Economic substance – BVI law in force

The British Virgin Islands (BVI) has passed legislation requiring certain legal entities carrying on relevant activities to demonstrate adequate economic substance in the BVI. The Act also introduces extended reporting obligations. Any company or limited partnership registered or incorporated in the BVI should be aware of this legislation and consider how it may be affected.

The Economic Substance (Companies and Limited Partnerships) Act, 2018 (the Act) came into force on 1 January 2019. It addresses the concerns of the EU Code of Conduct Group for Business Taxation and recent OECD guidance around the economic substance of entities in jurisdictions with low or (like the BVI) zero corporation tax. The Act demonstrates the BVI’s continued commitment to international best practice including the BVI’s implementation of the OECD’s Base Erosion and Profit Shifting (BEPS) framework and related EU initiatives.

The Act follows closely the approach taken to address the same issue by the Crown Dependencies of the UK (Jersey, Guernsey and the Isle of Man) and the other UK Overseas Territories including the Cayman Islands and Bermuda.

Further key details, in the form of Regulations, Rules and formal Guidance Notes, are expected to be published during the course of the first quarter.

Which entities need to demonstrate economic substance in the BVI?

The Act imposes economic substance requirements on relevant legal entities, other than non-resident entities^[1], which carry on a relevant activity. The requirements potentially apply to any BVI company or BVI limited partnership as well as any foreign company or limited partnership which is registered in the BVI as a foreign entity^[2]. Entities which do not carry on a relevant activity are not subject to the economic substance requirements but may be subject to certain reporting obligations (see “What are the reporting obligations and who will have access to information?” below).

The relevant activities are:

• Banking business
• Insurance business
• Shipping business
• Fund management business
• Finance and leasing business
• Headquarters business
• Holding business
• Intellectual property business
• Distribution and service centre business

Under the Act, economic substance will be measured by reference to reporting periods which are not longer than one year, recognising that compliance can only be evaluated over a period of time. Companies and limited partnerships which are incorporated or formed from 1 January 2019 (New Entities) and which need to demonstrate economic substance will have to comply for any reporting period ending on or after 31 December 2019. New Entities must elect to have a first financial period of not more than one year from the date of incorporation or formation, as applicable. Companies and limited partnerships in existence on 1 January 2019 and which need to demonstrate economic substance will have to comply for each reporting period starting no later than 30 June 2019.^[3]

Certain rebuttable presumptions of non-compliance will apply to entities carrying on intellectual property business that are classified as a “high risk IP legal entity” or which do not carry on research and development or marketing, branding and distribution activities in the BVI, as appropriate to the type of intellectual property involved. Entities carrying on intellectual property business are encouraged to seek legal advice.

What will relevant entities that carry on relevant activities need to do?

An analysis will need to be carried out to assess whether a relevant entity is conducting any relevant activity. Any affected entities then need to consider their position and take appropriate action.

Entities which are subject to the economic substance requirements (other than pure equity holding entities, as described below) must manage and direct the relevant activity in the BVI and conduct core income-generating activity. They must also, taking into account the nature and scale of the relevant activity, show that they have an adequate level of employees and expenditure in the BVI and appropriate physical offices or premises for the core income generating activity. It should be noted that outsourcing of the income generating activity is permitted in certain circumstances.

A different test applies to a pure equity holding entity, which carries on no relevant activity other than holding equity participations in other entities and earning dividends and capital gains. Under this test, the relevant entity will be deemed to have adequate substance if it complies with its statutory obligations under the BVI companies / limited partnership laws and has adequate employees and premises for holding and, where relevant, managing those equity interests.

Harneys Fiduciary is able to provide various services to assist relevant entities with meeting their substance requirements.

What are the reporting obligations and who will have access to information?

The Act made changes to the BVI Beneficial Ownership Secure Search (BOSS) System regime, as a result of which BVI and foreign registered companies and limited partnerships will generally be required to report certain information to their BVI registered agent to be uploaded onto the BOSS system. Previously “exempt persons” (including mutual funds) will remain exempt from the BOSS reporting requirements unless they carry on a relevant activity.^[4]

Broadly, in addition to their existing obligations under the BOSS regime, BVI and foreign registered companies and limited partnerships which are subject to the BOSS reporting requirements will have to identify and provide their registered agent with certain information.

This information will be provided to the BVI International Tax Authority (ITA) via the BOSS system. The ITA may use the information to discharge its duty to supervise and enforce the economic substance requirements. Information will be disclosed by the ITA to relevant overseas authorities in certain appropriate cases, including where there is breach of the economic substance requirements or where the entity claims to be tax resident in an EU member state.

Substantial fines and up to 5 years’ imprisonment can be imposed for non-compliance and the relevant entity may be struck off the register.

What happens next?

The Regulations, Rules and formal Guidance Notes, when issued, will provide further detail and a clearer picture. We will be in touch with more information on the steps required to understand the impact (if any) of the economic substance requirements and the measures that entities need to take to ensure compliance. We believe that, for many entities, the impact will be minimal and compliance will be straightforward. If you have any questions in the meantime, please contact your usual Harneys contact or fill out our enquiry form here.

^[1] Tax resident in a jurisdiction outside the BVI (which is not itself treated by the EU as non-cooperative for tax purposes).

^[2] Other than certain limited partnerships registered without legal personality – please consult with your usual Harneys contact for further information.

^[3] It is possible to apply to the BVI International Tax Authority (ITA) to shorten or lengthen a financial period so as to alter the commencement date for successive financial periods, provided that no such altered period shall exceed twelve months in length. Please consult with your usual Harneys contact for further information.

^[4] It is possible that exempt persons not carrying on a relevant activity may be required to submit a “nil return” confirming this to their registered agent at the end of each financial period.