• Jay Judas

Tier One: What are the Economic Substance Regulations?

One of the areas we increasingly work with clients is the formation of life insurance companies in offshore jurisdictions such as Bermuda, Barbados and the Cayman Islands. Our clients in these engagements are often groups of investors who are keen to establish an insurance company in order to use life insurance structures through which to make tax-efficient investments.

Hamilton Bermuda
A View of Bermuda's Waterfront

It used to be that an insurer could be set up in a place like Bermuda using a ‘boilerplate’ office and a third-party administrator to handle any transactions which needed to occur in the country. For the most part, many insurers were run from other jurisdictions, including the United States. That has changed.


In December 2017, the European Union Code of Conduct Group assessed the tax policies of jurisdictions with no or only nominal tax (so-called “NOONS”) against the criteria of ‘economic substance’. The criteria stated that a jurisdiction should not facilitate offshore structures or arrangements aimed at attracting profits which do not reflect real economic activity in the jurisdiction. Specifically, the Conduct Group investigated the tax policies of both EU member and nonmember states, assessing:

  • tax transparency;

  • fair taxation; and

  • implementation of anti–BEPS measures (The OECD’s project on Base Erosion and Profit Shifting).

As result of the Conduct Group assessment, in November 2018, the Organization for Economic Cooperation and Development (‘‘OECD’’) announced a new global framework for jurisdictions to prevent business activities from being relocated to NOONs.


In response to the above, and to avoid reputational concerns, governments of the following NOONs enacted legislation introducing enhanced economic substance requirements for tax purposes, bringing the rules into force as from January 1, 2019:

Bermuda

BVI

Cayman Islands

Isle of Man

Jersey

Guernsey

Mauritius

Bahamas

Seychelles

WHICH ENTITIES ARE SUBJECT TO THE SUBSTANCE REGULATIONS?

The precise scope of the economic substance legislation varies somewhat from jurisdiction to jurisdiction. As a first step, clients should take an inventory of all their entities in the affected jurisdictions and make note of the type of company, LLC or partnership and how they are taxed. Then, jurisdiction-specific advice should be sought from local counsel on whether the economic substance rules will apply in any given situation.


ARE YOUR IN-SCOPE ENTITIES CONDUCTING A RELEVANT ACTIVITY?[1]

While all relevant entities will be required to make a filing setting out particulars relating to their business, an in-scope entity will only be required to meet the economic substance test if it carries on a “relevant activity”. The relevant activities in each jurisdiction are:

Banking

Insurance

Fund Management

Financing and Leasing

Headquarters

Shipping

Distribution and Service Centers

Holding Entity

Intellectual Property

WHAT ARE THE ECONOMIC SUBSTANCE REQUIREMENTS?

An entity (other than a holding entity, and entities that conduct intellectual property business, for which there are different criteria) conducting a relevant activity will satisfy the economic substance requirements if:

  • it is managed and directed in the jurisdiction;

  • core income generating activities (CIGA) are undertaken in the jurisdiction in relation to the relevant activity;

  • it maintains adequate physical premises in the jurisdiction;

  • there are adequate employees in the jurisdiction with suitable qualifications;

  • there is adequate expenditure incurred in the jurisdiction in relation to the relevant activity; and

  • it files a confidential economic substance report each year with the applicable authority in its jurisdiction which will assist the authority in assessing compliance.

The economic substance legislation also sets out the circumstances where the above activities may be outsourced.


As a specific example, in the Cayman Islands, what must entities subject to the Economic Substance Act show in relation to their relevant activities? These entities must:

  • be directed and managed in Cayman;

  • conduct CIGA in Cayman; and

  • have adequate employees, expenditure and physical assets in Cayman.[2]

A company is 'directed and managed' in Cayman when:

  • the board's members have adequate knowledge and expertise;

  • the board meets in Cayman with adequate frequency, having regard to the amount of decision making required (it is not expected that all or a majority of board meetings will be held in Cayman);

  • a quorum is physically present at each board meeting in Cayman;

  • strategic decisions of the company are made in those meetings with minutes recorded; and

  • minutes and other records of the company should be kept at the office in Cayman.

If the advantages of doing business is an offshore jurisdiction is worthwhile, then those seeking these advantages should prepare to operate as a part of that jurisdiction.

[1] Economic Substance Law - Legislation & Regulations. (n.d.). Appleby. Retrieved June 6, 2022, from https://www.applebyglobal.com/sectors/economic-substance/ ‌ [2] In a nutshell: Cayman Islands’ economic substance law. (n.d.). Www.bedellcristin.com. Retrieved June 6, 2022, from https://www.bedellcristin.com/knowledge/briefings/in-a-nutshell-cayman-islands-economic-substance-law/

 

Since its inception, Life Insurance Strategies Group has solely focused on the individual high net worth life insurance market. We do not sell products. This allows us to offer unbiased, pragmatic advice. Visit us at www.lifeinsurancestrategiesgroup.com.