Vincent Chan, Counsel of Appleby (Hong Kong office), provides an overview of the recent updates on economic substance requirements and reporting obligations in Bermuda, the British Virgin Islands and the Cayman Islands.
Since October 2019, the date of my last article in CSj summarising the economic substance (ES) requirements in Bermuda, the British Virgin Islands (BVI) and the Cayman Islands (Cayman), the governments of these jurisdictions have introduced amendments to their ES legislation or rules, or have issued updated versions of their guidance notes. This article outlines some of these amendments up to 13 April 2020.
Bermuda has introduced key amendments to its ES Act and ES Regulations, which came into force on 24 December 2019, including the change of definition of ‘holding entity’, ‘shipping’ and ‘finance and leasing’, which impact the scope and applicability of the ES regime to Bermuda entities.
In addition to such amendments, Bermuda has also released the Guidance Note – General Principles (previously in draft form) to give guidance on the application of the ES Act and ES Regulations.
1. Holding entity
One important amendment is to the definition of ‘holding entity’, which has been narrowed in line with other jurisdictions to mean a ‘pure equity holding entity’ (PEHE), being ‘an entity which as its primary function acquires and holds shares or an equitable interest in other entities, performs no commercial activity and which (Majority Test):
(a) holds the majority of the voting rights in another entity
(b) is a shareholder, member or partner in another entity and has the right to appoint or remove a majority of the board of directors, managers or equivalent of that other entity, or
(c) is a shareholder, member or partner in another entity and controls alone, under an agreement with others, a majority of the voting rights in that other entity.’
Thus, in order to fall within this new definition, a Bermuda entity must acquire and hold shares or equitable interests as its primary function, hold a majority or controlling stake in another entity and not carry out any other commercial activity. As a result of this change, Bermuda entities that do not carry out any other relevant activity under the ES regime and either (i) carry out any commercial activity other than being a PEHE, or (ii) do not satisfy the Majority Test, will be out of scope of the ES legislation.
The Guidance Note also clarifies that placing dividend monies received on deposit or using them to acquire and passively hold other securities will not constitute a ‘commercial activity’. Such entity will still be regarded as a PEHE.
A holding entity is subject to reduced ES requirements.
Another significant change is to the definition of ‘shipping’ – now defined to mean engaging ‘in any of the following activities involving the operation of a ship anywhere in the world other than in the territorial waters of Bermuda:
(a) transporting, by sea, passengers or animals, goods or mail for a charge
(b) renting or chartering of ships for the purpose described in paragraph (a)
(c) sale of travel tickets and ancillary ticket-related services connected with the operation of a ship
(d) use, maintenance or rental of containers, including trailers and other vehicles or equipment for the transport of containers, used for the transport of anything by sea, or
(e) functioning as a private seafarer recruitment and placement service.’
This now excludes those entities that own a vessel but do not otherwise take part in its operation. The defining characteristics for this relevant activity are now the operation and management of a ship, which better reflects the commercial reality of the industry. However, the new definition has been expanded to include all ships (other than a pleasure vessel), rather than just a ‘ship that is used to transport goods’, as defined in the previous ES Act and ES Regulations.
3. Financing and leasing
Amendments have also been made to the definitions of ‘financing’ and ‘leasing’ so that they are no longer separate relevant activities, but have been condensed into a single relevant activity of ‘financing and leasing’, meaning providing credit facilities of any kind for consideration (including by way of interest) to any person. The provision of credit may be by way of instalments for which a separate charge is made and disclosed to the customer in connection with the supply of goods by hire purchase, financial leasing (excluding land and interests in land), or conditional sale or credit sale. Also, where any credit repayable is assigned to another person, such other person shall also be considered to be the person providing the credit facility. The amended definition excludes any relevant activities of banking, insurance or fund management, which avoids any potential double reporting.
Important changes have also been made to the definition of ‘insurance’ – now defined to mean engaging ‘in insurance business in accordance with the Insurance Act 1978’, instead of engaging ‘in business for which registration is required in accordance with the Insurance Act 1978’, as defined in the previous ES Regulations. ‘Insurance business’ is defined in the Insurance Act 1978 to mean ‘the business of effecting and carrying out contracts protecting persons against loss or liability to loss in respect of risks to which such persons may be exposed, or to pay a sum of money or render money’s worth upon the happening of an event, and includes reinsurance business’.
This in effect has been narrowed in scope so that insurance intermediaries (being managers, agents and brokers), which require registration under the Insurance Act 1978 but do not necessarily engage in any insurance business, are no longer within scope of this relevant activity which now only captures insurers/reinsurers.
5. Local entities
The revisions simplify the ES requirements for ‘local entities’, which are subject to the requirement of being at least 60% beneficially owned and controlled by Bermudian persons. A local entity will no longer have to complete and file an ES declaration form provided that it is not carrying out ‘insurance’ or ‘banking’ activities and it is not part of a multinational enterprise group.
On 10 February 2020, BVI made what are considered to be minor changes to its ES Rules (originally released on 9 October 2019). Below is a summary of the changes.
