Insights on Bermuda’s Economic Substance Act 2018
On 17 December 2018, Bermuda formally introduced the Economic Substance Act 2018, the measures therein becoming applicable with effect from 1st January, 2019. Its genesis resulted from Bermuda being placed on the EU’s grey list of jurisdictions due to concerns over fair taxation (and other factors), and which led to the Code of Conduct Group (‘COCG’) declaring Bermuda a ‘Criterion 2.2’ jurisdiction, along with other jurisdictions including the Cayman Islands, British Virgin Islands, Jersey, Guernsey and the Isle of Man.
To demonstrate its commitment to tax transparency, Bermuda’s government addressed the concerns raised by the COCG and moved swiftly to introduce the Economic Substance Act. This will impact all Bermuda-resident entities, from local and overseas companies to limited liability companies and partnerships that are deemed to engage in ‘relevant activities’.
These 10 activities include: banking, insurance, fund management, financing, leasing, headquarters, shipping, distribution & service centres, intellectual property and holding entities.
“We already have the Bermuda Companies Act which sets out the legal and regulatory requirements of what is required for companies to be set up on the island, and that remains unchanged,” comments James Dockeray (pictured), Tax Partner, Deloitte.
“Regulated entities that have been operating under the pre-existing regulatory environment, before the ESA was introduced, should be largely unaffected. That is because in the Banking and Insurance Act, there is already contained within it the concept of the ‘home office’; i.e. to be regulated in Bermuda, it already had to demonstrate substance including oversight and management on the island.”
Insurance groups already have economic substance, as a result, with adequate numbers of employees working in Bermuda. Funds that are registered and regulated by the BMA are a slight anomaly in the sense that the fund manager is likely to sit in London or New York.
Where the ESA is likely to have the biggest impact is on what were previously non-regulated entities such as those operating in intellectual property, shipping, financing or leasing.
“There may be a requirement to perform more economic activity on the island for those who operate in those industries,” says Dockeray. “With respect to Funds, the Fund will have to determine if indeed it does fall into one of the 10 relevant activities. Although fund management is a relevant activity that doesn’t necessarily include the fund structure if domiciled in Bermuda. If the answer to the question of having a relevant activity is ‘No’ then nothing more substantial needs to be done.
“If the answer is ‘Yes’, one has to consider the concept of ‘core income generating activities’ (CIGA) with respect to the relevant activity. The whole point of the ESA is to manage and control those entities and have substance around the CIGA in Bermuda. This will mean different things for different entities. It may be enough to hold robust board level meetings on island, or another entity may need more substantial day-to-day operations.
“Economic substance exists in most any country. If you’re setting up an entity in France or Luxembourg and you’re going to claim tax treaty benefits, you need to demonstrate substance in those countries. This is not something new and it will become more of a global focus in the near future,” outlines Dockeray.
Bermuda doesn’t have a double taxation treaty network, although it shares tax information with over 100 countries using TIEAs (tax information exchange agreements) and a network of multilateral automatic exchange of information agreements. Regulations such as the ESA and BEPS (Base Erosion and Profit Shifting) are designed partially to solidify the business functions in offshore jurisdictions and as Dockeray says, “I’m bullish that this is an opportunity for Bermuda to pull more jobs and more economic activity back to the island”.
“A lot of companies across a variety of industry sectors have long operated out of Bermuda,” says Dockeray, “although some will need to beef up their local footprint.
“Any increase in economic activity, whether it’s more board meetings, hiring people locally, renting large office space, is a good thing for Bermuda. On the flip side, however, I think you might see some companies not wishing to spread themselves too thin, especially if they have to meet substance requirements in places like Ireland, the UK, Luxembourg, etc.
“There will be some economic inflows but also some economic outflows. The reality is the government doesn’t know what the net effect will be. They’ve done some economic studies but in a year from now we’ll know better.”
In terms of infrastructure, Bermuda is 21 square miles. It stands to reason that with Bermuda-based entities now expected to meet the economic substance requirements, at some point a ceiling will be reached in terms of office capacity. Currently, the number of work permits remain some way below the high-water mark of 2010. As such, Bermuda still has plenty of additional capacity before it reaches and exceeds 2010 employee levels.
Dockeray refers to two other key points in relation to the ESA, relating to work permits and payroll tax. Recognising that the work permit process and immigration is an important issue, Bermuda’s government has done a couple of things to open the door and make things easier.
“Firstly, there will be some payroll tax concessions for companies creating new jobs, not unlike you would find in any jurisdiction focused on creating employment opportunities. And secondly, for certain exempt companies, up to five work permits will be processed automatically (with the ability to add more at a later date). It’ll make things a bit more streamlined and efficient,” comments Dockeray.
To conclude, the introduction of the ESA is the latest in a long line of commitments that Bermuda has made over the years to uphold a robust and tax transparent regime.
Bermuda has a long history of working with the OECD and other organisations to be leader in tax transparency including previously co-chairing a tax sub-committee at the OECD level. IT signed up to, and was among the first wave of countries adopting country-by-country reporting, Common Reporting Standard (CRS) and FATCA.
“In a recent meeting, Angel Gurria, Secretary General of the OECD, gave a speech, during which he made a point of saying what a great partner Bermuda was and that it was leading the charge on global tax transparency. That’s important. It reinforces the reputation of the jurisdiction,” concludes Dockeray.