Economic Substance: challenges and opportunities for The Bahamas?
The Economic Substance initiative, which is the subject of this article, started life with the work of the Organisation for Economic Cooperation and Development (“OECD”) Forum on Harmful Tax Practices (“FHTP”). In particular, one of the initial focusses of the OECD’s work was on requiring jurisdictions with preferential tax regimes (e.g. a regime that provides for a lower corporate tax rate for certain industry sectors, such as shipping or intellectual property) to ensure that such regimes only applied to those companies with a sufficient degree of relevant “substance” in that jurisdiction. This resulted in changes to the tax regimes of a significant number of jurisdictions globally.
In November 2016 the European Union (“EU”) commenced work on a list of “non-cooperative jurisdictions” for tax purposes. Through 2017 the EU screened some 92 jurisdictions against criteria based upon transparency, fair taxation and the implementation of measures under the OECD’s Base Erosion and Profit Shifting (“BEPS”) initiative. As we know, The Bahamas has responded to a multitude of initiatives in the tax arena over recent years – not least in relation to automatic exchange of information measures and BEPS minimum standards. As a result of this EU screening process, and against the risk of black-listing by the EU [for the avoidance of doubt The Bahamas is currently on the EU ‘grey list’ – per our attached alert of 25 February 2022], The Bahamas introduced Economic Substance legislation and guidance notes. It must be appreciated that the legislation only impacts certain geographically mobile income sectors – these range from the regulated sectors of banking, insurance and fund management, through to shipping, distribution and service center businesses, finance and leasing, “headquartering” entities, holding companies and last (but definitely not least) intellectual property (“IP”) entities.
An analysis of the Economic Substance requirements would not fit within this article, but it is fair to conclude that most Bahamas entities have an annual Economic Substance reporting requirement and probably fit into one of the following categories:
- The legislation has no impact on the entity.
- The entity is within scope of the rules, but it clearly has the required “Economic Substance” and with relatively minor amendments to, for example, its record keeping it will be able to demonstrate that fact.
- The entity is within scope, but will need to make material changes to the manner in which it operates if it is to satisfy the requirements.
- The entity is within scope and without fundamental change to its modus operandi will simply not be able to satisfy the requirements.
It is these final two categories that require careful consideration. And it must be borne in mind that the consequences of non-compliance can be severe – for certain entities, those consequences can include a $150,000 penalty, a $300,000 penalty and strike-off proceedings if failure persists. On an annual basis, businesses should therefore be:
- Determining whether they are in scope of the Economic Substance requirements.
- Undertaking classification exercises to determine whether they undertake any ‘relevant activities’ in a given financial period.
- For those entities that perform one or more relevant activities, undertaking gap analyses on how they comply with the Economic Substance Test and taking action to fill any gaps identified.
- Ensuring that an appropriate Economic Substance risk operating model exists within the organization, e.g. policies and procedures documentation, training, etc.
- Collating information/data internally and from outsourcing providers.
- Reporting to the relevant authorities.
- Retaining documentation.
Some (presumably small amounts of) businesses will ultimately conclude that they cannot (or are unwilling to) satisfy the requirements and thus will leave the island. In many ways that is exactly what the legislation is trying to achieve. On the other hand, there will be businesses located in other jurisdictions (e.g. the British Virgin Islands) that are equally struggling with the equivalent legislation and may conclude that The Bahamas is exactly the place for them to cement their business going forward - after all, we are a jurisdiction of substance, that is well placed in terms of a relatively larger pool of qualified people, financial services expertise and space!
Indeed, the Economic Substance legislation can present itself as an opportunity in a jurisdiction of substance like The Bahamas, in terms of driving new levels of consistency, upholding the highest levels of quality, creating a net increase in jobs and economic activity. In fact, we are starting to see various large multinational groups who are currently physically present on the island and are moving away from outsourcing functions to onshore facilities, and retaining such functions within The Bahamas – which has clearly resulted in relocation or appointment of new local staff.
There is no doubt that there remain areas of uncertainty with the legislation – for example, how much is “adequate” in terms of the level of Economic Substance that impacted entities must have on the island? Answers are starting to emerge following the first few reporting cycles across multiple jurisdictions. But for businesses that may still have to make changes to their operations, immediate engagement with the requirements is key.
Finally, we take the opportunity to provide (i) a brief summary of the Economic Substance rules and (ii) a copy of our Economic Substance Tool brochure.
If you would like to discuss how the Economic Substance requirements impact your business, please do get in touch with me or your usual KPMG contact.