Created Date:
02 August 2019

New order: (Economic) substance and the Bermuda funds industry

Bermuda was one of several international financial centres to enact economic substance legislation during the latter part of 2018. Along with these other jurisdictions, which included the British overseas territories of the Cayman Islands and the British Virgin Islands and the Crown Dependencies of Guernsey, Jersey and the Isle of Man, Bermuda introduced this legislation in order to meet the commitment it had made to address certain concerns raised by the European Union's Code of Conduct Group (Business Taxation) (the "Code Group") in relation to the need for relevant businesses to demonstrate economic substance in Bermuda. This article explores the ways in which Bermuda's Economic Substance Act 2018 (the "ESA") could impact the island's funds industry.

In 2017 the Code Group assessed the tax regimes of 92 countries against its good governance criteria regarding tax transparency, fair taxation, and implementation of measures to combat base erosion and profit shifting (Beps). The Code Group acknowledged that most offshore financial centres had cooperated with the assessment and implemented international tax transparency and Beps measures.

As part of the fair taxation assessment, the Code Group assessed jurisdictions with low or zero rates of corporate income tax against its criterion 2.2, which states: "The jurisdiction should not facilitate offshore structures or arrangements aimed at attracting profits which do not reflect real economic activity in the jurisdiction."

The Code Group expressed concerns that these "criterion 2.2 jurisdictions" might not impose adequate legal substance requirements on entities doing business in or through them and that their tax regimes were therefore potentially harmful if they encouraged international businesses to engage in jurisdictional arbitrage and benefit from low or zero tax rates by artificially transferring profits to jurisdictions imposing little or no corporate income tax. In late 2017 Bermuda and other criterion 2.2 jurisdictions committed to enact laws by the end of 2018 to address the Code Group's concerns.

Affected entities

The ESA applies to companies to which the Companies Act 1981 applies, which would include an overseas company with a permit to engage in business in Bermuda, a limited liability company formed under the Limited Liability Company Act 2016, or an exempted partnership, an exempted limited partnership or an overseas partnership that has elected, or elects, to have separate legal personality under the Partnership Act 1902. Most Bermuda fund managers and investment funds are formed as exempted companies or as exempted limited partnerships; the latter will not be subject to the ESA if they have not elected to have separate legal personality.

Relevant activities

In the summer of 2018, the Code Group published a scoping paper setting out its expectations in terms of what economic substance legislation should address in order for the criterion 2.2 jurisdictions to satisfy their commitment to enact laws by the end of 2018 to address the Code Group's concerns. This scoping paper identified "at least banking, insurance, fund management, financing, leasing, headquarters, and shipping" as being activities in respect of which substance requirements should apply.

The ESA was duly extended to entities engaging in a "relevant activity", which for these purposes is banking business, insurance business, fund management business, financing business, leasing business, headquarters business, shipping business, distribution and service centre business, intellectual property holding business and conducting business as a holding entity. It will be noted that, while the activities of investment funds do not form part of this list, those of fund managers do.

Fund management

The Economic Substance Regulations 2018 made under the ESA provide that "an entity engages in fund management if it manages investments for funds and in respect of which a licence is required in accordance with the Investment Business Act 2003 or for which a licence would be required if such activity were taking place in Bermuda”.

Not all Bermuda-based fund managers will be subject to the ESA. The Investment Business Act 2003 (the "IBA") imposes a licensing requirement on Bermuda entities engaging in "investment business" (which term includes both managing investments and giving or offering, or agreeing to give, investment advice) from a physical place of business in Bermuda, unless subject to an exemption order made by the Minister of Finance.

While Bermuda entities operating from a place of business outside the jurisdiction are not, therefore, subject to this licensing requirement, they will nevertheless be required to meet the ESA's economic substance requirements if their place of business being outside Bermuda is the only reason why they do not require a licence under the IBA.

However, certain investment businesses are exempt from the licensing requirement under the Investment Business Exemptions Order 2004. Among those exempted under this order are persons (other than market intermediaries) who provide investment services exclusively to certain categories of client, including, among others, high income private investors, high-net-worth private investors, sophisticated private investors, bodies corporate with total assets of at least $5m, and bodies corporate, partnerships and trusts whose shareholders, members and beneficiaries respectively fall into one or more of those categories. Most investment funds will fall into one or both of the latter two categories, meaning many Bermuda fund managers do not require a licence under the IBA and, as such, will not fall within the ESA's scope.

Economic substance requirements

To the extent a fund manager is subject to the ESA, it will need to demonstrate compliance with the economic substance requirements in the legislation. The ESA provides that these are satisfied if:

  • the entity is managed and directed in or from Bermuda;
  • the relevant activity’s core income-generating activities are undertaken in Bermuda;
  • the entity maintains an adequate physical presence in Bermuda;
  • there are adequate full-time employees with suitable qualifications in Bermuda; and
  • adequate operating expenditure relative to the relevant activity is incurred in Bermuda.

For a fund manager, the "core income generating activities" to be undertaken in Bermuda include taking decisions on the holding and selling of investments; calculating risk and reserves; taking decisions on currency or interest fluctuations and hedging positions; and preparing relevant regulatory or other reports for government authorities and investors.

At the time of writing, industry was still awaiting the publication of guidance notes on these requirements and how they might apply in respect of each relevant activity. Affected managers will, in any event, be expected to demonstrate satisfaction of these requirements in the annual economic substance declaration to be filed with the Registrar of Companies.

Investment funds

Funds themselves are not expressly made subject to the ESA, a position which is consistent with the Code Group's position in its scoping paper that "…the usual substance requirements cannot automatically be applied to [collective investment vehicles]."

While funds per se are not made subject to economic substance requirements under the ESA, a fund may nevertheless fall within the ESA's scope if it carries on one or more of the relevant activities as a business. The requirement to carry on a relevant activity "as a business" should mean that a fund which engages in what might otherwise constitute a relevant activity on an occasional or one-off basis should be outside the scope of the ESA.


The introduction of the ESA, and similar legislation in other international financial centres, has the potential to represent a significant change to the manner in which businesses engaged in a relevant activity will operate. While the ESA will not automatically apply to funds, a fund should nevertheless consider whether pursuing its investment strategy might constitute a relevant activity under the legislation. And while fund management certainly falls into this category, not all fund managers will be affected. Even if a fund manager is required to comply with the ESA, Bermuda is fortunate in that a good number of investment managers have already elected to set up physical, staffed offices in the jurisdiction from which to run their businesses, and so it is anticipated that many fund managers will find they readily satisfy the requirements.  


An original version of this article was published in HFM Week's 2019 Special Bermuda Report, June 2019.

© Carey Olsen 2019.

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