VIRGIN ISLANDS
Economic Substance (Companies and Limited Partnerships) Act, 2018 [read]
Economic Substance (Companies and Limited Partnerships) (Amendment) Act, 2019 [read]
Rules on Economic Substance in the Virgin Islands, 9 Oct 2019 [read]
Background of the economic substance requirement act
Base erosion and profit shifting (BEPS) refers to tax planning strategies used by multinational enterprises that exploit gaps and mismatches in tax rules to avoid paying tax. An instance of these gaps and mismatches is one between full taxation and a preferential tax regime under which income is either tax-exempted in whole or in part, or taxed at a reduced rate. Most countries that impose corporate income tax establish preferential tax regimes to promote trade and investment. This changed with the creation of the OECD BEPS 15-point Action Plan, including the publication in 2015 of the Action 5 - 2015 Final Report: "Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance". In the wake of the Action 5 Final Report, countries that already have the preferential regime must comply with the economic substance requirement. In contrast, traditional offshore jurisdictions offering no or only nominal tax treatment, also referred to as the tax haven jurisdictions, do not impose any economic substance requirement on the same activities as those under the preferential tax regime. The existence of mismatches gives rise to BEPS concerns in that it creates the opportunity for tax avoidance.
The mismatches between tax rules not only create the opportunity for tax avoidance but also pose risks to the tax base of the host country that has the preferential regime in place. To address the level playing field issue arising from the different requirement for the economic substance, the Inclusive Framework agreed to apply the substanital activities to no or only nominal tax jurisdictions, in the same way as those having preferential regimes. Subsequently, members of the OECD Inclusive Framework including the British Virgin Islands, have introduced legal rules to impose the substance requirement on entities that are engaged in prescribed geographically mobile activities. In this regard, the Economic Substance (Companies and Limited Partnership) Act, 2018 came into force on 1st January 2019. [Referred to hereafter as "the ES Act"]
Scope of application
The ES Act requires a legal entity (a company or a limited partnership) that conducts relevant activities during a financial period to comply with the economic substance requirements in relation to that activity.
A non-resident company which is resident for tax purposes in a jurisdiction outside the Virgin Islands which is not on Annex 1 to the EU list of non-cooperative jurisdictions for tax purposes are excluded from the requirement for economic substance.
Meaning of relevant activities [Section 6, the ES Act, 2018]
In this Act, unless the context otherwise requires, “relevant activities” mean any of the following activities:
(a) banking business;
(b) insurance business;
(c) fund management business;
(d) finance and leasing business;
(e) headquarters business;
(f) shipping business;
(g) holding business;
(h) intellectual-property business;
(i) distribution and service centre business.
Meaning of core income-generating activities [Section 7, ES Act, 2018]
The expression "core income-generating activities" includes, in relation to relevant activities
(a) in respect of banking business
(i) raising funds, managing risk including credit, currency and interest risk;
(ii) taking hedging positions;
(iii) providing loans, credit or other financial services to customers;
(iv) managing regulatory capital;
(v) preparing regulatory reports and returns;
(b) in respect of distribution and service centre business
(i) transporting and storing goods;
(ii) managing stocks;
(iii) taking orders;
(iv) providing consulting or other administrative services;
(c) in respect of insurance business
(i) predicting and calculating risk;
(ii) insuring or re-insuring against risk;
(iii) providing insurance business services to clients;
(d) in respect of fund management business
(i) taking decisions on the holding and selling of investments;
(ii) calculating risks and reserves;
(iii) taking decisions on currency or interest fluctuations and hedging positions;
(iv) preparing relevant regulatory or other reports for government authorities and investors;
(e) in respect of finance or leasing business
(i) agreeing funding terms;
(ii) identifying and acquiring assets to be leased (in the case of leasing);
(iii) setting the terms and duration of any financing or leasing;
(iv) monitoring and revising any agreements;
(v) managing any risks;
(f) in respect of headquarters business
(i) taking relevant management decisions;
(ii) incurring expenditures on behalf of affiliates;
(iii) co-ordinating group activities;
(g) in respect of shipping business
(i) managing the crew (including hiring, paying and overseeing crewmembers);
(ii) hauling and maintaining ships;
(iii) overseeing and tracking deliveries;
(iv) determining what goods to order and when to deliver them;
(v) organising and overseeing voyages;
(h) in respect of intellectual property business
(i) where the business concerns intellectual property assets such as patents, research and development;
(ii) where the business concerns non-trade intangible assets such as brand, trademark and customer data, marketing, branding and distribution.
