Navigating Bermuda’s Economic Substance Act: A guide for financing and leasing companies

A financing and leasing company in Bermuda must comply with the Economic Substance Act (ESA) 2018 by demonstrating a substantial economic presence and meeting specific criteria.

In this article, Sam Butler, Client Director in Bermuda, provides valuable insights into the ESA's requirements, with a particular emphasis on the financing and leasing companies.

Can you provide a quick refresher on how the economic substance requirements in Bermuda came about?

In 2017, the Code of Conduct Group (COCG) announced that it would begin investigating the tax policies of non-EU countries, including Bermuda, against the concept of “tax good governance” standards on tax transparency, fair taxation, and anti-BEPS measures.

Following its review, the COCG expressed concerns regarding the lack of economic substance requirements for entities doing business in and through the 2.2 jurisdictions (largely the traditional offshore jurisdictions). COCG mandated that such jurisdictions pass economic substance legislation by the end of 2018. In response, Bermuda passed the Economic Substance Act (the “Act”) and the Economic Substance Regulations (the “Regulations” and, together with the Act, the “ESA”) with effect from December 31, 2018.

Which entities would be deemed to be carrying out the relevant financing and leasing activities?

The guidance notes state that “An entity will be carrying on the relevant activity of “financing and leasing” if it provides credit facilities of any kind for consideration to any person”. Frequently, we see companies that provide loans (including intra-group loans) for consideration falling into this bucket.

How can an entity ensure it complies with the requirements for a financing and leasing company?

For all relevant activities, an entity must evidence that:

• It is managed and directed in Bermuda
• The Core income-generating activities (CIGA) are performed in Bermuda
• Has adequate physical presence in Bermuda
• Has adequate, suitably qualified employees in Bermuda
• Has incurred adequate operating expenses in Bermuda

What are the core income-generating activities for a financing and leasing company?

The guidance notes establish five areas:

1. Agreeing on funding terms, which includes deciding on the type and quantum of funding, the rates of interest payable, the security given (if any), and any covenants.

2. Identifying and acquiring assets to be leased (in the case of leasing), which includes agreeing on a suitable price or quantity of assets to be leased, identifying sources of those assets, and negotiating the acquisition and terms of supply.

3. Setting the terms and duration of any financing or leasing, which includes setting the financial terms, the parameters as to acceptable counterparties and transactions, the amounts, rates of interest, the legal agreements, and the period for which financing or leasing is to be provided.

4. Monitoring and revising agreements, which includes the acquisition of credit data about a borrower or lessee (or group of borrowers or lessees), testing against covenants, extending the duration of loans, and feeding back into decision-making on writing new terms.

5. Managing risk associated with such agreements, which includes monitoring credit data on debtors or lessees, instigating debt collection, considering diversification of risk across sectors or consumer groups, and in relation to leasing, includes monitoring and maintaining the underlying assets.

How do you see companies carrying out these last two requirements?

Often, the last two requirements are overlooked. Companies that have done this well have included in board packs financial statements of the loanee as well as a credit rating, where it is available. This allows the board to review in detail the financial strength of the loanee to manage any risk with the loan agreement.

We encourage all financing and leasing companies to think about including a review (at least annually) of the agreements and to manage the risk associated with these agreements.

How can Ocorian assist in ensuring compliance with the Economic Substance Regulations for such companies?

Ocorian has experienced client directors who are experts in Bermuda's regulations. These directors can keep the board up to speed with the local regulations, as well as helping to ensure the company is managed and directed in Bermuda. We also have a team of accountants who provide loan monitoring services the help companies to truly carry out these final two CIGA requirements for a financing and leasing company.