The Economic Substance (Companies and Limited Partnerships) Act, 2018 (the Act)
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 nonresident entities, 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. 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 – raising funds, managing risk (including credit, currency and interest risk); taking hedging positions; providing loans, credit or other financial services to customers; managing regulatory capital; and preparing regulatory reports and returns.
- Insurance business – predicting and calculating risk; insuring or re-insuring against risk; and providing insurance business services to clients.
- Shipping business – managing the crew (including hiring, paying and overseeing crew members); hauling and maintaining ships; overseeing and tracking deliveries; determining what goods to order and when to deliver them; and organising and overseeing voyages.
- Fund management business – taking decisions on the holding and selling of investments; calculating risk and reserves; taking decisions on currency or interest fluctuations and hedging positions; and preparing regulatory and other reports for government authorities and investors.
- Finance and leasing business – agreeing funding terms; identifying and acquiring assets to be leased (in the case of leasing); setting the terms and duration of any financing or leasing; monitoring and revising any agreements; and managing any risks.
- Headquarters business – taking relevant management decisions; incurring expenditures on behalf of affiliates; and co-ordinating group activities.
- Intellectual property business -where the business concerns intellectual property assets such as patents, research and development; and where the business concerns non-trade intangible assets such as brand, trademark and customer data, marketing, branding and distribution.
- Distribution and service centre business – transporting and storing goods; managing stocks; taking orders; and providing consulting or other administrative services.
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.
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.
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.
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 Act allows for related regulations and rules to be issued with respect to the obligations imposed by the Act. These will further clarify the substance requirements prescribed by the Act and provide guidance on the interpretation of very significant terms. Such guidance, rules and regulations will be issued eventually. We believe that, for many entities, the impact will be minimal and compliance will be straightforward.
If you require further information or would like to discuss how the Act may impact your business, please get in touch.Meade Malone