Bermuda formed the first modern captive in 1962 and remains the leading offshore captive domicile, with approximately 700 licenced captives on its register. Bermuda’s captive industry has remained resilient in the face of unprecedented events, including the COVID-19 pandemic, experiencing recent growth due to the current hard market, and a growing trend for increased diversification to write emerging risks such as climate, cyber and employee benefits given the current lack of suitable solutions in the commercial market. Increasingly, however, captives are required to further evidence the value they provide as a necessary risk management strategy, given changes driven by the shifting regulatory landscape in the name of global transparency.

Bermuda has embraced the global fight against financial crime and has signed up for the Foreign Account Tax Compliance Act (FATCA), adopted the Common Reporting Standard, and supported The Organisation for Economic Co-operation and Development’s (OECD) Forum in Base Erosion and Profit Shifting (BEPS) measures. Over time, this has been followed by the introduction of corporate tax, entry into mandatory disclosure regimes, economic substance laws, and exchanges of information between governments. Certainly, part of Bermuda’s attractiveness to captive owners is Bermuda’s adherence to international regulatory standards and its resulting stellar reputation. However, the changing global operating environment brings with it increased budgets to ensure compliance, complex rules, and new processes for compliance functions.

This article highlights a few recent changes to Bermuda regulatory and legal landscape with roots in global transparency and regulatory standards, which offshore captives should be aware of given their (recent or pending) transposition into law, further delineating the importance for captive owners to seek out domiciles, such as Bermuda, that adhere to global standards whilst remaining highly competitive.

Economic Substance

Bermuda enacted the Economic Substance Act (the ES Act) and its related regulations in 2018 in response to the requirements of OECD’s Forum on Harmful Tax Practices and the European Union’s (EU) Code of Conduct Group. The OECD Forum on Harmful Tax Practices determined in April 2022 that Bermuda was effectively monitoring resident entities’ compliance with the economic substance regime and on that basis, the EU Code of Conduct Group (Business Taxation) has placed Bermuda on its ‘white list’.

The criteria under the ES Act serve to place limits on entities operating in Bermuda without substance. Substance requires “adequate” levels of expenditure, people and premises along with evidence of certain “core income generating activities” of certain relevant activities (including, among others, the relevant activity of “insurance”). There are no prescriptive rules as to what is deemed “adequate”, and an entity will be assessed against the requirements based on the nature, scale and complexity of the business of that entity.

For Bermuda captives who are carrying on the relevant activity of “insurance” (other than in the cases where such entity is non-Bermuda tax resident, for example, having made a 953(d) election under section 953(d) of the U.S. Internal Revenue Code to be treated as a domestic company), complying with the ES Act requires captives to consider the amount of economic substance they have in Bermuda. It requires that captives (i) are managed and directed from Bermuda, (ii) have core income-generating activities undertaken in Bermuda, (iii) maintain adequate physical presence in Bermuda, (iv) incur adequate expenditure in Bermuda, and (v) have adequate full-time employees with suitable qualifications in Bermuda.

Bermuda captives have been able to demonstrate that they satisfy the criteria under the ES Act as they will hold an adequate number of board and/or committee meetings in Bermuda (based on the nature, scale and complexity of the captive’s business) at which meetings key executive board members may travel to Bermuda for the purpose of attending such meeting(s). In addition, captives frequently appoint Bermuda resident directors and employ a third-party service provider (such as an insurance manager) who will undertake the core income generating activities of the captive in Bermuda (such core income generating activities for the relevant activity of insurance include predicting and calculating risk, insuring or reinsuring against risk, providing client services and preparing regulatory reports).

As such, captives need to carefully consider the amount of economic substance they have in Bermuda which includes evaluating whether or not it is the intent of the captive to place employees on the ground (which would typically not be required for a straightforward captive) and if not, the level of sufficient and high-quality resources in Bermuda which will support compliance with the criteria under the ES Act.

