summary of the economic substance requirements (Requirements) as legislated in Bermuda, the BVI and the Cayman Islands, respectively.

BERMUDA

Bermuda’s legislation and “registered entities”

Bermuda’s Economic Substance Act 2018 (Bermuda Act) and Economic Substance Regulations 2018 became operative on 31 December 2018.   The regulations were subsequently amended (as amended, Bermuda Regulations).  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 Act and Bermuda Regulations, a “registered entity” is:

  1. a company incorporated or an overseas company registered under the Companies Act 1981;
  2. a company formed under the Limited Liability Company Act 2016; or
  3. a partnership (exempted, exempted limited or overseas) which has elected to have separate legal personality under s.4A of the Partnership Act 1902.

There is currently no exemption from Bermuda’s Requirements for entities which are tax resident outside of Bermuda.

Bermuda’s “relevant activities”

A “registered entity” will be in scope of the Bermuda Act if it conducts any of the following “relevant activities”:

  • banking;
  • insurance;
  • fund management;
  • financing;
  • leasing;
  • headquarters;
  • shipping;
  • distribution and service centre;
  • intellectual property; and
  • holding entity.

Each relevant activity is defined in the Bermuda Regulations and anticipated to be clarified when the guidance notes are issued in due course.

Bermuda Requirements for in-scope entities

A registered entity conducting a relevant activity (as outlined above) will satisfy the Bermuda Requirements if:

  1. it is managed and directed in Bermuda;
  2. its core income-generating activities are undertaken in Bermuda with respect to the relevant activity;
  3. it maintains adequate physical presence in Bermuda;
  4. there are adequate full-time employees in Bermuda with suitable qualifications; and
  5. there is adequate operating expenditure incurred in Bermuda in relation to the relevant activity.

The Bermuda Act and the Bermuda Regulations place enhanced Requirements on registered entities that carry on intellectual property businesses.

Bermuda’s “pure equity holding entity”

For the purposes of the Bermuda regime, a registered entity will be classified as a “pure equity holding entity” if it only holds or manages equity participations, and earns passive revenues from dividends, distributions, capital gains and other incidental income only.

A pure equity holding entity is subject to reduced Requirements and will comply with Bermuda Requirements if it:

  1. complies with (a) the applicable corporate governance requirements as set out in the applicable company or partnership legislation; and (b) submits on an annual basis an economic substance declaration (Declaration) with the Bermuda Registrar of Companies (Bermuda Registrar); and
  2. can demonstrate that it has adequate people and premises in Bermuda to hold and manage equity participations.

A registered entity will be classified as a holding entity if it engages in activities including holding or managing any assets or equity participations, in which case it will be within scope of the full Bermuda Requirements as outlined above.

Bermuda’s reporting obligations

A registered entity that is subject to the Bermuda 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 such Requirements.

THE BRITISH VIRGIN ISLANDS

BVI’s legislation and “legal entities”

The BVI’s Economic Substance (Companies and Limited Partnerships) Act, 2018 came into force on 1 January 2019 and was subsequently amended (as amended, the BVI Act).  The BVI Act will be supplemented by the BVI’s Economic Substance Code (BVI Code) which is currently in draft form and is expected to be finalised shortly.  For the purposes of the BVI Act, a “legal entity” is:

  1. a company incorporated or a foreign company registered under the BVI Business Companies Act, 2004 (as amended); or
  2. a limited partnership or a foreign limited partnership formed or registered under the Partnership Act, 1996 or the Limited Partnership Act, 2017, excluding any limited partnership which does not have legal personality;

but does not include:

  1. an investment fund (within the meaning of applicable BVI legislation); or
  2. a non-resident company or a non-resident limited partnership.

An entity is a “non-resident company” or a “non-resident partnership” if the company or partnership is resident for tax purposes in a jurisdiction outside the BVI which is not on the EU list of non-cooperative jurisdictions for tax purposes.

BVI’s “relevant activities”

The BVI Act imposes Requirements on all “legal entities” carrying on any “relevant activity”.

A legal entity will be in scope of the BVI Act if it conducts any of the “relevant activities” listed above under Bermuda’s relevant activities.  We note, however, that for the purposes of the BVI regime, each relevant activity is defined in the BVI Act and will be clarified further in the BVI Code.

BVI’s requirements for in-scope entities

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:

  1. the relevant activity being directed and managed in the BVI;
  2. 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);
  3. adequate expenditure being incurred in the BVI;
  4. appropriate physical offices or premises in the BVI; and
  5. where the relevant activity is intellectual property business and requires the use of specific equipment, the equipment being located in the BVI.

The BVI Act places enhanced Requirements on legal entities that carry on intellectual property businesses.

BVI’s “pure equity holding entity”

For the purposes of the BVI regime, pure equity holding entities are those entities that fall within the scope of the BVI Act, but which carry on no other relevant activity other than holding equity participations in other entities and only earn dividends and capital gains.  A pure equity holding entity is subject to reduced Requirements and will comply with the BVI Requirements if it:

  1. complies with its statutory obligations under the BVI Business Companies Act, 2004 (as amended) or the Limited Partnership Act, 2017, as applicable; and
  2. has, in the BVI, adequate employees and premises for holding equity participations and, where it manages those equity participations, has in the BVI adequate employees and premises for carrying out that management.

BVI’s reporting obligations

All legal 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 Act.  Such filings will be made through the legal entity’s registered agent in the BVI into the BVI’s existing Beneficial Ownership Secure Search System.