- the anticipated duration of compliance plans has been clarified
- the procedure to file tax residency claims has been clarified
- the reference to ‘general partner’ has been corrected
- clarification and examples of intellectual property holding businesses were added
- clarification and an example of distribution and service centre businesses were added
- clarification on where strategic decisions are to be taken has been provided
- clarification on where core income generating activities (CIGAs) are to be performed has been given
- clarification on outsourcing has been added, and
- the summary on the applicability of the ES Rules has been set out more clearly.
On 19 November 2019, the Cayman government released a draft updated guidance note (version 3.0) on ES requirements for industry consultation, which includes sector-specific guidance for each relevant activity, setting out the scope and CIGAs, as well as examples for each of the relevant activities.
The International Tax Co-operation (ES) Law (2020 Revision) reflected a revision and consolidation, as at 31 December 2019, of the 2018 ES Law with subsequent amendments. The 2020 Revision was later amended by the International Tax Co-operation (ES) (Amendment) Law 2020, on 12 February 2020, which made changes to the notification requirements and the requirements to provide and share information under the ES Law. One of the principal amendments is that the notification requirements now apply not only to the ‘relevant entities’ (which exclude domestic companies, investment funds and entities that are tax resident outside Cayman), but to all ‘entities’, which include, among others, all companies and limited liability companies incorporated in Cayman.
Each entity shall now annually notify the Cayman Tax Information Authority of whether or not it is carrying out a relevant activity and, if so, whether or not it is a relevant entity. In the case of an entity that is carrying out a relevant activity but which is tax resident in a jurisdiction outside Cayman, the following information must be provided: (i) the name and address of its immediate parent, ultimate parent and ultimate beneficial owner, along with any other information reasonably required to identify its immediate parent, ultimate parent and ultimate beneficial owner, (ii) the date of the end of its financial year, and (iii) the jurisdiction in which the entity is claiming to be tax resident, along with any other information as may reasonably be required to support that claim. In the case of a relevant entity that is carrying out a relevant activity, such relevant entity not only needs to notify the Authority of the date of the end of its financial year, but also the name and address of the officer who is responsible for providing information to the Authority and shall provide appropriate supporting evidence, as may reasonably be required by the Authority.
This expanded notification requirement is an important change and many Cayman entities that are not relevant entities would have earlier this year been receiving questionnaires from their Cayman registered office service providers to complete for the purpose of notification, stating whether they are carrying out a relevant activity and, if so, whether they are a relevant entity.
With the exception of an extension of time for ES notification filings this year as summarised in the section below, the annual ES notification will need to be completed no later than 31 March each year as a prerequisite for an entity’s filing of its annual return.
Implications of COVID-19 for compliance and filing
Due to the evolving global COVID-19 pandemic, authorities in Bermuda, BVI and Cayman have each responded to its implications for, or have implemented measures that relate to compliance with, their respective ES requirements.
The Registrar of Companies in Bermuda has advised that it will take circumstances surrounding COVID-19 into account when assessing compliance, such as in the case where meetings or other similar compliance measures have not been possible due to necessary travel or quarantine restrictions. Entities should keep careful records of all such circumstances and should continue in good faith to ensure their ongoing compliance with the ES requirements.
On 18 March 2020, the BVI International Tax Authority (BVI ITA) issued a press release to the effect that while there is no current proposal to change the ES filing deadlines, a reasonable and practical approach will be adopted for legal entities being required to make adjustments to their operating practices to mitigate COVID-19 threats. Such arrangements should be temporary and every effort should still be made to ensure compliance with the ES requirements (including filing deadlines), except where the practical and reasonable approach is necessary to manage the threats.
On 27 March 2020, the BVI ITA issued a follow-up press release with the following points:
- where possible, recourse should be made for the appointment of alternate directors in the BVI to meet ES requirements
- all directors do not have to attend board meetings in the BVI – only as many as required to make the meeting quorate (given social distancing protocols, virtual meetings may be preferred)
- not all board meetings need to be held in the BVI – only those related to CIGAs
- where it is still not possible to hold a board meeting in the BVI or to meet some other ES requirement due to restrictions (whether in the BVI or otherwise) brought about by the COVID-19 outbreak, entities are urged to retain documentation that will enable them to support such claims for the applicable periods of time affected, and
- individual requests, along with any supporting evidence, should be made to the BVI ITA for any extension of time.
As a result of an extension of time for the annual fee payment and filing of annual returns for Cayman companies from 31 March 2020 to 30 June 2020 due to the COVID-19 pandemic, the deadline for ES notification filings has now also been extended to 30 June 2020, but such notification filings remain a prerequisite for the successful filing of a Cayman company’s annual return.
Cayman’s Department for International Tax Cooperation has acknowledged that COVID-19 may impact travel in 2020, which may in turn affect the ability of some entities to hold their board meetings in Cayman, and will therefore take this into consideration on a case-by-case basis when determining whether an entity has passed or failed the ES test.
Entities incorporated or registered in Bermuda, BVI or Cayman should consider whether and how the above amendments or changes to the respective ES legislation and rules will impact them, and consider whether any operational or structural changes are required. It is also recommended that such entities continue to seek advice on which steps should be taken to comply with the relevant jurisdiction’s ES requirements.
Vincent Chan, Counsel
Appleby (Hong Kong office)