Understanding economic substance in the Cayman Islands and BVI
Entities looking to incorporate in the BVI or Cayman Islands should examine the economic substance (ES) legislation and balance the benefits of incorporation against the cost of ES requirements. When expanding into these jurisdictions, organisations should review their structure and intended activities against the economic substance requirements to ensure their chosen location aligns with their strategy.
What is economic substance?
The Economic Substance (Companies and Limited Partnerships) Act 2018 as amended for the BVI and the International Tax Cooperation (Economic Substance) Act (2021 Revision) as amended for the Cayman Islands were introduced to satisfy the new requirements of the OECD.
These directives were created as a response to the European Union’s (EU) Code of Conduct Group for business taxation (COCG), a tax initiative that requires certain entities incorporated or registered in low tax or tax free jurisdictions to demonstrate that they are operating in jurisdictions where they are tax resident – in other words, to demonstrate substance.
Who does economic substance apply to?
The legislation applies to all companies and limited partnerships (LP – BVI), limited (liability) partnerships (LLP – Cayman Islands) and exempted limited partnerships (ELP – Cayman Islands), unless they are considered non-resident by the Act, and to all foreign companies engaged in relevant activities.
In the Cayman Islands, domestic companies and investment funds fall within the exemption category and are only required to submit a notification to the Registrar of Companies in the Cayman Islands.
Similarly, for the BVI, investment funds fall within the exemption category.
Trusts are not included in ES requirement for the BVI or Cayman Islands.
What are the relevant activities?
To establish whether an entity must demonstrate economic substance, the legislation provides definitions for eight relevant activities:
- Banking business
- Distribution & service centres business
- Fund management business
- Headquarters business
- Holding business
- Insurance business
- Intellectual property business
- Shipping business
What are the classification groupings?
| Relevant activity | Tax residency – outside of the BVI / Cayman Islands | Requirement |
| No | Not applicable | Out of scope: simple annual filing confirming that the entity does not carry out any relevant activities. Annual confirmation of the classification grouping. |
| Yes | Yes | Out of scope: a slightly higher level of filing is required, including the supply of documented evidence covering the entire financial period, supporting the claim of tax residency as well as low-level data relating to the parent entity (if applicable). Annual filing and confirmation of unchanged classification group. |
| Yes | No | In scope for substance: entities in this category must demonstrate that they are operating at appropriate levels in the BVI/Cayman Islands (demonstrating substance) unless they are a pure equity holding company or PEHC (a reduced substance test applies). A higher level of data is required for filing and will vary according to the relevant activity. Annual confirmation of the classification grouping. |
How does an entity demonstrate substance?
The legislation refers to demonstrating ‘adequate’ or ‘appropriate’ substance depending on the relevant activity and the scale and complexity of the operation. Substance would include:
- Having an adequate number of employees in the BVI/Cayman Islands to carry out business
- Having adequate premises in the BVI/Cayman Islands to carry out business
- Managing and directing business from the BVI/Cayman Islands (not applicable for PEHC)
- Incurring adequate expenditure in the BVI/Cayman Islands
- Carrying out core income-generating activities in the BVI/Cayman Islands
- When the relevant activity is intellectual property business and requires the use of specific equipment that is located in the BVI
Outsourced activities to agents in the BVI/Cayman Islands would be considered a suitable contribution to substance declaration.
Ultimately, the decision about the level of substance to demonstrate lies with the directors of the entity. However, due to the vague wording of ES legislation, we would strongly recommend that organisations in scope for substance undertake a legal review of their entities.
Entities carrying out purely holding activities have reduced substance requirements. Conversely, entities carrying out intellectual property activities require a more substantial demonstration of substance.
Further information can be found in the useful links below.
Financial period
BVI
The default financial periods are determined by incorporation date as follows:
- Company or limited partnership (with legal personality) incorporated before 1 January 2019: financial period runs from 30 June – 29 June annually.
- Company or limited partnership (with legal personality) incorporated after 1 January 2019: financial period starts on the date of incorporation and ends in 12 months less one day. For example, if the incorporation date is 14 February, the financial period will be 14 February – 13 February each year.
- Limited partnership (without legal personality) formed before 1 July 2021: financial period runs from 1 January -31 December.
- Limited partnership (without legal personality) formed after 1 July 2021: financial period starts on the date of formation and ends in 12 months.
A company may apply to change its financial period to align with its accounting period, provided the period does not exceed 12 months. For example, a company can change its financial year from 30 June – 29 June to 1 January – 31 December each year.
Cayman Islands
The Cayman Islands does not have a default financial year end like the BVI. Cayman Islands entities will need to adopt a financial year end to comply with the ES regime.
Reporting Requirements
| Relevant activity | Tax residency – outside of the BVI / Cayman Islands | Requirement | BVI timing | Cayman Islands timing |
| No | Not applicable | Annual confirmation of classification group. Simple annual filing confirming that the entity does not carry out any relevant activities. | Filing must be submitted within six months of the completion of the financial period. | ES notification confirming classification and relevant activities must be filed in January, regardless of financial period. |
| Yes | Yes | A slightly higher level of filing is required, including documented evidence covering the entire financial period to support the claim of tax residency and low-level data relating to the parent entity (if applicable). Annual filing and confirmation of unchanged classification group. | Filing must be submitted within six months of the completion of the financial period. | ES notification confirming classification and relevant activities must be filed in January, regardless of financial period. The annual ES return for those carrying out relevant activities must be submitted within 12 months of the end of a financial period. |
| Yes | No | A higher level of data is required for filing and will vary according to the relevant activity. Data must be supplied annually relating to each financial period. Annual confirmation of the classification grouping. | Filing must be submitted within six months of the completion of the financial period. | ES notification confirming classification and relevant activities must be filed in January, regardless of financial period. The annual ES return for those carrying out relevant activities must be submitted within 12 months of the end of a financial period. |
Struck off and liquidating entities
Struck off entities (but not yet dissolved) must still comply with ES, as well as file their annual BVI or Cayman Islands ES return. Their lack of turnover related to the relevant activity would be demonstrated by the data filed and reflected in the ‘appropriate’ substance levels required.
Liquidated entities are expected to file for any financial period during which they were still considered active in the companies’ registry, meaning they will always end with a partial period to file. As it is not possible to file until a financial period is concluded, the data for filing must be supplied prior to final dissolution so that filing can take place after the liquidation is complete.
Penalties
The first offence of failure to comply (either by not submitting a filing or insufficient substance demonstration) will trigger a penalty of minimum US$5,000 (BVI) or US$12,200 (Cayman Islands).
A second offence will trigger an escalation of the penalty, with a minimum of US$10,000 (BVI) or US$122,000 (Cayman Islands). In BVI, penalties could be as high as US$400,000 for an entity conducting IP business and US$200,000 for other legal entities. The tax authority could ultimately recommend that the entity be struck from the register for continued failure to comply.
Provision of false data could result in further penalty or imprisonment.
How can we help?
- Support and guidance through the classification process
- Timely annual filing for ES
- Facilitate ES assessment or classification with a local partner
- Development and provision of bespoke substance service packages
- Enhancement of BVI and Cayman Islands presence: directorship, accounting and tax, corporate secretarial services