Economic Substance Requirement
1) Economic substance relating to non-pure equity holding companies
As per section 8(1) of the EC Act, subject to section 8(2), a legal entity complies with economic substance requirement if
(a) the relevant activity is directed and managed in the Virgin Islands;
(b) having regard to the nature and scale of the relevant activity
(i) there are an adequate number of suitably qualified employees in relation to that activity who are physically present in the BVI;
(ii) there is adequate expenditure incurred in the BVI;
(ii) there are physical offices or premises as may be appropriate for the core income-generating activities; and
(iv) where the relevant activity is intellectual property business and requires the use of specific equipment, that equipment is located in the BVI;
(c) the legal activity conducts the income-generating activity; and
(d) in the case of income-generating activity carried out for the relevant legal entity by another entity
(i) no core income-generating activity is carried on outside the BVI;
(ii) only that part of the activities of that other entity which are solely attributable to generating income for the relevant legal entity and not for any other legal entity shall be taken into account when considering if the relevant legal entity meets the economic substance requirements;
(iii) the relevant legal entity is able to monitor and control the carrying out of that activity by the other entity.
2) Economic Substance Requirement for pure equity holding company
Holding companies that provide benefits only to dividends and capital gains, however, raise different policy considerations than other preferential regimes in that they primarily focus on alleviating economic double taxation. Therefore, they may not in fact require much substance in order to exercise their main activity of holding and managing equity participations. Countries' concerns about holding company regimes are often related to transparency and their inability to identify the beneficial owner of the dividends, but not related to economic substance.
As per section 8(2), 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, has adequate substance if it
(a) complies with its statutory obligations under the BVI Business Companies Act, 2004 or the Limited Partnership Act 2017 (whichever is relevant);
(b) has adequate employees and premises for holding equitable interests or shares and, where it manages those equitable interests or shares, has adequate employees and premises for carrying out that management.
As noted, a pure equity holding entity which only earns dividends and capital gains will be subject to a reduced level of economic substance requirement. It is not required to be directed and managed in the BVI, and is not subject to the core income-generating activity either.
It remains necessary to have in the BVI adequate employees and premises for holding or managing its equity participation. In accordance with the BVI authority guidance, there are no restrictions on the extent to which a pure equity holding entity may outsource its activity. Where any activity is outsourced, the extent of the outsourcing will be taken into account in assessing the adequacy of the employees in the BVI, but only if the outsourcing is itself to a person operating in the BVI. As a rule, any legal entity will retain the services of a registered agent, and the performance of those services will be taken into account when assessing economic substance for pure equity holding entities.
Determination by Competent Authority [Section 10(1), ES Act, 2018]
The competent authority may determine that a legal entity has not complied with the economic substance requirements during any financial period of the legal entity ending on or after 31st December 2019.
Penalty for non-compliance
Penalty for a legal entity not providing information for the competent authority
Section 11 provides for the penalty for a legal entity not providing information for the competent authority
A legal entity shall provide any information reasonably required by the competent authority in order to assist the competent authority in making a determination under section 10.
