This article first appeared in Captive International, March 2020.
Fears that the implementation of an "economic substance" regime in Bermuda might dent its prominent captive industry appear to have been misplaced. If anything, recent developments look set to strengthen rather than undercut Bermuda's global position in the captive arena, particularly given the strategic advantage that its recent "white-listed" status gives it over an important competitor in the area, the Cayman Islands. These developments, coinciding as they do with a recent hardening of rates in many property and casualty lines, promise fair winds for Bermuda's captive industry in 2020.
Bermuda's global position in the captive sector
Bermuda is the premier domicile for captive insurers. As at 31 December 2019, there were 715 companies licensed as captive insurers in Bermuda, representing annual gross premium income of approximately $40 billion. Bermuda licenses more captive insurers than any other domicile other than the United States of America (USA) and more than any single state of the USA.
The implementation of economic substance legislation in Bermuda
At the end of 2018, Bermuda implemented the Economic Substance Act 2018 and Economic Substance Regulations 2018 (together, ESA) in response to guidance published by the European Code of Conduct Group (Business Taxation) (COCG) regarding the manner in which the COCG will assess Bermuda's compliance with the "economic substance" element of its "fair taxation" criteria. The compliance date was 1 July 2019.
The legislation requires all insurers (including captives) to maintain a "substantial economic presence" in Bermuda. A certain amount of local outsourcing in Bermuda is permitted, provided the outsourcing entity complies with economic substance requirements.
Fears had been expressed that the cost of compliance with the ESA would disturb the economics of maintaining a Bermuda captive, or at least tip the scales in favour of redomestication to jurisdictions with less onerous, or no, substance requirements, such as Vermont and other USA states with captive insurer regimes.
Others had been more sanguine. Bermuda's Minister of Finance, Curtis Dickinson, portrayed the legislation as a positive development for Bermuda when he announced its enactment at a press conference on 9 January 2019. His expectation was that the legislation would in fact lead to a rise in employment levels in Bermuda responding to any additional resourcing needs for compliance with ESA.
The consequences in practice – one year on
It will be some months, following the first statutory filings, before we know how many captives are approved as compliant with ESA by the supervisor of ESA matters in Bermuda, the Bermuda Registrar of Companies. But since captives were already subject to requirements to maintain a presence by virtue of the regulatory rules under the Insurance Act 1978 (Insurance Act), they will be able to demonstrate compliance with ESA by continuing to comply with applicable provisions of the Insurance Act.
While there has been a notable uptick in the levels of discontinuances and voluntary liquidations of Bermuda companies generally in the last year, the majority of these appear to be intellectual property companies and funds. As yet, overall captive numbers seem to have held steady.
So it looks as if the Minister of Finance's optimism in January 2019 may have been well-founded.
Furthermore, not only has Bermuda's global position apparently survived the legislative reforms, its success in implementing substance requirements may yield further dividends.
At a meeting of the EU Economic and Financial Affairs Council (ECOFIN) on 18 February 2020, Bermuda, along with 15 other jurisdictions, was found to have implemented all necessary reforms to comply with EU tax good governance principles ahead of the agreed deadline and was therefore removed from Annex II of the EU list of 'non-cooperative' jurisdictions for tax purposes (Annex II being the 'watch-list' for possible inclusion in Annex I, the list of jurisdictions deemed non-cooperative).
Not only has the ESA resulted in Bermuda's new "white-listed" status, it has indirectly provided it with a strategic advantage over jurisdictions which also compete in the captive arena, who are either still on the watch list or have been "black-listed", such as the Cayman Islands.
The Cayman Islands has a substantial captive industry, notably focusing on the healthcare sector. But its funds industry is the more prized asset, and its failure to enact new private funds legislation prior to a deadline imposed by ECOFIN of 31 January 2020 resulted in the jurisdiction's "black-listing" at the ECOFIN meeting on 18 February 2020.
Whether blacklisting will present serious issues for Cayman's industry, at all or in the long-term, is unclear.
True, there are tangible detriments to a jurisdiction's "black-listing". It means that Member States of the EU are to apply "defensive measures" in respect of it, including reinforced monitoring of transactions, increased audit risks for taxpayers benefiting from the tax regime in the jurisdiction and increased audit risks for taxpayers using structures or arrangements involving the jurisdiction. Other measures include non-deductibility of costs, controlled foreign company rules, withholding tax measures, mandatory disclosure of specific tax schemes. Blacklisting also carries with it reputational damage.
But a large proportion of captive risks insured in Cayman originate in the Americas; European risk represents a less notable component. Furthermore, Bermuda itself managed to reverse, after 66 days, a temporary blacklisting in 2019 following delay in passing new legislation prior to another ECOFIN deadline. Cayman currently seems confident that its blacklisting will be temporary and can be resolved, although this is now unlikely to happen before the next ECOFIN review of non-cooperative jurisdictions, expected to be in October 2020.
In the meantime, however, during this encouraging time for the captive industry, one can expect Bermuda to extract as much value as possible in its global business development activities from its favourable comparison with Cayman.
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. Kennedys operates in Bermuda in association with Kennedys Chudleigh Ltd.