I would take this opportunity to update you on the status of the economic substance requirements introduced in the BVI earlier this year, and the proposed course of action in respect of these requirements.
Economic Substance in a Nutshell
The Economic Substance (Companies and Limited Partnerships) Act, 2018 (the “Act”) was enacted in the BVI in December 2018, and came into force on 1 January 2019. The Act can be found at this link: https://eservices.gov.vg/
The Act applies to all “legal entities” that are resident in the BVI and that are carrying on “the relevant activities”. “Legal entities” include BVI companies and limited partnerships, and foreign companies and foreign limited partnerships that are registered and tax resident in the BVI. The Act does not apply to non-resident companies, non-resident limited partnerships and limited partnerships that have elected not to have legal personality. A non-resident company or non-resident limited partnership is a company or limited partnership which is tax resident outside the BVI (except for jurisdictions which are included on the EU black list of non-cooperative jurisdictions). The economic substance requirements apply to BVI-resident legal entities that carry on the “relevant activities”, namely the following types of activities:
a) holding
b) finance and leasing
c) intellectual property
d) headquarters
e) distribution and service centre
f) banking
g) fund management
h) insurance
i) shipping.
Legal entities formed in 2019 shall comply with economic substance requirements starting from their registration date. Legal entities formed before 2019 shall demonstrate compliance with economic substance requirements no later than 30 June 2019.
The Test
Each “relevant activity” should be analysed in terms of its compliance with the economic substance requirements. Subject to 2 special situations discussed below, a BVI-resident legal entity should be ready to proof economic substance with reference to the following criteria, having regard to the nature and scale of each relevant activity:
1. whether the relevant activity is being directed and managed in the BVI;
2. whether there is an adequate number of qualified employees who are physically present in the BVI;
3. whether adequate expenditure is incurred in the BVI;
4. whether there is an appropriate physical office or premise in the BVI.
Outsourcing of core income generating activities may be possible in certain circumstances.
Pure holding companies should also comply with the economic substance requirements, albeit of the reduced scale.
In contrast, intellectual property (IP) companies are subject to more onerous economic substance requirements. Specifically, there is a general presumption that all IP companies (including high-risk IP companies) do not comply with the economic substance test unless they rebut this presumption in accordance with the prescribed rules. Also, where the relevant activity involves IP business and requires the use of specific equipment, such equipment shall be located in the BVI.
Obligations and Implications
All BVI-resident legal entities must provide the information on the relevant activities and compliance with the economic substance requirements upon the requests of the BVI’s tax authorities. All BVI-resident legal entities should also file annual reports on their relevant activities and compliance with the economic substance requirements.
Penalties are prescribed both for failure to provide requested information, and for failure to comply with the economic substance requirements. The penalties may include fines, imprisonment and/or strike-off. The fines vary from USD5,000 to USD50,000 for first breach. The maximum fine applies to high-risk IP companies. If the legal entity fails to rectify the breach, it can be served with the second determination and be fined from USD10,000 to USD400,000.
The BVI tax authorities may also recommend to strike the legal entity off the state register.
The BVI tax authorities should also disclose to the foreign tax authorities (for example, where the UBO or parent company is located) should the relevant legal entity fails to satisfy the BVI substance requirements.
Recent developments
The BVI’s authorities committed to release special guidelines to bring more clarity and help applying the new economic substance requirements. A draft of such guidelines labelled the Economic Substance Code (“the Code”) was released in late April 2019, and expected to the finalized before the end of June. The Code can be useful for carrying on the cost-benefit analysis and deciding on whether it is economically viable to absorb the additional costs and compliance in the BVI, or it makes sense to restructure.
Way forward
It is evident that the cost of maintaining existing structures will increase, especially for IP structures. In addition to the expected increase in maintenance and compliance costs, existing BVI structures often have other inherent issues, namely:
- bank account opening
- difficulty encountered in making or receiving payments
- no tax treaty network protection
- introduction of beneficial ownership and GAAR tests in various domestic laws and tax treaties makes it risky to continue using existing structures for channelling income (especially royalties, interest and dividends) to the BVI.
Therefore:
1. Consider if the existing BVI structure is still viable. If assistance with cost-benefit and viability analysis is needed, we are here to assist.
2. If you conclude that the existing BVI structure is no longer viable, consider the available options for your BVI company:
i) re-domicile it to a feasible jurisdiction (this option can help preserving the bank accounts)
ii) have its assets and/or business transferred to a new entity in a feasible jurisdiction;
iii) becoming a tax non-resident of the BVI.
If you have any questions or need assistance in respect of your existing presence in the BVI , please feel free to contact me. I would also welcome the opportunity to organize a meeting or a call with you to discuss in detail your structure, its viability, alternatives (if applicable) and next steps.
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