A person who fails to provide information without reasonable excuse, or who intentionally provides false information in response to a request under this section commits an offence and is liable
(a) on summary conviction, to a fine not exceeding forty thousand dollars (USD40,000) or to imprisonment for a term not exceeding two years or both; or
(b) on conviction on indictment, to a fine not exceeding seventy five thousand dollars (USD75,000) or to imprisonment for a term not exceeding five years; or both.
Section 12 provides for the penalty on the determination of non-compliance.
12(1) provides that on a first determination of non-compliance under section 10, the competent authority shall issue a notice to the legal entity notifying it
(a) that the competent authority has determined that the legal entity has not complied with the economic substance requirements for that financial period;
(b) of the reasons for that determination;
(c) of the amount of penalty imposed on the legal entity under subsection (2);
(d) of the date from which the penalty under subsection (2) is due, being not less than 28 days after the issue of the notice;
(e) of what action the competent authority considers should be taken by the legal entity to meet the economic substance requirements and the date by which such action needs to have been taken; and
(f) of the legal entity's right of appeal under section 13.
12(2) provides that the amount of penalty referred to in subsection (1)(c) is such amount as is determined by the competent authority subject to a minimum penalty of five thousand dollars (USD5,000) and to a maximum penalty of
(a) in the case of a high risk IP legal entity, fifty thousand dollars (USD50,000); and
(b) in the case of all other legal entities, twenty thousand dollars (USD20,000).
12(3) If a legal entity fails to comply with any requirements imposed upon it under paragraph (e) of subsection (1) within the time there stated, or within such longer period as the competent authority may allow, the competent authority shall issue a second determination.
12(4) On a second determination of non-compliance under section 10, the competent authority shall issue a further notice to the legal entity notifying it
(a) that the competent authority has determined that the legal entity has not complied with the economic substance requirements;
(b) of the reasons for that determination;
(c) of the amount of the additional penalty imposed on the legal entity under subsection (5);
(d) of the date from which the penalty under subsection (5) is due, being not less than 28 days after the issue of the notice;
(e) that the competent authority may make a report to the Commission under subsection (6);
(f) of what action the competent authority considers should be taken by the legal entity to meet the economic substance requirements and the date by which such action needs to have been taken; and
(g) of the legal entity's right of appeal under section 13.
12(5) The amount of the additional penalty referred to in subsection (4)(c) is such amount as is determined by the competent authority subject to a minimum penalty of ten thousand dollars (USD10,000) and to a maximum penalty of
(a) in the case of a high risk IP legal entity, four hundred thousand dollars (USD400,000); and
(b) in the case of all other legal entities, two hundred thousand dollars (USD200,000).
Striking-Off
After issuing the notice of a second determination of non-compliance, the BVI authority has the power to strike the legal entity off the Register of Companies or the Register of Limited Partnerships.
Notification
Economic substance is assessed by reference to financial periods. In particular, the question of whether an entity is required to comply with the economic substance requirements depends on whether it has carried on a relevant activity during a financial period (see ESA section 5(1)). Further, the issue of whether an entity has complied with the economic substance requirements is determined by reference to its activities (including its turnover, expenditure, staff, premises, location of equipment, and direction and management) over the course of a financial period.
The trigger for the commencement of an entity's obligations to comply with the provisions of the ESA is the start of its first financial period. Time starts to run for the purposes of an entity’s periodic reporting obligations from the end of the financial period (see section 9(6A) of the BOSS Act).
Rule 13 to Rule 16 [the ITA Guidance]
The International Tax Authority (the ITA) of the Virgin Islands issued guidance for the practical administration of the ES Act (the ITA guidance), which became effective following the entry into force of the Beneficial Ownership Secure System (Amendment) (No. 3) Act, 2019.
Rule 13. The first financial period of a legal entity that has been incorporated or formed on or after 1 January 2019 shall commence on the date of incorporation or formation and shall terminate on the expiry of one year from that date unless the legal entity gives notice to the ITA in accordance with rule 14 that it wishes to elect for an earlier termination of its first financial period.
