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 “relevant activities” to have “economic substance” in Bermuda, the BVI and the Cayman Islands, respectively.
The 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.
Below is a summary of the economic substance requirements in Bermuda, the BVI and the Cayman Islands.
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, “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.
A registered entity will be in scope of the Bermuda Substance Act if it conducts any of the following “relevant activities”:
- fund management;
- financing and leasing;
- distribution and service centre;
- holding entity;
- intellectual property.
Each of the above activities is defined in the Bermuda Substance Regulations.
A registered entity conducting a relevant activity will satisfy the Bermuda economic substance requirements if:
- it is managed and directed in Bermuda;
- 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.
Pure equity holding companies are subject to a reduced test and certain intellectual property entities will be subject to enhanced requirements. Outsourcing of core income generating activities is permitted in certain circumstances.
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 regime applies to the following “legal entities”:
- companies and foreign companies incorporated/registered under the BVI Business Companies Act, 2004, 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.
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 following “relevant activities”:
- banking business;
- insurance business;
- fund management business;
- finance and leasing business;
- headquarters business;
- shipping business;
- holding business;
- intellectual property business;
- distribution and service centre business.
Each of the above activities is defined in the BVI Substance Act.
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.
Outsourcing of core income generating activities is permitted in certain circumstances.
Pure equity holding entities which carry on no relevant activity other than holding equity participations in other entities and which only earn dividends and capital gains are subject to less onerous requirements. Certain intellectual property entities will be subject to enhanced requirements.
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.
For the purposes of the Cayman Substance Law, “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, unless its business is centrally managed and controlled in a jurisdiction outside the Cayman Islands and the company is tax resident outside the Islands;
- a limited liability partnership registered under the Limited Liability Partnership Law, unless its business is centrally managed and controlled in a jurisdiction outside the Cayman Islands and the limited liability partnership is tax resident outside the Islands; and
- a company that is incorporated outside of the Cayman Islands and registered under the Companies Law, unless its business is centrally managed and controlled in a jurisdiction outside the Cayman Islands and the company is tax resident outside the Islands.
A relevant entity is only in scope of the Cayman Islands economic substance requirements if and to the extent that it conducts any “relevant activity”. Relevant activities are:
- banking business
- distribution and service centre business
- finance and leasing business
- fund management business
- headquarters business
- holding company business
- insurance business
- intellectual property holding business
- shipping business
Each of the above activities is defined in the Cayman Substance Law.
A 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 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.
Pure equity holding companies are subject to a reduced test and certain intellectual property entities will be subject to enhanced requirements. Outsourcing of core income-generating activities is permitted in certain circumstances.
Appleby expects that there will be further refinements to the definition of “relevant entity” in the coming weeks, so clients are encouraged to watch for our further updates on this point.
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.
Additional guidance will be forthcoming from the government in each of Bermuda, the BVI and the Cayman Islands on the nuances of the substance requirements. Once guidance has been issued, Appleby can assist in addressing the requirements of the new regime.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.