Background and scope of application
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. To counter harmful tax practices and enhance transparency and substance, 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 Virgin Islands Economic Substance (Companies and Limited Partnership) Act, 2018 was enacted and came into force on 1st January 2019. [the ES Act]
The ES Act requires a legal entity (a company or a limited partnership) that conducts relevant activities, as defined under section 6 of the ES Act, during a financial period 1 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 2 for tax purposes are excluded from the requirement for economic substance.
Meaning of relevant activities [Section 6, the ES Act]
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]
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
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.
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 provided under section 6(g) of the ES Act, 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. If it complies with the two requirements under section 8(2) of the ES(CPL) Act, it satisfies the substance requirement.
Determination by Competent Authority [Section 10(1), ES Act]
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 of the ES Act 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 of the ES Act 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).
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.
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 ES Act 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 ES Act 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 15 [the ITA Guidance]
The International Tax Authority of the Virgin Islands issued a guidance for the practical administration of the ES Act (the ITA guidance). 3
13. The first financial period of a legal entity which 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.
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.
15. The first financial period of a legal entity which 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.
Rules 12.2 and 12.3 [the ITA Guidance]
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.
Under the reporting regime, the content of the registered agent (the RA) database, which 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.
1 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.
3 The ITA Guidance became effective following the entry into force of the Beneficial Ownership Secure System (Amendment) (No. 3) Act, 2019
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.