When considering the use of offshore vehicles in structuring an M&A transaction, it is important to know what regulatory and compliance requirements are applicable in each jurisdiction. This article will provide an overview of what is required in Bermuda and the Cayman Islands, highlighting the similarities and differences between the two jurisdictions and charting a course through the confusing landscape of regulatory acronyms.
As leading offshore jurisdictions, Bermuda and the Cayman Islands continue to be at the forefront of global regulatory developments. These developments have, at times, witnessed a departure from traditional regulatory models and are not without their challenges. However, with such changes also come opportunities.
KNOW YOUR CLIENT (KYC)
Businesses and service providers in Bermuda and the Cayman Islands are subject to stringent anti-money laundering (AML) and anti-terrorist financing (ATF) legislation both at a local and an international level. These include recommendations and regulatory pronouncements from the Financial Action Task Force on Money Laundering (FATF), the UN Security Council, the Basel Committee on Banking Supervision, the International Association of Insurance Supervisors (IAIS) and the International Organisation of Securities Commissions (IOSCO).
The broad regulatory objective is for businesses in these jurisdictions to know who their clients are and what they do. The precise legislation and regulation applicable to a business will depend upon the type of business and the industry in which it operates within the jurisdiction. Whilst such laws primarily apply to financial institutions and fiduciaries, they can extend to other parties such as attorneys and estate agents in certain jurisdictions. Anyone contemplating an M&A transaction in Bermuda or the Cayman Islands should expect to encounter the KYC regime at some point or another.
FOREIGN ACCOUNT TAX COMPLIANCE ACT (FATCA)
FATCA was signed into US law on 18 March 2010 and is intended to have global reach.
The FATCA legislation primarily imposes a reporting system on US taxpayers holding financial assets outside the US, requiring them to report those assets to the Internal Revenue Service (IRS). However, FATCA also requires foreign financial institutions (FFIs) to report certain information directly to the IRS about financial accounts held by US tax payers or by foreign entities in which US tax payers hold a substantial ownership interest.
The definitions of "foreign financial institution" and "financial accounts" are complex and not as obvious as one might expect. The critical point is for each business in Bermuda and the Cayman Islands to determine in which FATCA category each entity in their group structure falls and then what aspects of their business amount to a "financial account".
The core objective of FATCA is to ensure that the US tax authorities are able to identify all assets held by US persons in FFIs outside of the United States and collect the appropriate amount of tax from all US persons.
Although FATCA is a US law, other countries have already begun to follow suit. The UK made FATCA a priority topic at the G8 summit in June 2013 and championed it as a global standard. In preparation, businesses should ensure that the systems they put in place to comply with FATCA are capable of handling the same obligations in relation to persons of each country enacting similar legislation.
Due to jurisdictional limits on the extent of US legislation, FATCA is enforced in a number of ways and is very much dependent upon each cooperating country entering into an agreement with the US authorities to assist in its implementation. The incentive for compliance is high; there is a 30% withholding tax levied on all US sourced payments to foreign businesses who do not comply with the FATCA obligations.
Three methods of cooperation are available for jurisdictions seeking to become FATCA-compliant, with the chosen method determining how the businesses of that jurisdiction will report requisite FATCA information. Under the Model 1 Intergovernmental Agreement (IGA 1), local FFIs are not required to report information directly to the IRS but instead, to a local authority established in their home jurisdiction by their own government. This authority is then responsible for onward disclosure of the information to the US authorities.
The Model 2 Intergovernmental Agreement (IGA 2) provides for direct registration and reporting by businesses in a country to the US authorities, which requires local laws to be adapted to ensure local businesses are not subject to any legal restriction preventing them from complying with the FATCA reporting obligations directly with the US authorities.
The third option is for a jurisdiction not to enter into either an IGA 1 or IGA 2 and simply leave it up to local businesses to determine whether and how to comply with FATCA.
The Cayman Islands have entered into an IGA 1 with the US and Bermuda has entered into an IGA 2. The IGA 1 eliminates the need for individual FFIs within the Cayman Islands to enter into a separate agreement with the IRS and the IGA 2 eliminates the need for individual FFIs in Bermuda to provide information to the local government authorities for onward transmission to the IRS; but, otherwise, the obligations for FFIs in both jurisdictions will be the same in terms of what information they will be required to obtain, maintain and report.
