The Council of the EU adopted a resolution on a Code of Conduct for business taxation, the aim of which is counteracting the effects of zero tax and preferential tax regimes around the world. In 2017 the Code of Conduct Group (Code Group) investigated the tax policies of both EU member states and third countries, assessing (i) tax transparency; (ii) fair taxation; and (iii) implementation of anti–BEPS measures.
Following assessment by the Code Group, Bermuda was included in a list of jurisdictions which are required to address the Code Group's concerns about 'economic substance'. Like their counterparts in BVI, Cayman, Guernsey, Jersey and Isle of Man, the government of Bermuda has been working closely with the Code Group to ensure those concerns are addressed. As a result of this engagement, the Economic Substance Act 2018 (Substance Act) and the Economic Substance Regulations 2018 (Substance Regulations) became operative on 31 December 2018.
Which entities are subject to the Substance Act?
The Substance Act applies to "registered entities" which means:
- companies incorporated under the Companies Act 1981 (Companies Act);
- companies formed under the Limited Liability Company Act 2016 (LLC Act); and
- partnerships (exempted, exempted limited or overseas) which have elected to have separate legal personality under s4A of the Partnership Act 1902.
A registered entity will be in scope of the Substance Act if it conducts a relevant activity. The relevant activities are:
- fund management;
- financing and leasing;
- distribution and service centers;
- holding entity;
- intellectual property.
What are the economic substance requirements?
A registered entity conducting a relevant activity will satisfy the economic substance requirements if:
- it is managed and directed in Bermuda;
- core income generating activities1 (CIGA) are undertaken in Bermuda in relation to the relevant activity;
- it maintains adequate physical premises in Bermuda;
- there are adequate full time employees in Bermuda with suitable qualifications;
- there is adequate operating expenditure incurred in Bermuda in relation to the relevant activity.
How will an entity be assessed on compliance?
The Minister of Finance (Minister) will determine whether an entity is compliant with the economic substance requirements. The Substance Regulations set out various factors which the Minister will consider when assessing compliance and includes four key elements:
(i) the extent of the relevant activity engaged in by the relevant entity and in particular the CIGA undertaken with respect to such relevant activity;
(ii) the extent of the entity's presence in Bermuda, including physical offices occupied by the entity or its affiliate in Bermuda and the entity's level of annual expenditure in Bermuda;
(iii) whether the entity is managed and directed in or from Bermuda, having regard to where strategic, risk and operational decision-making is occurring. The Minister will also have regard to the number of suitably qualified senior executives, employees or other persons in Bermuda who are responsible for oversight or execution of its CIGA. Consideration will also be given to the location of board meetings and the frequency of meetings held in Bermuda in relation to the overall number of meetings;
(iv) the extent of outsourcing to affiliates or service providers in Bermuda and whether the employees responsible for the oversight of the outsourcing arrangements are suitably qualified and whether the employees of the affiliate/service provider are suitably qualified.
Each entity will be assessed individually as to its compliance with the substance requirements. There is no group filing nor group exemption available under the Substance Act.
Compliance with the Substance Act for certain regulated entities
A company licensed under the Insurance Act 1978 or the Banks and Deposit Companies Act 1999 (together the Regulatory Acts) will be in compliance with the economic substance requirements if the relevant company complies with (i) the appropriate requirements set out in the Companies Act with respect to corporate governance; and (ii) complies with the applicable requirements, rules and regulations under the relevant Regulatory Act.
Minimum economic substance requirements
Local entities (that are not otherwise registered under a Regulatory Act) are required to adhere to "minimum economic substance requirements". This means (i) complying with the applicable corporate governance requirements as set out in the Companies Act, LLC Act or applicable partnership legislation; and (ii) submitting an annual Declaration (see below for further details of the reporting obligations) (Minimum Economic Substance).
A holding entity will comply with economic substance requirements if it complies with Minimum Economic Substance and can demonstrate that it has adequate people and premises in Bermuda to hold and manage equity participations. An entity will be classified as a holding entity if it only holds equity participations, and earns passive revenues from dividends, distributions, capital gains and other incidental income. If the holding entity also engages in any relevant activity, it will be within scope of the full economic substance requirements.
Enhanced substance requirements for IP income
The Substance Regulations set out specific requirements for IP related activities which will apply whether or not that is the entity's main activity. An entity is engaging in "IP activities" if it derives revenue from the exploitation of its IP assets. "IP assets" include patents, technical know-how, trademarks, brands and goodwill and will therefore be applicable to a broad range of businesses and not restricted to pure IP companies.
When assessing if an entity is engaging in IP activities, the Minister will consider (a) the nature of the IP asset; and (b) how the IP asset is being used to generate income for the entity.
Certain IP companies are deemed to be "high-risk". This includes companies that own IP assets that have been acquired from related parties and are licensed back to (or otherwise monetised through the activities of) such related parties, as well as IP-owning companies that do not carry out R&D activities in the jurisdiction. A high-risk IP entity will be presumed not to comply with the economic substance requirements unless the entity can demonstrate that (i) the CIGA related to IP activity is generated in Bermuda; and (ii) that the entity does not merely passively hold and generate revenue from assets in Bermuda.
How is "adequate" to be assessed?
The legislation does not impose a minimum annual expenditure, nor a minimum number of employees in order to satisfy the economic substance requirements. Rather, "adequacy" will be assessed based on the particular circumstances of the entity . Guidance notes (which will include illustrative examples of CIGA for each of the relevant activities) will be issued by the Government in due course to facilitate assessment of and compliance with the economic substance requirements.
Is outsourcing of CIGA permitted?
The Substance Regulations provide that, in certain circumstances, outsourcing of CIGA to an affiliate or service provider in Bermuda will count towards satisfying economic substance requirements.
Reporting obligations: Economic Substance declaration
Entities that are subject to economic substance requirements will be required to file on an annual basis an economic substance declaration (Declaration) with the Registrar of Companies (Registrar), confirming that the entity complies with the economic substance requirements.
The Declaration will require the disclosure of certain key information applicable to an analysis of substance requirements, including (i) the nature and of the relevant activity being undertaken by the entity and the CIGA being undertaken by that entity in Bermuda; and (ii) the nature and extent of the entity's presence in Bermuda. A draft of the Declaration is being prepared and will be prescribed by the Minister in due course.
The Substance Act makes it clear that disclosure of economic substance information to members of the public will not be permitted and that the Public Access to Information Act will not be applicable to information relating to economic substance.
Compliance and Enforcement
The Registrar will have monitoring and enforcement powers under the Registrar of Companies (Compliance Measures) Act 2017 which includes the power to fine companies for non-compliance, as well as having the power to apply to the Bermuda Court to make an order requiring a non-compliant entity to take any action to satisfy economic substance requirements, including to prohibit business activity. The ultimate sanction, for repeated non-compliance with the substance requirements, is for the relevant entity to be struck off the register.
The commencement date for the Substance Act was 1 January 2019 and the new regime is immediately applicable to new registered entities incorporated or registered after this date. For existing entities, there is a 6 month transitional period. The first reporting will commence in 2020.
1 Please refer to the appendix for examples of CIGA applicable to each relevant activity
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.