Rule 14. A legal entity which wishes to give notice to the ITA pursuant to rule 12 that it wishes its first financial period to terminate sooner than one year from the date of its incorporation or formation must give that notice within three months of the date of incorporation or, if later, within three months following 30 June 2019. Such a legal entity may not elect to terminate its first financial period on a date prior to the date of the notice.
Rule 15. The first financial period of a legal entity that has been incorporated or formed before 1 January 2019 shall commence on 30 June 2019 unless the legal entity gives notice to the ITA in accordance with rule 15 that it wishes to elect for an earlier commencement date.
Rule 16. A legal entity which wishes to give notice to the ITA pursuant to rule 15 that it wishes its first financial period to commence on a date prior to 30 June 2019 must give that notice on or before 31 December 2019. Such a legal entity may not elect to commence its first financial period on a date prior to 1 January 2019.
Reporting Duties under the BOSS Platform
Paragraphs 12.2 and 12.4 [the ITA Guidance]
12.2. The reporting regime introduced by the ES Act by way of amendment to the BOSS Act builds upon the pre-existing regime for the collection of information relating to beneficial ownership under the BOSS Act.
12.3. Under the reporting regime, the content of the RA database, which a registered agent (the RA) is obliged to establish and maintain in respect of each entity for which it acts as registered agent, has been expanded to include additional information which enables the ITA to determine (i) whether the relevant legal entity is subject to economic substance requirements and (ii) if so, whether the relevant entity is complying with them. It has also been expanded to include limited partnerships with legal personality, which hitherto have not been subject to the BOSS Act at all.
12.4. The information which the RA database must hold with respect to an entity is set out in section 10(3) of the BOSS Act, and is referred to as “the prescribed information”. It comprises the following:
(a) the particulars of each corporate and legal entity including
(i) the name, including alternative names;
(ii) the incorporation number or its equivalent;
(iii) date of incorporation;
(iv) status;
(v) registered address;
(va) whether it carries on a relevant activity;
(vi) any relevant activities which it carries on; and
(vii) any other particulars as the Minister may by Order prescribe.
(b) with respect to each beneficial owner of the corporate or legal entity:
(i) name;
(ii) residential address;
(iii) date of birth; and
(iv) nationality.
(c) with respect to each registrable legal entity of the corporate and legal entity:
(i) details of the registrable legal entity as outlined in subsection (3)(a) (i) to (v);
(ii) jurisdiction in which the registrable legal entity is formed;
(iii) the basis or bases upon which the legal entity is designated as a registrable legal entity;
(iv) where the registrable legal entity is a foreign regulated person, the name of the jurisdiction of regulation and the name of the foreign regulator; or
(v) where the registrable legal entity is a sovereign state or a wholly owned subsidiary of a sovereign state the name of that sovereign state and (if applicable) wholly owned subsidiary.
(d) with respect to an exempt person
(i) the details of the exempt person as outlined in subsection (3)(a); and
(ii) the basis or bases upon which the exempt person is designated as an exempt person.
(e) with respect to the parent (if any) of any corporate and legal entity which carries on a relevant activity and which claims to be outside the scope of the economic substance requirements by reason of being a non-resident company or a non-resident limited partnership:
(i) details of the parent as outlined in subsection (3)(a) (i) and (ii);
(ii) jurisdiction in which the parent is formed;
(f) with respect to any corporate and legal entity which is registered on a recognised stock exchange, details of the stock exchange listing.
(g) with respect to any corporate and legal entity which carries on a relevant activity and claims to be outside the scope of the economic substance requirements by reason of being a non-resident company or a non-resident limited partnership, the jurisdiction in which it is tax resident together with evidence to support that tax residence.
