Economic Substance Regulations

Bahrain has always strived to provide a business friendly environment to local, Saudi backed, regional and international companies. Hence the authorities aim to ensure the necessary legal and regulatory framework exists in alignment to international economic regulations. To fulfill its commitment as a member of OECD Inclusive Framework on BEPS and to meet the European Union Criterion 2.2, the intent of Economic Substance Regulations is to protect the reputation of offshore jurisdictions and those companies, that operate from such jurisdictions, by ensuring that the revenue streams from certain activities are real and based on local business activities to substantiate the use of low tax jurisdiction.

Therefore, the Ministry of Industry, Commerce, & Tourism (MOICT) and the Central Bank of Bahrain (CBB) have issued Ministerial Order number 106 of 2018 and Directive (OG/499/2018) respectively, which provides an initial guidance on demonstrating Economic Substance. The purpose of the ministerial order is to enhance economic substance requirements in the Kingdom of Bahrain and clarify the requirements for any Traders carrying out certain types of Relevant Activities in or through Bahrain (other than those activities undertaken by licensees of the Central Bank of Bahrain).

The entities within scope would be those entities formed under the MOICT legislations that are carrying on a relevant activity, which can be identified as follow:

•         Distribution and service center activities
•         Headquarters activities
•         Holding company activities
•         Leasing activities (other than those activities undertaken by licensees of the Central Bank of Bahrain)
•         Shipping activities
•         Intellectual property activities in Bahrain
•         Banks (covered in CBB’s directive)
•         Financing companies (covered in CBB’s directive)
•         Insurance (covered in CBB’s directive)
•         Investment Business Firms (covered in CBB’s directive)
•         Fund Administrators (covered in CBB’s directive)

Amongst other obligations, as per the Guidance Notes, all Relevant Entities are required to file an Economic Substance Rules Annual Return Form (“ESR Annual Return”) with the MOICT within three months of the Relevant Entity’s financial year end. For Relevant Entities with a financial year that ends on 31 December 2020, the ESR Annual Return should be submitted to the MOICT by the 31 March 2021.

It is of paramount importance that substantial economic presence is demonstrated by a two-part test.

The first part of the test determines whether the relevant entity is conducting its core income-generating activities (CIGA) in The Kingdom of Bahrain. Industry-specific CIGA are outlined in article 3 of the MO 106. The CIGA should be undertaken with:

•         An adequate amount of annual operating expenditure
•         An adequate level of qualified full-time employees
•         An adequate number of physical offices.

A relevant entity is prohibited from outsourcing any of its core income generating activities to an entity or person outside of The Kingdom of Bahrain; but it may outsource such activities to a service provider within Bahrain provided it is able to demonstrate adequate supervision of the outsourced activity and the activities took place within Bahrain.

The second part of the test determines whether the relevant entity’s direction and management are in The Kingdom of Bahrain, which is satisfied by five requirements:

•         An adequate number of meetings of the relevant entity’s board of directors must take place in Bahrain
•         At least a quorum of the board must be physically present in Bahrain during the meetings
•         Strategic decisions concerning the relevant entity must be made at the above-mentioned meetings and recorded in the meeting minutes
•         All the relevant entity’s records and minutes must be kept in Bahrain
•         The board of directors must possess the necessary knowledge and expertise to discharge its duties.

The Economic Substance Regulations requires all registered entities who are conducting any of the above activities to file an annual return with the MOICT. These returns are submitted through the Ministry’s Sijilat system either by company or its appointed agent, i.e. Auditor or professional body.

Generally, the Economic Substance report includes but is not limited to – Core Income Generating Activities (CIGA) of a Trader, Structure of the board (number, names, nationality, experience), Number and place of board members’ meetings, External Auditor, Physical Address, Annual Income Statement, Strategic Decisions, Notification on change of directors or shareholding, other trader disclosures, immediate and ultimate beneficial owner etc.  Non-Compliance of above regulations can attract various monetary and non-monetary penalties including criminal proceedings depending on nature and extent of breach and judgement of MOICT.

In Summary, all Bahrain based Business should ensure to adhere to the obligations imposed by the economic substance rules, undertake a “health check” on their’ existing level of economic substance in Bahrain and ensure the required ESR Annual Return is completed and filed with the MOICT on time. The entity assessment should include sufficient consideration of the Local federal laws, Tax laws, transfer pricing and other international laws, DTAA Agreements, Internal Controls and its implementation, SOPs, internal policies, and its practice. Companies should now give sufficient importance to documentation kept by the entity. Evidence needs to be submitted to prove the exemption which may include Tax details, return filed, etc.

Bahrain Authorities acknowledge that businesses vary in size and nature, and what is adequate and appropriate as part of ESR reporting, will actually depend on the nature and level of activities carried out, and the level of income earned by a company. The Regulatory Authorities are expected to take a pragmatic approach when assessing whether a Company has met the Economic Substance Test. However, it is pertinent to note that companies should seek professional advice in understanding the law and its implications.

Quantum Auditing offers support to the business community in Bahrain in ensuring compliance with Economic Substance Regulations. We are well placed to assess the impact of the Rules on your organisation and assist you to complete and submit the required ESR Annual Return.