Senior executives of FFIs in both Bermuda and the Cayman Islands will need to be aware of the obligations imposed upon their business by FATCA and ensure that (i) adequate processes are put in place to obtain, maintain and report requisite information in relation to all clients and customers going forward, and (ii) an historical due diligence exercise is implemented to ensure that existing client records are updated and upgraded to meet the new requirements.
TAX INFORMATION EXCHANGE AGREEMENTS (TIEAS)
The global financial crisis of 2008 resulted in increased scrutiny of the offshore world and renewed focus on the development and implementation of international standards in tax cooperation. The main organisations that have been responsible for forging global acceptance and cooperation in such matters are the Organisation for Economic Co-operation and Development (OECD) and the G20.
The OECD has assessed and reported on the legal and administrative framework for transparency and exchange of information on a global scale, in particular the commitment to transparency and exchange of tax information under the umbrella of eliminating so-called "Harmful Tax Practices" and identifying so-called "uncooperative countries or territories".
The OECD has established standards on transparency and exchange of information for tax purposes, and has strongly encouraged countries to adopt these standards which are based on internationally agreed principles of transparency and cooperation for the exchange of tax related information (the Principles). The key aspects of the Principles are:
- exchange of information on request where it is foreseeably relevant to the administration and enforcement of the domestic laws of a treaty partner;
- no restrictions on exchange caused by bank secrecy or domestic tax interests requirements;
- availability of reliable information, particular accounting, bank and ownership information and powers to obtain it;
- respect for taxpayers' rights; and Bullets 1st Level Green
- strict confidentiality of information exchanged.
In compliance with the Principles, Bermuda and the Cayman Islands have together entered into 69 TIEAs (Bermuda currently has 38 and the Cayman Islands 31). Tax information exchange under a TIEA is by request only, and there are strict criteria with which each request must comply. These safeguards require that each request relates to a real and specific matter and is not just part of a "fishing expedition".
More recently the OECD and G20 introduced and promoted the Convention on Mutual Administrative Assistance in Tax Matters (CMAATM), which has now been accepted as the new internationally recognised standard for the mutual administrative assistance in tax matters. Whilst the CMAATM includes provisions for information exchange on request (as was provided for under TIEA) it has also included provisions to cover spontaneous and automatic exchange of information.
The CMAATM is already in force in both Bermuda and the Cayman Islands.
ALTERNATIVE INVESTMENT FUND MANAGERS DIRECTIVE (AIFMD)
The AIFMD is a European Union directive originally introduced in response to the global financial crisis of 2008 to establish a comprehensive regulatory and supervisory framework for managers of alternative investment funds at a European level.
Prior to the introduction of the AIFMD, only those funds that fell within the scope of, and were required to comply with the rules set out in, the UCITS Directive (85/611/EEC) (Undertakings for Collective Investment in Transferable Securities), were subject to harmonised cross-European regulation of the sector. All other funds are, for the purposes of the AIFMD, identified by the European Commission as Alternative Investment Funds (AIFs).
Historically AIFs were subject to the financial and company laws of each jurisdiction in which they operated or were involved, and in some cases they were also subject to additional industry developed standards. It was determined that the historical regulatory environment did not adequately address the level and type of risks involved in the cross border activities of AIFs and, due to the vulnerability of Member States to cross border contamination of AIF risks, that a European wide approach, similar to that provided for under the UCITS Directive, be introduced.
Implications for businesses in Bermuda and the Cayman Islands only extend to managers of AIFs that either perform risk management or portfolio management functions in the European Union or market units, shares or interests in AIFs to European investors.
The regulatory landscape in Bermuda and the Cayman Islands continues to change in response to global demands for higher levels of AML, ATF, tax cooperation, transparency and fund oversight standards. Bermuda and the Cayman Islands now lead the world with the highest regulatory standards in these areas. Although these changes have introduced a slew of intimidating-sounding acronyms, the reality is that with the help and guidance of a trusted local advisor in these jurisdictions, regulatory reforms have provided new and exciting opportunities for offshore M&A activity to thrive in the current environment and into the future.
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.