Vincent Chan, Counsel of Appleby (Hong Kong office), summarises recent economic substance requirements and reporting obligations in Bermuda, the British Virgin Islands and the Cayman Islands.

The governments of Bermuda, the British Virgin Islands (BVI) and the Cayman Islands (Cayman) have each passed legislation that will require certain entities carrying out any ‘relevant activity’ to have economic substance (ES) in its jurisdiction. The legislation was introduced in response to concerns expressed by the Council of the European Union (EU) about the absence of ES requirements for entities doing business in and through these jurisdictions.

Below is a summary of the ES requirements (Requirements) as legislated in Bermuda, BVI and Cayman, respectively, as of 10 October 2019.

Bermuda

Legislation and registered entities

Bermuda’s ES Act 2018 (as amended) (Bermuda Act) and ES Regulations 2018 (Bermuda Regulations) became operative on 31 December 2018, and will be supplemented by the Guidance Note (Bermuda Guidance), which is currently in draft form. New registered entities incorporated or registered on or after 1 January 2019 have to comply with the Requirements from the date of incorporation/registration, whereas registered entities incorporated/registered on or before 31 December 2018 have to comply from 1 July 2019.

For purposes of the Bermuda Act and Bermuda Regulations, a ‘registered entity’ includes:

1. a company incorporated or an overseas company registered under the Companies Act (as amended)
2. a limited liability company formed under the Limited Liability Company Act, or
3. a partnership that has elected to have a separate legal personality under the Partnership Act.

Relevant activities

A registered entity will be in-scope of the Bermuda Act if it conducts any of the following ‘relevant activities’ (as defined in the Bermuda Regulations):

• banking
• insurance
• fund management
• financing
• leasing
• headquarters
• shipping
• distribution and service centre
• intellectual property (IP), and
• holding entity (HE).

Requirements

1. A registered entity conducting a relevant activity (other than a pure equity holding entity; PEHE) will satisfy the Requirements if:
2. it is managed and directed in Bermuda
3. its core income–generating activities (CIGAs) are undertaken in Bermuda with respect to the relevant activity
4. it maintains adequate physical presence in Bermuda
5. there are adequate full-time employees in Bermuda with suitable qualifications, and
6. there is adequate operating expenditure incurred in Bermuda in relation to the relevant activity.

PEHE and HE

A PEHE, being a company that carries out no relevant activity other than holding or managing equity participations, and which earns passive revenues from dividends, distributions, capital gains and other incidental income only, is subject to the following reduced Requirements:

1. compliance with (a) the applicable corporate governance requirements in the applicable company or partnership legislation, including keeping records of accounts, books and papers, and financial statements; and (b) submission on an annual basis of an ES declaration (Declaration) to the Registrar of Companies in Bermuda (Bermuda Registrar), and
2. adequate employees for holding and managing equity participations, as well as adequate premises in Bermuda. Pursuant to the draft Bermuda Guidance, this does not imply a positive obligation on that entity to hire employees or to acquire premises where no such employees or premises are reasonably required by that entity, and the maintenance of a registered office and the management of such entity by the board of directors in Bermuda may be considered to be adequate, having regard to the nature, scale and complexity of the entity’s business.

A registered entity will be classified as an HE if it engages in activities including holding or managing any assets or equity participations, in which case, unless it is a PEHE, it will be within the scope of the full Requirements for in-scope entities as outlined above.

Reporting obligations

Starting in 2020, within six months after the end of each financial year commencing in 2019, a registered entity that is subject to the Requirements will be required to file on an annual basis a Declaration with the Bermuda Registrar confirming that the entity complies with such Requirements.

BVI

Legislation and legal entities

BVI’s ES (Companies and Limited Partnerships) Act, 2018 (as amended) (BVI Act) came into force on 1 January 2019, and is supplemented by the Rules on Economic Substance in the British Virgin Islands (BVI Rules), issued by the BVI International Tax Authority (ITA), which were released on 9 October 2019.

For the purposes of the BVI Act, a ‘legal entity’ includes:

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

However, a ‘legal entity’ 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.

Relevant activities

The BVI Act imposes Requirements on all legal entities carrying out 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, but each relevant activity as defined in the BVI Act and clarified further in the BVI Rules should be referred to.

Requirements

Each legal entity (other than a PEHE) must, in relation to any relevant activity, carry out defined CIGAs in BVI and demonstrate ES by reference to the following criteria, having regard to the nature and scale of the relevant activity:

1. the relevant activity is directed and managed in BVI
2. there is an adequate number of suitably qualified employees in relation to that activity who are physically present in BVI
3. there is adequate expenditure incurred in BVI
4. there are appropriate physical offices or premises in BVI for the CIGAs, and
5. where the relevant activity is an IP business requiring the use of specific equipment, that equipment is located in BVI.

PEHE

A PEHE, being a company that carries out no relevant activity other than holding equity participations in other entities, and which earns dividends and capital gains only, is subject to the following reduced Requirements:

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

A legal entity that is an HE which holds something other than pure equity participations, or which earns income other than from dividends and capital gains, does not fit into the definition of a PEHE. If its other activities amount to any other relevant activity, it will be within the scope of the full Requirements as outlined above.

Pursuant to the BVI Rules, if a legal entity only holds equity participations during a given financial period, the relevant activity will be entirely passive in nature, and the requirements for adequate and suitably qualified employees and for appropriate premises will be applied accordingly. Also, the performance of the services of a BVI registered agent will be taken into account when assessing ES for a PEHE. However, if an entity actively manages its equity participations, it should have adequate and suitably qualified employees, and appropriate premises, in BVI to carry out such function.