(h) with respect to any corporate and legal entity which carries on a relevant activity, and which does not claim to be outside the scope of the economic substance requirements by reason of being a non-resident company or a non-resident limited partnership, in relation to each such activity which it carries on during a financial period, and in respect of that period
(i) the total turnover generated by the relevant activity;
(ia) the total amount of expenditure incurred on the relevant activity
(ii) the amount of expenditure incurred on the relevant activity within the Virgin Islands;
(iii) the total number of employees engaged in the relevant activity;
(iv) the number of employees engaged in the relevant activity within the Virgin Islands;
(v) the address of any premises within the Virgin Islands which is used in connection with the relevant activity and the address of each such premises;
(vi) in the case of a corporate and legal entity which carries on an intellectual property business, the nature of any equipment located within the Virgin Islands which is used in connection with the relevant activity;
(vii) the names of the persons responsible for the direction and management of the relevant activity, together with their relationship to the company and whether they are resident in the Virgin Islands;
save that where the relevant activity is holding business the prescribed information required under this paragraph (h) shall be limited to subparagraphs (iii), (iv) and (v).
(i) with respect to any corporate or legal entity which carries on an intellectual property business, and which does not claim to be outside the scope of the economic substance requirements by reason of being a non-resident company or a non-resident limited partnership, in addition to the particulars supplied under section 10(3)(h), in relation to that activity
(i) whether or not the corporate or legal entity is a high risk IP legal entity within the meaning of section 2 of the Economic Substance (Companies and Limited Partnerships) Act, 2018;
(ii) whether the corporate or legal entity wishes to contest the rebuttable presumption introduced by section 9(2)(a) or, as the case may be 9(2)(b) of the Economic Substance (Companies and Limited Partnerships) Act, 2018;
(iii) if the corporate or legal entity wishes to contest such a rebuttable presumption the facts and matters relied upon for that purpose.
(j) with respect to any corporate or legal entity which carries on a relevant activity and which does not claim to be outside the scope of the economic substance requirements by reason of being a non-resident company or a non-resident limited partnership, but for which core income-generating activity is carried out by another entity, the name of the entity which carries out that activity on its behalf, together with details of the resources deployed by that entity in carrying out the activity on its behalf.
Rule 19 to Rule 21 [the ITA Guidance]
The definition of “parent” appears in section 7(3) of the BOSS Act. The obligation to give this information is clarified by rule 19.
Rule 19. References in the BOSS Act to the parent of a corporate and legal entity mean references to the immediate parent of the corporate legal entity, and to the ultimate parent of the corporate and legal entity.
Rule 20. The ultimate parent of a corporate and legal entity means the parent of the corporate and legal entity which itself has no parent.
The scope of prescribed information relating to a pure equity holding company is given in rule 21.
Rule 21. Where the relevant activity being carried on by a corporate and legal entity is holding activity, of the information prescribed in section 10(3)(h), only that set out in paragraphs (iv) and (v) need be provided.
Reporting prescribed information to the Registered Agent
The reporting obligation is set out under paragraphs 12.12 to 12.17 of the ITA Guidance.
12.12 Registrable legal entity is defined in the BOSS Act section 8.
12.13 The duty on a corporate and legal entity to ascertain prescribed information and notify its RA arises in two circumstances, as provided for in section 9(6A):
(6A) A corporate and legal entity shall notify the registered agent of information prescribed in section 10(3)(a) (va) and (vi) and section 10(3)(e) to (j) within a period following the end of the financial period to be fixed by regulations and shall notify the registered agent of any matters prescribed in section 10(3)(a) to (d), excluding section 10(3)(a)(va) and (vi), within 15 days of identifying those matters.
12.14 This means that for the purpose of determining when the corporate and legal entity’s obligation to ascertain prescribed information and pass it on to the RA arises, prescribed information is divided into 2 categories:
(1) Information regarding the corporate and legal entity itself, and its beneficial owners and registrable legal entities.
(2) All other prescribed information (ie the carrying on of a relevant activity, exempt person details, parent company details, stock exchange listing details, tax residence details, turnover, employees, equipment and premises details, intellectual property business details and outsourcing details). The exception for information within section 10(3)(a)(vi) excludes information about relevant activities.
