Economic substance rules may bring benefits
Bermuda could benefit from the introduction of economic substance rules for companies registered on the island, but the guessing game is not over yet.
Indeed, less than two months after coming into force, the Economic Substance Regulations 2018 have seen amendments — reportedly after further discussions between the Government and the European Union.
The amendments made on February 22 mostly involved a tightening up of wording and terms to provide clarity, but there are also a new definitions of a “holding entity” and “intellectual property”, substantially increasing the scope of the regulations.
Companies and business entities registered in Bermuda are being required to demonstrate they have an acceptable level of economic activity on the island. Similar action is being taken in a number of other jurisdictions that are also currently on the EU's taxation and Customs “grey list”.
The EU is expected to respond by the end of this month to the regulations put in place by Bermuda and the other jurisdictions.
Speaking about the latest amendments to Bermuda's regulations, James Ferris, advisory director at PwC Bermuda, said: “The new changes cover almost every entity in Bermuda.”
He was speaking at an information session on the economic substance requirements.
Mr Ferris believes the island has gone “above and beyond” what is required, but he warned it must stay alert and act speedily if any regulatory arbitrage occurs between Bermuda and others, including British Virgin Islands and Cayman Islands, who are jockeying to meet the EU Code of Conduct Group's concerns regarding economic substance of companies and business entities registered in their jurisdictions.
That possibility exists because each jurisdiction has created its own economic substance regulations. One example is that Bermuda has not sought a “carve out”, whereby the economic substance requirements would not apply to companies on the island that are tax resident elsewhere.
“It is something that is in every other jurisdictions' legislation. We are told that the reason that has not been enacted in Bermuda is because the EU doesn't want it. We've got to believe that the Government is right in that regard. But it does seem strange that we are the outlier,” said Mr Ferris.
He described the requirements of economic substance, which include:
• being managed and directed from Bermuda;
• core income generating activities being undertaken in Bermuda with respect to the “relevant activity”;
• maintaining an adequate physical presence in Bermuda;
• having adequate full-time employees in Bermuda with suitable qualifications;
• incurring adequate operating expenditure in Bermuda in relation to the “relevant activity”.
In addition, core income generating activities that are outsourced must be undertaken in Bermuda.
One of the big changes in the new amendments is that the regulations now encompass “every entity that holds something”, and that could be an asset, a bond, or it being used as an investment vehicle. Previously, the regulations applied to holding companies that had an equity holding.
Mr Ferris said: “It encompasses a large number of extra companies. I've highlighted that they still have employees and premises in this definition of holding company. There are a large number of holding companies globally that don't have employees or premises — they don't need them in their own right. So that is something we are going to have to get over. Hopefully, the [EU] guidance will assist us with that.”
He added: “The other question mark is, you have holding companies that actively trade in investments; does that bleed into the fund structures that people have, whereby within a fund structure you have holding companies that may be holding many different assets? They may be trading in those, are they now captured under economic substance? We need to understand that.”
Using a figure of 12,000 companies in Bermuda being impacted, the audience heard that it is estimated those companies spend about $130 million per year on the island. If some were now to increase their economic substance on the island, such as through additional people and office space, there would be a “net positive”.
Mr Ferris said there is potentially a big opportunity for Bermuda with regards to the estimated 500,000 companies listed in BVI, and upwards of 200,000 in the Cayman Islands. He said some company groups that are spread across all the territories are looking to rationalise in terms of economic substance. For Bermuda, that could mean companies that already have a presence here, consolidating further onto the island rather than try to meet economic substance regulations in a number of different jurisdictions.
The same course of action is available to other jurisdictions. However, Mr Ferris said: “For us, as a territory, we have a huge population of companies that we can go after in terms of BVI and Cayman. They can [only] go after 12,000 of our companies.
“We have a huge advantage, not just to grow the population of these companies as it stands, but also to bring people onto the island to create economic substance as well.”
An audience member asked if the Bermuda Government was geared up to deal with “a massive influx of permit applications in April, when we know exactly where we stand. Are they going to be able to process that by the first of July?”
Mr Ferris said: “I'd like to think they are aware of the issues here. We and other professional services are telling them what we are hearing, and they are out there speaking to people who are looking to bring people on to the island, so I would like to think they are aware that issue could arise, and they are willing to expedite permits so they can meet economic requirements.”