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 British Virgin Islands’ International Tax Authority (ITA) in its guidance note of March 27, 2020[iii], following up on its earlier guidance note of March 18[iv], provided as follows:
- “where possible, recourse should be had to the appointment of alternate directors in the BVI in order to meet substance requirements;
- all directors do not have to attend Board meetings in the BVI - only as many as required to make the meeting quorate (given social distancing protocols, virtual meetings may be preferred);
- not all Board meetings need to be held in the BVI - only those related to core income generating activities;
- where it is still not possible to have a Board meeting in the BVI or to meet some other substance requirement due to restrictions (whether in the BVI or otherwise) due to the Covid-19 outbreak, then entities are urged to retain documentation to be able to support such claims for the applicable periods of time affected;
- individual requests should be made to the ITA for any extension of time within which to comply with Notices, along with any supporting evidence.”
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 D. Nicholls is an international trade consultant with over a decade of experience providing bespoke trade research and advisory services to a variety of clients. She is currently a research fellow and part-time lecturer with the University of the West Indies. Miss Nicholls is the founder of the Caribbean’s leading trade policy and development blog, www.caribbeantradelaw.com, since 2011. She also presents regularly at both regional and international academic and industry-related conferences and webinars. While she maintains an interest in all issues affecting Caribbean trade and trade policy, her specific research focuses primarily on global financial regulation and small States, foreign investment law and policy and international business.