Commercial Entities (Substance Requirements) Act 2018 – What you need to know.
The Commercial Entities (Substance Requirements) Act, 2018 (the “Act”) came into force in The Bahamas on 31 December 2018. The Act was enacted by the Parliament of The Bahamas, along with other pieces of legislation, in response to the European Union’s inter-governmental Code of Conduct Group (Business Taxation) guidance for determining substance when considering whether a tax measure is harmful or ‘fair’ and the Organization for Economic Co-Operation and Development’s Base Erosion Profit Shifting (BEPS) Project. The Act requires certain entities incorporated, registered or continued under Bahamian law to demonstrate “economic substance” in The Bahamas. Please see the questions below, which are aimed at outlining some of the main features of the Act.
Question 1: Does the Act apply to me?
The Act imposes substance requirements upon “included entities” and “holding companies”. However, all entities incorporated, registered or continued under Bahamian companies or partnerships legislation are required to report annually to the Minister of Finance in the applicable prescribed form within nine months of their fiscal year end.
Question 2: What is an included entity and what are my obligations if I am one?
Under the Act, an “included entity” is an entity incorporated, registered or continued under the Companies Act, the International Business Companies Act, the Partnership Act, the Partnership Limited Liability Act or the Exempted Limited Partnership Act that carries on “relevant activities”, (i) is not owned by a person who is “resident” for Exchange Control purposes and conducts its core income generating activities within The Bahamas; or (ii) is centrally managed and controlled outside of The Bahamas and is tax resident in a jurisdiction other than The Bahamas.
For the purposes of the Act, “relevant activities” means any of the following activities:
- Banking business;
- Insurance business;
- Fund management business;
- Financing and leasing business;
- Headquarters business;
- Distribution and service centres business;
- Shipping business;
- Commercial use of intellectual property; or
- A holding company engaged, or where one or more of its subsidiaries is engaged, in any of the above-listed activities.
An included entity must have substantial economic presence in The Bahamas. An included entity incorporated or registered before 31 December 2018 has until 30 June 2019 to meet the substance requirements imposed by the Act.
Question 3: How do I demonstrate a substantial economic presence if I am an included entity?
In order for an included entity to demonstrate substantial economic presence in The Bahamas, it must show that core income generating activities are conducted in The Bahamas and that it is managed and controlled in The Bahamas.
Core Income Generating Activities
There is no definition of “core income generating activities” provided in the Act. However, the Act includes a non-exhaustive list of examples of activities that may be core income generating activities for some relevant activities. In order to conduct core income generating activities in The Bahamas, there is a presupposition that:
- there is an adequate amount of annual operating expenditure;
- there are adequate levels of qualified full-time employees;
- there is an adequate number of physical offices; and
- there are adequate levels of board management and control, within The Bahamas in light of the activities carried on by the included entity.
“Adequate” carries its ordinary meaning and for the purposes of the Act, means “as much or as good as necessary and sufficient for a specific need or requirement”.
An included entity is prohibited from outsourcing any of its core income generating activities to an entity or person outside The Bahamas. However, an included entity may outsource any of its core income generating activities conducted in The Bahamas to an outsourcing service provider within The Bahamas provided that the included entity is able to demonstrate supervision and control of the outsourced core income generating activity. Importantly, outsourcing a core income generating activity does not do away with the presupposition regarding core income generating activities outlined above. An entity that provides outsourcing services to an included entity must report to the Minister of Finance on an annual basis in the prescribed form.
Direction and Management
An included entity will be deemed to demonstrate direction and management in The Bahamas if it satisfies the following criteria:
(a) an adequate number of meetings of the Board of Directors are conducted in The Bahamas given the level of decision making required;
(b) there is a quorum of the Board of Directors physically present within The Bahamas during the meetings referred to in (a) above;
(c) strategic decisions of the included entity made at the meetings referred to in (a) above must be recorded in the minutes of the meetings;
(d) all included entity records and minutes are be kept in The Bahamas; and
(e) the Board of Directors, as a whole, has the necessary knowledge and expertise to discharge its duties.
Question 4: What if I am an included entity that carries on intellectual property (“IP”) related activities?
There are enhanced substance requirements for IP income generating included entities that apply in addition to the substance requirements outlined above.
A “low-risk” IP income generating included entity must demonstrate that the following activities are undertaken in The Bahamas:
- taking the strategic decisions and managing, as well as bearing the principal risks relating (i) to the development and subsequent exploitation of the intellectual property asset, or (ii) to the third-party acquisition and subsequent exploitation of the intellectual property asset; or
- carrying on the underlying trading activities through which the intellectual property asset is exploited and which lead to the generation of revenue from a third party.
A “high-risk” IP income generating included entity must demonstrate that the following activities are undertaken in The Bahamas:
- taking the strategic decisions and managing principal risks;
- carrying on underlying trading activities within The Bahamas; or
- a high degree of control over the development, exploitation, maintenance, enhancement and protection of the intellectual property asset.
Question 5: What is a pure equity holding company, a passive holding entity and what are my obligations if I am one?
Pure Equity Holding Company
Under the Act, a “pure equity holding company” is a company which only holds equity participations and only earns dividends and capital gains or incidental income. An included entity that only engages in business as a pure equity holding company is subject to reduced substance requirements as follows: (i) it shall comply with all applicable laws and regulations of The Bahamas; and (ii) it shall have adequate human resources and adequate premises in The Bahamas for holding and managing equity participation in other entities.
Passive Holding Entity
Under the Act, a “passive holding entity” is an entity which does not by itself, or by any of its subsidiaries, conduct any relevant activity and includes a collective investment entity or equity participation entity (eg., an investment fund). A “non-included entity” is any entity which is not an included entity. A non-included entity that is a passive holding entity is subject to reduced substance requirements of complying with all applicable laws and regulations of The Bahamas.
Question 6: Does the Act contain anti-avoidance provisions?
Yes. Any arrangement that is entered into with the main intention of avoiding an obligation under the Act will be disregarded for the purposes of assessing compliance with the Act.
Question 7: What if I fail to comply with my obligations under the Act?
There are administrative penalties for failing to comply with the requirements of the Act and in certain circumstances the entity concerned being struck off the Register of Companies or Register of International Business Companies.
Question 8: Will Guidelines accompany the Act?
The Minister of Finance in his capacity as the Competent Authority issued Guidelines on 25 February 2019 for complying with the Act.
The above information is provided for the general interest of the reader and is not intended to constitute legal advice. Please feel free to contact any Partner in the Commercial Transactions or Financial Services Practice Groups should you have any questions or wish to obtain specific legal advice.