Following the Economic Substance (Companies and Limited Partnerships) Act 2018 (the “Act”) coming into force on the 1st of January, 2019 in the British Virgin Islands (BVI), the requirements set out by the European Union Code of Conduct Group have been satisfied. These requirements were introduced by the EU in an attempt to establish a more transparent tax structure, while also setting out an economic substance test for tax-resident entities. For years, the BVI has been on the receiving end of copious amounts of pressure from not only the EU, but also from other jurisdictions. Despite not being a Member State of the EU, the BVI – a notoriously popular tax haven – has been urged by many jurisdictions and authorities to implement more stringent economic substance requirements for the abundant amounts of Companies that are registered and benefit from its almost non-existent tax rates. The Act is intended to create transparency in both the ownership structure of a legal entity and in the actions and activities of the said entity. However, due to its many requirements, the Act has also urged many to reconsider having their businesses located in the BVI.
The ‘Economic Substance’ Test
The Act applies to all Companies and limited partnerships (excluding any partnerships without a legal personality, as well as trusts, since they too do not have a legal personality) which are registered in the BVI, or a foreign jurisdiction but operate/do business in the BVI, and constitute a tax ‘resident’, as set out by the Act. Worth noting is that a legal entity cannot claim to be a ‘non-resident’ of the BVI by virtue of being a tax resident in another jurisdiction, if that jurisdiction is listed on the EU’s list of non-cooperative jurisdictions.
Any and every legal entity which is a tax resident in the BVI by virtue of carrying out any ‘relevant activity’, is required by the Act to establish adequate and relevant economic substance in the BVI. A relevant activity is defined as being any of the following:
- Banking Business
- Distribution and Service Centre Business
- Finance and Leasing Business
- Fund Management Business
- Headquarters Business
- Holding Business
- Insurance Business
- Intellectual Property Business
- Shipping Business
This means that if a legal entity undertakes any of the aforementioned business activities, it must then show that it is adequately directed and managed and carries out core income generating activities in the BVI. This is demonstrated by showing that the entity in question has an adequate number of qualified employees which are physically present in the BVI, at appropriate physical offices/premises, while also demonstrating adequate expenditure in the BVI. In the event that the entity is an intellectual property business which requires the use of specific equipment, then even that equipment must be located in the BVI. Also worth noting however, is that pure equity holding entities must only comply with statutory obligations, such as having adequate employees (which, if applicable, includes management) and premises in the BVI in order to be deemed to have adequate economic substance. Although, they must undertake no relevant activity other than holding shares or interests in other entities, thus only earning dividends and capital gains.
Any affected legal entities, which perform any of the above relevant activities within a financial period, must now report to the BVI International Tax Authority (ITA) to prove that they are complying with the aforementioned substance requirements. Failure to do so could lead to penalties being imposed in the form of fines, the entity’s strike-off, and/or imprisonment.
Impact of the Act
Given the stringent requirements imposed on legal entities in the BVI, it is of little surprise that many entities are being re-domiciled to other jurisdictions. A substantial amount of business owners are looking to re-domicile their entity to another jurisdiction with either less economic substance requirements, or a lack of them altogether. However, in the case of the latter, it would only be for a very short period of time, as jurisdictions such as the Cayman Islands, Bermuda, Jersey and Isle of Man, to name a few, are all following suit and adhering to the EU Code of Conduct Group’s concerns about economic substance. As such, entities that are exploring the option of re-domiciliation have to come to terms with either adhering to very similar substance requirements to the BVI’s and/or to becoming a tax resident in a jurisdiction which has a much higher tax rate.
Interestingly, one of the leading causes behind these re-domiciliations is not the cost associated with satisfying the BVI’s economic substance requirements, but rather the degree of difficulty in doing so. This is because, as of 2018, the estimated population of the BVI was 31,719, coupled with the islands’ total surface area of 153 km², makes the ability to find qualified individuals and suitable premises a rather tall order. As such, many individuals just see the notion of relocating their legal entities to another jurisdiction as being a simpler solution, even if they are no longer subject to the BVI’s minimal tax rates. This has caused jurisdictions such as Cyprus to grow in popularity, as the tax rates are relatively low at 12.5% and while it has its own substance requirements, they are still much easier to be achieved since the island has a population of approximately 1,189,085 people (as of 2018) and a total surface area of 9,251 km². There are also businesses which provide substance services to legal entities in order to aid them in attaining a tax residence in Cyprus.
The Act has been introduced as a form of transparency, whereby a legal entity’s actions and even its ownership (by virtue of the changes that this Act makes to the ‘Beneficial Ownership Secure Search System Act 2017’) are made clear to its regulator and are constantly kept up to date. In doing so, the legal entity will satisfy its economic substance requirements, thus making it able to benefit from the BVI’s tax residence benefits. An alternative to satisfying its economic substance requirements would be that the legal entity becomes subject to the tax status of another jurisdiction through the act of re-domiciliation, which some have already opted in favour of, in an attempt to benefit from the similarly low tax rates of another jurisdiction. However, given the fact that the BVI, arguably the most popular of the so called ‘tax haven jurisdictions’, has introduced economic substance requirements, it is only a matter of time until the other jurisdictions do the same. As such, all relevant entities will need to undertake an internal review and determine what measures, if any, they must undertake in order to ensure compliance with the Act.
This Article and any content forming part of it is only intended to provide a guide on the subject matter and does not constitute legal or any other advice. If professional advice is required, G.C Charalambous & Co LLC would be glad to assist you in this respect.