To avoid being blacklisted as having harmful tax practices, several international financial centres (IFCs), including in the Caribbean, have passed legislation imposing economic substance requirements on tax resident companies carrying on ‘relevant activities’. Such substance requirements are to ensure that geographically mobile businesses are taxed where genuine economic activity is taking place and value created. But, given the on-going novel coronavirus disease 2019 (COVID-19) pandemic, many jurisdictions have had to release guidelines for tax resident companies on how to meet these substance requirements, such as the requirements for physical meetings in an environment where social distancing, lockdowns, and travel restrictions have become the norm. COVID-19 raises questions as to the suitability of requiring physical presence at meetings given contemporary realities.
How COVID-19 Is Challenging Economic Substance Requirements
Caribbean countries’ management of the COVID-19 pandemic has been a largely unsung story internationally, with many having managed to keep their infection numbers low, and some reporting low or no death tolls to date. However, in order to prevent and control the spread of COVID-19, Caribbean IFCs, like other countries globally, have introduced measures restricting travel and imposing mandatory quarantining requirements and curfews, as well as social distancing requirements.
One of the elements of the test of economic substance under the legislation of these jurisdictions is the ‘directed and managed’ test which mandates inter alia, an adequate number of board meetings with a quorum, as well as that the majority of those voting be physically present in the jurisdiction. This raises the question of the ability of companies to meet the requirement to physically hold board meetings in the jurisdiction under current restrictions. Failure to adhere to the economic substance requirements could result in hefty sanctions for the companies concerned, which has further contributed to companies’ anxiety.
Caribbean IFCs’ Guidelines On COVID-19
In response to this dilemma, the regulatory authorities of several Caribbean IFCs have joined the list of jurisdictions globally which have released guidance to their tax resident companies undertaking relevant activities on meeting their substance requirements in this ‘new normal’.
The Barbados Financial Services Commission (FSC) in its guidance note of March 20, 2020[i], noted that “where there are, or will be, adjustments to operations as a result of the restrictions, for example, by hosting virtual meetings or conference calls where persons who would normally travel to Barbados to be physically present for board meetings and who are avoiding travel, or are self-isolating such adjusted practices would not automatically be regarded as failing to meet the EST”.
It further advised that “licensees that have adjusted their operating procedures in response to COVID-19 should clearly record in their books and records, and particularly in board minutes for meetings, when directors have not been physically present due to implementation of such measures”. Further, licensees are required “to notify the Financial Services Commission and the Director of International Business, in writing [via email], whenever circumstances arise as outlined above”.
Bermuda’s Office of the Registrar of Companies released an Industry Notice on Economic substance[ii] on March 31, 2020 which stated that “the Registrar will take all appropriate circumstances into account in assessing compliance”. It further indicated that “where meetings or other similar compliance measures are not possible due to necessary travel or quarantine restrictions, this may be taken into account.”. It cautioned companies that “as with all information evidencing compliance, entities should keep careful records of all such circumstances, and should continue in good faith to ensure their ongoing compliance with the economic substance requirements as set out in the legislation and Guidance Notes”.
The ITA also noted that “entities should note that this is only a temporary arrangement”. It further urged companies “to make every effort to otherwise comply with full substance requirements (including filing deadlines) as the practical and reasonable approach described above can only obtain where entities need to make adjustments to their usual operating practices and so far as these are necessary to manage threats from the Covid-19 outbreak”.
The Cayman Islands’ Ministry of Financial Services extended the time period for companies to file their economic substance notification. In its guidance of March 21, 2020, the Department for International Tax Cooperation (DITC) provided that “where board of director meetings are required to be held virtually during this period of uncertainty, it would take that into consideration on a case-by-case basis when determining whether an entity has passed or failed the ES test in reporting, which is due in 2021”.[v]
Conclusion – The ‘Substance’ Of Substance
The Guidance has tended to be similar, although some is more detailed than others. Companies will not be penalised once these changes are on a temporary basis and are as a result of the COVID-19 restrictions. They must, however, maintain adequate records of how their normal operations were impacted by the restrictions.
Until a proven vaccine is commercially available, recurring COVID-19 outbreaks will be likely, with the threat of restrictions always a possibility. This heightens the uncertainty for companies, especially in light of the potential penalties for not meeting substance requirements. Caribbean IFCs also risk the possibility of being blacklisted by the EU and individual EU Member States which still maintain their own non-cooperative tax jurisdictions lists, if perceived to be not ‘tough enough’ on ensuring companies demonstrate substance.
It raises the question of the requirement of physical meetings as part of the ‘directed and managed’ test where the trend in the corporate world has already been increasingly to hold online meetings to cut costs and to reduce their carbon footprint given the more pervasive availability of online meeting platforms. Perhaps it is time to question and relook the ‘substance’ of this test of substance.
Alicia Nicholls, B.Sc.(Hons), M.Sc. (Dist.), LL.B. (Hons) is an international trade and development specialist with over a decade of experience working in, and writing on, trade and development matters of interest to the Caribbean. She holds a Bachelor of Science in Political Science (First Class Honours), a Bachelor of Laws (Upper Second Class Honours), and a Masters in International Trade Policy (with distinction) from the University of the West Indies, and an Associate Degree in French, Spanish and German for Business and Tourism from the Barbados Community College. She also holds the FITT Diploma in International Trade from the prestigious Canadian-based Forum for International Trade Training (FITT) and has been a FITT General Member since 2015. She is also a member of the Michigan-based Academy for International Business (AIB) since 2016. Alicia presents and writes on a wide gamut of trade and development issues for regional and international publications and industry magazines. Her research interests include international business, MSMEs, AML/CFT issues, investment law and policy and investment migration programmes. She is also the author of one of the Caribbean's leading trade and development blogs www.caribbeantradelaw.com. Alicia is currently part of the research team of the Shridath Ramphal Centre for International Trade Law, Policy & Services of The University of the West Indies, Cave Hill, the premier trade policy training, research and outreach institution in the Caribbean.