Why was the law adopted?
The British Virgin Islands ("BVI") joined a global effort to establish an international standard for tax residence of entities doing business in a jurisdiction to avoid the Harmful Tax Practice of Base Erosion and Profit Shifting. The BVI (like many other offshore jurisdictions) put in place a law requiring certain entities which are tax resident in the BVI to demonstrate that they have sufficient 'economic substance' in the BVI to show they are a true tax resident if they carry out certain specified activities.
The law is The Economic Substance (Companies and Limited Partnerships) Act, 2018 (the "ES Law"). The Economic Substance Code (guidance) accompanies the ES Law.
The ES Law applied from 1 January 2019 to all newly formed entities that are in scope of the ES Law and from 30 June 2019 to entities formed prior to 1 January 2019 that are in scope.
Which entities are subject to the ES Law?
Any company (incorporated in the BVI or a foreign company registered under Part XI of the BVI Business Companies Act, 2004) or limited partnership (formed in the BVI or a foreign limited partnership registered under Part VI of the Limited Partnership Act, 2017) which is tax resident in the BVI and carries on any of the following "Relevant Activities" as a business (i.e. for profit and with regularity):
- banking business;
- insurance business;
- fund management business;
- finance and leasing business (which, among other activities, includes the provision of credit facilities);
- headquarters business;
- shipping business;
- holding company business (i.e. only pure equity holdings not holdings of another kind of asset e.g. real estate or bonds);
- intellectual property holding business; or
- distribution and service centre business (which, among other activities, includes the provision of services to foreign affiliates).
Definitions of each Relevant Activity are provided in the ES Law.
What do such entities need to show?
Entities subject to the ES Law must (subject to certain exceptions described below), in respect of their Relevant Activities:
- be directed and managed in the BVI;
- conduct Core Income Generating Activities in the BVI; and
- have adequate employees, expenditure and physical assets in the BVI.
When is a company 'directed and managed' in the BVI?
A company will be directed and managed in the BVI in an appropriate manner if:
- the board's members have adequate knowledge and expertise;
- it meets in the BVI with adequate frequency, having regard to the amount of decision making required (it is not expected that all or a majority of board meetings will be held in the BVI);
- a quorum is physically present at each board meeting in the BVI;
- strategic decisions of the company are made in those meetings with minutes recorded; and
- minutes and other records of the company are kept at the registered office in the BVI.
What are 'Core Income Generating Activities'?
Examples of Core Income Generating Activities ("CIGA") are provided in the ES Law for each of the Relevant Activities. The CIGA are considered to be the key essential and valuable activities that generate the income of the company and these activities must be carried out in the BVI.
However, non CIGA activity such as back office functions, expert professional advice or specialist services can be obtained elsewhere. A company can outsource its CIGA so long as it continues to monitor and control the outsourced activities.
Note also that not all CIGA have to be carried out in the BVI. On a case by case basis with reference to each individual entity it may be possible to satisfy the requirements of the ES Law conducting only some CIGA in the BVI.
How can I tell if an entity has adequate employees, expenditure and physical assets?
This needs to be assessed on a case by case basis depending on the activities of the entity and how its CIGA arises. Directors should consider these factors, make a determination in good faith and ensure there are records to demonstrate the basis and operation of that determination.
Note also that the ES Law does not require a company to incur more expenditure or engage more employees than it actually needs.
Are there any exceptions?
Entities which are tax resident outside of the BVI do not have to have, or report on, Economic Substance but do have to annually report and prove their tax residence.
Entities which carry on the following activities are subject to a slightly different regime:
- holding business: entities conduct holding business if they only own equitable interests or shares in other entities. If this is the case there is no requirement they be directed and managed in the BVI nor is there any requirement to carry out CIGA in the BVI. Adequate employees and premises are still required in the BVI but where the holding is passive in nature this may be satisfied by compliance with pre-existing statutory obligations (such as appointing a registered agent and having a registered address in the BVI);
- intellectual property holding business: entities which hold, exploit or derive income from intellectual property in a manner defined as "high risk" are automatically deemed non-compliant with the substance requirements unless they provide additional evidence of compliance.
How is compliance with the ES Law monitored?
Compliance with the ES Law is monitored and enforced by the BVI International Tax Authority. Entities subject to the ES Law are required, in respect of each financial period, to confirm to their registered agent whether or not they carry out any Relevant Activities and, if so, provide details of such activities. This information must be provided to the registered agent within 6 months of the end of the relevant financial period. Failure to comply with the ES Law will result in fines ranging from US$5,000 up to US$400,000 (applicable for IP companies after multiple infractions). The details of non-compliant companies will also be disclosed to the relevant foreign tax authorities.
Where can I find out more?
Please refer to Bedell Cristin's detailed economic substance briefings and 'top tips', available on our website, and contact any of our specialists if you would like more information or advice.