Economic Substance update Q1 2020

In the case of the Cayman Islands, this step appears to relate to a missed deadline for legislation relating to the funds industry (which legislation came into force on 7 February 2020).  The Cayman Islands Government has already commenced the process of having Cayman removed from the list.  The next EU meeting at which this could take place is currently scheduled for October 2020.  Every effort is being made to accelerate the process.  The revised legislation and regulations introduced significant changes which may impact your existing or proposed Bermuda, BVI or Cayman entities.  Further details on the economic substance regime of each of Bermuda, the BVI and the Cayman Islands may be found here.

In this article we look at the latest developments in the economic substance legislation in Bermuda, the British Virgin Islands and the Cayman Islands in the past few months; in particular, updates to the filing requirements which are of particular relevance to many entities at this stage.

Cayman Islands

On 20 November 2019, the Cayman government released a revised and enhanced draft guidance (version 3.0) on economic substance requirements for industry consultation, including sector-specific guidance for each relevant activity.  The draft guidance reflected responses received from the industry so far, and clarified  the scope of the International Tax Co-operation (Economic Substance) Law, 2018 and The International Tax Co-Operation (Economic Substance) (Prescribed Dates) Regulations, 2018. The revised guidance is expected to remain a work in progress for the time being and we will report any further update once this becomes available.

The International Tax Co-operation (Economic Substance) Law (2020 Revision) was recently gazetted, reflecting a revision and consolidation as at 31 December 2019 of the 2018 Law with subsequent amendments. The 2020 Revision was amended effective 12 February 2020 by the International Tax Co-operation (Economic Substance) (Amendment) Law, 2020 which made changes to the notification requirements and the requirements to provide and share information under this Law (as revised and amended, ES Law).  One of the principal amendments to note is the application of certain notification requirements of the ES Law to all “entities” as opposed to “relevant entities” only.  In summary, entities are all legal personalities that are registered with the Cayman Islands’ General Registry while a relevant entity is an entity that is not a domestic company, an investment fund or an entity that is tax resident outside of the Cayman Islands.  This broader notification requirement is an important change and, in anticipation of implementation, many Cayman domiciled entities are receiving questionnaires from their Cayman registered office service providers to complete in this respect.  Starting in 2020, all entities are required to notify the Cayman Tax Information Authority (TIA)  annually of, among other things, whether or not they are carrying on a relevant activity and, if so, whether or not they are a relevant entity (with evidence supporting tax residency required if a claim is made that an entity carrying on any relevant activity is exempt from the economic substance test by virtue of being tax resident outside the Cayman Islands). This annual notification will be filed via an online portal and will need to be completed before an entity’s existing annual return form can be filed.  The first filings are due by 31 March 2020, but because an entity cannot obtain a certificate of good standing without having made its annual return filing, for all practical purposes this filing should be made as soon as possible.

A relevant entity that carries on any relevant activity is required to satisfy an economic substance test and is also required to prepare and submit to the TIA a report in prescribed form for the purpose of the TIA’s determination whether the economic substance test has been satisfied.  The first economic substance report is due twelve months after the last day of the end of the relevant entity’s financial year commencing on or after 1 January 2019.

BVI

The Rules on Economic Substance in the BVI were published by the BVI International Tax Authority (ITA) on 9 October 2019 and were updated on 10 February 2020 (as updated, Rules).  The Rules provide detailed explanations and interpretations of the legislative requirements of The Economic Substance (Companies and Limited Partnerships) Act, 2018 (as amended, the Substance Act) which came into force on 1 January 2019.  The rules in their original form became effective on the coming into force of the Beneficial Ownership Secure Search System (Amendment) (No.3) Act on 31 October 2019.

The Rules closely follow the draft Economic Substance Code published in April 2019 with some notable differences as set out below:

1. the Rules clarify that entities that have commenced the winding up process remain subject to their obligations under the Substance Act throughout such process;
2. the Rules specify that “expenditure” (as required to meet substance requirements under the Substance Act) means only expenditure arising from the relevant activity;
3. an entity exempt from the scope of the Substance Act by virtue of being tax resident outside of the BVI will be required to submit to its registered agent information about whether or not it carries on a relevant activity, even though it has no obligations to meet any economic substance test; and
4. an entity will only be required to submit supporting documentary evidence as part of its annual reporting when specifically requested by the ITA to do so.

It is expected that further regulations relating to filing requirements and submission periods will be released in due course.  The reporting regime requires the registered agent of each corporate and legal entity for which it acts as registered agent to enter into its database maintained under the Beneficial Ownership Secure Search System Act, 2017, as amended, prescribed information to be entered in the data base in accordance with the Beneficial Ownership Secure System (Time Limit for Filing Prescribed Information) Regulations, 2019.  With respect to a relevant entity that is not claiming to be outside the scope of the economic substance regime and that engages in any relevant activity in a financial period, that prescribed information includes particulars with respect to the entity’s relevant activity (or relevant activities, if engaged in more than one) and related turnover, expenditures and operations, to be entered in the database within six months after the end of that financial period.  The first Substance Act reporting period for an entity incorporated or formed, as the case may be, before 1 January 2019 begins on 30 June 2019 and ends a year later unless the entity elects to shorten the period (for example, in order to conform its reporting period with its financial period).  The first reporting period for an entity  incorporated or formed, as the case may be, after 1 January 2019 begins (or began) on its date of incorporation or formation and runs for one year  (unless the entity elects to have a shorter first reporting period).

Bermuda

Following the coming into force of the Economic Substance Amendment (No. 2) Act, 2019 on 24 December 2019 (Amendments), guidance notes were issued on the same day to iterate the general principles of the economic substance requirements in Bermuda.

The Amendments introduce key changes to the economic substance regime. One of the most significant changes is to the definition of “holding entity”. The revised definition now only includes “pure equity holding entities”. In order to fall within this new definition, an entity must acquire and hold equitable interests as its primary function; hold a controlling stake in another entity (which may involve consideration on shareholding, voting rights or right to appoint or remove directors or equivalent positions); and must not carry on any other commercial activity. As a result of this change, those entities which were previously within scope of the economic substance regime solely on the basis that they held or managed “assets” but did not otherwise conduct a relevant activity, will now fall outside the scope.

Another significant change is to the definition of “shipping” which now excludes those entities which 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.  Important changes have also been made to the definition of “insurance”. This has been narrowed in scope so that insurance intermediaries (being managers, agents and brokers) are no longer within scope of this relevant activity which now only captures insurers/re-insurers.  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”. The Amendments clarify the activity that will fall within scope and will also avoid any potential double reporting.

The Amendments also simplify the substance requirements for “local entities” which will now not have to file an economic substance declaration provided that the local entity is not carrying out “insurance” or “banking” activity and provided that the local entity is not part of a multinational enterprise group.

With respect to filing requirements, separate basic economic substance declaration forms were issued by the Registrar of Companies in December 2019 for exempted companies, exempted partnerships, limited liability companies, overseas partnerships and permit companies.  Each of these entities is now required to inform the Registrar, annually, as to whether or not it is carrying on a relevant activity, and the type of relevant activity, if any, it is carrying on.  The declaration forms must be submitted when annual returns are filed, starting in 2020, with prescribed supplementary economic substance particulars to be filed on separate forms later in the year before the expiry of six months after the end of each financial year commencing in 2019.  Further updates will be provided when these economic substance forms as well as the online portal become available.