12.15 Prescribed information within (1) must be ascertained immediately and provided within 15 days of the information being ascertained to the RA.
Corporate and legal entities that are subject to the BOSS Act before the amendments came into force should already have performed this initial duty as regards Information regarding the corporate and legal entity itself, and its beneficial owners and registrable legal entities, and need not repeat it. Corporate and legal entities which become subject to the BOSS Act as a result of the amendments in the ESA (due to the amended wider definition of “corporate and legal entity”) will come under a duty to ascertain all the information within (1) as soon as the amendments come into force.
12.16 The duty to provide the information within (1) above about beneficial owners and registrable legal entities is a continuing duty, as a result of the terms of BOSS Act section 12(1), which reads as follows:
A corporate and legal entity shall within 15 days of becoming aware of a change of any of the prescribed information relating to beneficial owners or registrable legal entities notify its registered agent of such changes and the date such changes took place.
12.17 Information within (2) must be provided in respect of a financial period within 6 months of the end of the period.
Spontaneous Exchange of Tax Information
As per Schedule 4 of the BOSS Act, the International Tax Authority (the ITA) has obligations to disclose Information to overseas tax authorities, with which the BVI has signed exchange of tax information agreements.
(1) Schedule 4 of the BOSS Act requires the ITA to disclose or procure the disclosure of the relevant information stored in the RA database in respect of an entity with a “relevant overseas competent authority”, which, as defined by paragraph 1 of Schedule 4, means, in relation to any corporate or legal entity, the competent authority for each state in which
(a) a beneficial owner resides; or
(b) within which a registrable legal entity is registered; or
(c) within which the corporate or legal entity is registered; or
(d) within which a parent of the corporate or legal entity is registered; or
(e) within which the corporate or legal entity claims to be tax resident;”
(2) The triggering events for the spontaneous exchange of information with the relevant overseas competent authorities are
(i) there has been a breach of the economic substance requirements under section 2 of the ES Act or
(ii) the relevant entity carries on an intellectual property business and falls within the presumption that it does not conduct core-income generating activity in the BVI, as set out in section 9(2) of the ES Act section 9(2).
(iii) in the situation that an entity claims to be tax resident in another jurisdiction, the competent authority of that jurisdiction will receive a notification.
Glossary
Financial Period
In this Act, unless the context otherwise requires, "financial period" means
(a) in the case of a company incorporated on or after 1 January 2019, such period of not more than one year from the date of incorporation as the company shall notify to the competent authority and thereafter each successive period of one year running from the end of that period;
(b) in the case of a limited partnership formed on or after 1 January 2019, such period of not more than one year from the date of formation as the limited partnership shall notify to the competent authority and thereafter each successive period of one year running from the end of that period;
(c) in any other case such period of one year commencing on a date no later than 30 June 2019 as the legal entity shall notify to the competent authority and thereafter each successive period of one year running from the end of that period.
Legal Entity
A legal entity means a company and a limited partnership.
A company includes a company within the meaning of section 3(1) of the BVI Business Companies Act, 2004 and a foreign company within the meaning of section 3(2) of the BVI Business Companies Act, 2004 which is registered under Part XI of that Act, but does not include a non-resident company.
Pure Equity Holding Entity
"Pure equity holding entity" means a legal entity that only holds equity participations in other entities and only earns dividends and capital gains.
Relevant Activities
As per section 6 of the ES Act, the relevant activities including the following:
(a) banking business;
(b) insurance business;
(c) fund management business;
(d) finance and leasing business;
(e) headquarters business;
(f) shipping business;
(g) holding business;
(h) intellectual property business;
(i) distribution and service center business.
See the full legal texts of the Economic Substance (Companies and Limited Partnership) Act 2018 and amendments. [read]
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