Reporting obligations

Starting in 2020, a legal entity will be required to file information reasonably required by the BVI International Tax Authority (ITA) through its BVI registered agent with the BVI’s existing Beneficial Ownership Secure Search (BOSS) System. Annual reporting obligations commence at the end of the first financial period (being 12 months from the establishment date, if the BVI legal entity has been established on or after 1 January 2019, or 30 June 2019 for other BVI legal entities), and continues annually thereafter.

Cayman

Legislation and relevant entities

Cayman’s International Tax Co-operation (ES) Law, 2018 (as amended), and (Prescribed Dates) Regulations, 2018, (together, Cayman Law) became operative on 1 January 2019, and are supplemented by the Guidance for ES for Geographically Mobile Activities (Cayman Guidance) v2.0 (as amended). An updated version of the Cayman Guidance, together with the sector specific guidance notes, are currently being drafted and will be released in due course. New entities incorporated or registered on or after 1 January 2019 have to comply with the ES requirements from the date of incorporation/registration, whereas entities incorporated or registered on or before 31 December 2018 have to comply from 1 July 2019.

For the purposes of the Cayman Law, a ‘relevant entity’ means (with some exceptions):

1. a company, other than a domestic company, incorporated/registered under the Companies Law of Cayman (as amended) (Cayman Companies Law), or incorporated/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 incorporated outside Cayman and registered under the Cayman Companies Law.

However, a ‘relevant entity’ does not include:

• an investment fund (within the meaning of applicable Cayman legislation), or
• an entity that is tax resident outside Cayman.

Relevant activities

The Cayman Law imposes Requirements on all relevant entities carrying out any ‘relevant activity’.

A relevant entity incorporated or registered in Cayman will be in-scope of the Cayman Law if it conducts any of the relevant activities listed above under Bermuda’s relevant activities, but each relevant activity as defined in the Cayman Law and clarified further in the Cayman Guidance should be referred to.

Requirements

A relevant entity conducting a relevant activity (other than a PEHE) will satisfy the Requirements if it:

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

PEHE

A PEHE, being a company that carries out no relevant activity other than holding equity participations in other entities, and which earns dividends and capital gains only, is subject to the following reduced Requirements:

1. compliance with all applicable filing requirements under applicable Cayman legislation, and
2. adequate human resources and adequate premises in Cayman for holding and managing equity participations in other entities.

Engagement of a Cayman registered office service provider may be able to satisfy these reduced Requirements where the PEHE is passively holding equity interests in other entities, depending on the level and complexity of activity required to operate its business.

Reporting obligations

Starting in 2020, a relevant entity will be required to file a notice with the Cayman Tax Information Authority (TIA) stating whether it is carrying out any relevant activity and, if so, whether all or any part of the relevant entity’s gross income is subject to tax in a jurisdiction outside Cayman (with supporting evidence), and the date of the end of its financial year.

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 report setting out certain particulars.

IP business

Bermuda, BVI and Cayman place enhanced requirements on entities carrying out IP businesses, and further requirements for those engaging in high-risk IP activities (as defined in the respective legislation).

Tax residency outside Bermuda, BVI or Cayman

Any Bermuda, BVI or Cayman entity resident for tax purposes in a jurisdiction outside Bermuda/BVI/Cayman, respectively – and for Bermuda and BVI, such jurisdiction not in the EU list of non-cooperative jurisdictions for tax purposes – (such jurisdiction hereinafter described as Territory A) is regarded as a non-resident entity (or no longer regarded as a relevant entity) and therefore is exempted from compliance with the Requirements. Satisfactory evidence is required to be produced to substantiate the same, such as:

• Bermuda/BVI. A letter or certificate stating that the entity is considered to be tax resident in Territory A, or a tax assessment, tax self-assessment confirmation, tax demand, evidence of tax payment or any other document issued by the competent authority/tax authority for Territory A. For Bermuda, the Bermuda Registrar may also require a letter from a suitably qualified professional stating that, in his/her opinion, the entity is considered to be tax resident in Territory A.
• Cayman. A Tax Identification Number, tax residence certificate of Territory A, and assessment/payment of corporate income tax liability on its gross income in Cayman from a relevant activity.

Outsourcing

An in-scope entity may outsource some or all of its CIGAs to another person or entity (including a third-party service provider or an entity in the same group), provided that (i) such in-scope entity is able to monitor and control the carrying out of CIGAs by that person/entity, (ii) such CIGAs are performed in the respective offshore jurisdiction, (iii) there must be no double counting if services are provided to more than one in-scope entity carrying out relevant activities, and (iv) any third-party service provider engaged should have adequate resources to fulfil the outsourced activities.

Enforcement action

All ES filings in Bermuda, BVI and Cayman will be examined by the Bermuda Registrar, BVI ITA and Cayman TIA, respectively, to ensure that the relevant entity has adequate ES. If such relevant entity lacks adequate ES, such authority/registrar may give the entity reasons for such determination, as well as direction on how to meet the test, and may impose a fine. Continued failure to meet the test in the following year may result in higher fines and could lead to the entity being struck off the applicable register. Also, any person (which potentially includes directors or partners) who knowingly supplies false or misleading information to the authority/registrar shall be liable for a fine and/or imprisonment.

Recommendations

Entities incorporated or registered in Bermuda, BVI and Cayman should consider whether they meet the definition of Bermuda’s registered entity, BVI’s legal entity or Cayman’s relevant entity (and not being tax resident in Territory A), and undertake an internal review to determine if they carry out any one or more relevant activities. If so, they should consider whether any operational or structural changes are required. It is also recommended that such entities seek advice on which steps should be taken to comply with the relevant jurisdiction’s Requirements.

Vincent Chan, Counsel

Appleby (Hong Kong office)