THE CAYMAN ISLANDS

Cayman Islands’ legislation and “relevant entities”

The Cayman Islands’ International Tax Co-operation (Economic Substance) Law, 2018 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.  The above Law was subsequently amended (the Law, as amended, Cayman Law).  For existing relevant entities, there is a six-month transition period and the first reporting will commence in 2020.  The Cayman Law is supplemented by the Cayman Islands Guidance for Economic Substance for Geographically Mobile Activities (Cayman Guidance).

For the purposes of the Cayman Law, “relevant entity” means (with some exceptions):

  1. 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;
  2. a limited liability partnership registered under the Limited Liability Partnership Law; or
  3. a company that is incorporated outside of the Cayman Islands and registered under the Companies Law,

but does not include:

  1. an investment fund (within the meaning of applicable Cayman Islands legislation); or
  2. an entity that is tax resident outside the Cayman Islands.

Cayman Islands’ “relevant activities”

The Cayman Law imposes Requirements on all “relevant entities” carrying on any “relevant activity”.

A relevant entity incorporated or registered in the Cayman Islands will be in scope of the Cayman Law if it conducts any of the “relevant activities” listed above under Bermuda’s relevant activities.  We note, however, that for the purposes of the Cayman Islands regime, each relevant activity is defined in the Cayman Law and is clarified further in the Cayman Guidance.

Cayman Islands Requirements for in-scope entities

A relevant entity will satisfy the Cayman Islands Requirements in relation to a relevant activity if it:

  1. conducts Cayman Islands core income-generating activities (i.e. 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;
  2. is directed and managed in an appropriate manner in the Cayman Islands in relation to that relevant activity;
  3. having regard to the level of relevant income derived from the relevant activity carried out in the Cayman Islands:
  1. has an adequate amount of operating expenditure incurred in the Cayman Islands;
  2. has an adequate physical presence (including maintaining a place of business or plant, property and equipment) in the Cayman Islands; and
  3. has an adequate number of full-time employees or other personnel with appropriate qualifications in the Cayman Islands.

The Cayman Law places enhanced Requirements on entities that carry on intellectual property businesses.

Cayman Islands’ “pure equity holding company”

Under the Cayman Law, a “pure equity holding company” is a company that only holds equity participations in other entities and only earns dividends and capital gains.

A pure equity holding company is subject to reduced Requirements and will comply with the Cayman Islands Requirements if it confirms that:

  1. it has complied with all applicable filing requirements under the Companies Law; and
  2. it has adequate human resources and adequate premises in the Cayman Islands for holding and managing equity participations in other entities.

A relevant entity that is a holding company that holds something other than pure equity interests, or that earns income other than from dividends and capital gains, does not fit into the definition of “pure equity holding company”.  If its other activities amount to any other relevant activity (as defined in the Cayman Law), it will be within scope of the full Cayman Islands Requirements as outlined above.

Cayman Islands’ reporting obligations

A relevant entity that is subject to the Cayman Islands Requirements will be required to file a notice with the Cayman Islands Tax Information Authority (TIA) stating whether it is carrying out any relevant activity.

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.

RECOMMENDATION:  TAKE ACTION NOW

We recommend that entities incorporated or registered in Bermuda, BVI or the Cayman Islands consider whether they meet the definition of Bermuda’s “registered entity”, BVI’s “legal entity” or Cayman’s “relevant entity”.  Any entity that appears to be in scope of the economic substance legislation of any of these jurisdictions should undertake an internal review to determine if it undertakes any “relevant activity” (as defined under the legislation of the applicable jurisdiction) and, if so, seek advice as to which steps it must take in order to comply with that jurisdiction’s Requirements.

Partner, Appleby

Fiona Chan is a partner in the corporate department of Appleby´s Hong Kong office, advising on a full spectrum of banking and finance, non-contentious insurance, private client and trust matters relating to the laws of Bermuda, British Virgin Islands and Cayman Islands. Fiona is a member of Appleby's global Technology & Innovation Group and leads the Fintech/ICO team in Hong Kong. She also advises on latest developments of economic substance requirements in Bermuda, BVI and Cayman.

Fiona has been widely recognized by her clients as well as legal directories. She was selected as one of the region's 10 most notable offshore lawyers of the Asian Legal Business' Offshore Client Choice List 2017, 2018 and 2019. She was also selected as one of the 2017 Influential Women in Re/Insurance by Intelligent Insurer and recognized in Legal 500 Asia-Pacific (Offshore). She regularly speaks at conferences and seminars and is often asked to contribute to policy discussions, interviews and articles for leading industry organizations and journals in the offshore space. 

Senior Associate, Appleby

Shana S. Simmonds is a Senior Associate within the Corporate Practice Group in Hong Kong. Her practice areas include Corporate Finance, Banking and Asset Finance, Private Client and Intellectual Property. Prior to joining Appleby in 2015, Shana practiced at other well-established law firms in the British Virgin Islands where she was regularly instructed by leading financial institutions, law firms and trust companies on a variety of corporate transactions including corporate restructuring, securitisation, initial public offerings, general banking and commercial matters and financial regulated activities.

Shana has broad corporate law experience including advising on a range of finance, general corporate and commercial matters and other secured and structured financings, joint ventures, mergers and acquisitions, private equity transactions and restructurings, and regulatory matters. Shana also advises on probate and succession matters including applications for grants of personal representation and trademark applications. Shana is also a Notary Public.