The requirements under the ES Act are enforced by the Bermuda Registrar of Companies. Non-compliance of the criteria under the ES Act can result in the Registrar issuing requests for information, requiring on-site audits and imposing civil penalties in respect to previous relevant financial periods.

Solvency II

Bermuda achieved EU Solvency II equivalence in 2016. This formal recognition by the EU means that Bermuda’s insurance regime has achieved the same outcomes-based results as the EU’s Solvency II framework – and the corresponding phasing in of prudential regulations designed to bolster Bermuda’s regulatory and supervisory framework. As such, Bermuda’s commercial (re)insurers are not disadvantaged when placing business in the EU.

Although Solvency II may have significantly affected the European captive market, the same is not true in Bermuda. The Bermuda Monetary Authority (BMA) has adopted a bifurcated regulatory approach, which carves out captive insurers from the BMA’s prudential regime for commercial insurers. Thus, having equivalence to Solvency II allows captive owners that option if required; otherwise, a captive can apply for a Class 1, 2 or 3 licence and not be impacted by Solvency II equivalence. The BMA has successfully balanced the right regulation for the captive industry and separately, its Solvency II equivalent prudential regime.

International Tax

The OECD in 2015 issued guidance on BEPS to try to make sure that companies are not exploiting gaps in rules to artificially shift profits to low or no tax jurisdictions. At the end of 2022, the EU unanimously agreed to implement Pillar 2, the 15 per cent global minimum tax component of the OECD’s dual-pillar campaign. The EU unanimously agreed to implement Pillar 2 at the end of 2022.

In response to the foregoing, the Government of Bermuda has issued a series of consultation papers regarding the proposed introduction of a corporate income tax (CIT) that would be applicable to each Bermuda tax resident entity and Bermuda permanent establishment that are part of a Multinational Enterprise Group (MNE) with consolidated revenue of at least €750 million or more. It is worth noting that the CIT is not an OECD version of the Pillar 2 rules but Bermuda’s own minimum corporate income tax. The third consultation paper (issued on 15 November 2023) includes initial draft legislation of the CIT regime and follows two previous public consultations in August and October 2023, respectively. Public consultation on the third consultation paper is open until 30 November 2023 and further amendments to the CIT legislation may be made prior to being tabled in Parliament and is expected to be debated in the Bermuda House of Assembly in December 2023.

The CIT legislation is intended to be enacted by 1 January 2024 and would be effective for fiscal years beginning on or after 1 January 2025.

The introduction of CIT in Bermuda and the changes driven by Pillar 2 will influence strategic decision making regarding captive formations, the uses of captives and the jurisdictions they are located in. However, it may be that the impact of a minimum tax may be less relevant to captives than is thought – firstly, it is not uncommon for captives to already be registered as domestic taxpayers in the U.S. and thereby subject to U.S federal income tax (or paying tax elsewhere) and secondly, it is false to assume that tax benefits are always the primary consideration. Indeed, many captive owners do not view tax benefits as a value driver given significant other advantages to incorporating a Bermuda captive.

At this early stage, the potential impact of the CIT remains to be seen and once more guidance is issued on its implementation and rollout. Captive insurers should ensure that they are prepared for such requirements, involving their tax teams and senior management as soon as possible.

Why Bermuda?

Bermuda should take credit for its commitment to fully adhere to global disclosure and transparency standards imposed by bodies such as the OECD and the implementation and regulation of such standards. In today’s increasingly globalised world, captive domiciles that adhere to global standards effectively are of upmost importance. Given the increased compliance burden and to ensure that the benefits to be gained by the use of a captive are not compromised, this must be balanced by effective and proportionate regulation, a commitment to innovation and flexibility, and a talented and specialist workforce – all of which are Bermuda’s success areas. This is why Bermuda continues to be trusted by captive managers and investors worldwide.

This article was originally published in the IFC Economic Report 2024.

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