A Matter of Substance – How the British Virgin Islands is Dealing with Tax-Base Erosion

July 23, 2021

As tackling inequality gathering political momentum, the use of nominal-tax jurisdictions, such as the British Virgin Islands (“BVI”), is coming into focus. Since 2019, companies looking to benefit from the territory’s tax advantages must prove ‘economic substance’. We examine the core details of BVI’s requirements, and how to navigate them.

 On the first day of 2019, the BVI’s Economic Substance (Companies and Limited Partnerships) Act, 2018 (“the Act”),[1] came into effect. The legislation stemmed from European Union concerns about firms exploiting low-tax jurisdictions and a desire to comply with a similar OECD framework on managing base erosion and profit sharing (“BEPS”)[2].

How can companies seeking to leverage the BVI’s competitive excise system demonstrate the necessary economic substance? A formula to understand is:

A Legal Entity + Relevant Business Activity = Economic Substance Requirements

Companies that are defined as a legal entity and conduct certain relevant activities must meet these economic substance requirements. The first step to check whether a business will be captured by the legislation’s definition of a legal entity.

The Scope of Legal Entities Under the Economic Substance Requirements
The legislation four main categories of businesses that need to meet economic substance requirements. These encompass almost every type of enterprise worldwide:

  • BVI companies
  • BVI limited partnerships
  • Foreign companies
  • Foreign limited partnerships

The Act sets out the following as “Relevant Activities”:

  • Fund Management
  • Insurance
  • Banking
  • Holding Business
  • Headquarters Business
  • Distribution and Service Centre Business
  • Finance and Leasing Business
  • Intellectual Property Business
  • Shipping

There are two key exceptions to the four broad definitions:

1. Trusts and limited partnerships without legal personality
2. Non-resident companies and non-resident limited partnerships – with tax residency in other jurisdictions (except those deemed as non-compliant tax jurisdictions)

Qualifying for the second exception requires the business to provide supporting evidence. This includes:

  • A letter or certificate stating that the entity is considered to be a resident for tax purposes in that jurisdiction
  • A tax assessment
  • Confirmation of tax self-assessment
  • A tax demand
  • Evidence of tax payment

Companies seeking exceptions under this requirement should also be aware that the BVI and the claimed tax jurisdiction will exchange information for confirmation and compliance purposes.

The Three Main Economic Substance Requirements
If a company falls under the legal-entity scope described above, the next step is to check whether it performs a relevant activity. If it does, then the companies may have to create economic substance requirements, some of which are:

1. Having the relevant activity directed and managed in the BVI
2. Conducting its core income-generating activity in the BVI
3. Regarding the nature and scale of the relevant activity. The business:
a. Has an adequate number of suitably qualified employees physically present in the BVI
b. Incurs adequate expenditure in the BVI
c. Has physical offices in the BVI that are appropriate for its core income-generating activities

Specific Economic Substance Requirements
Specific economic substance requirements also apply to two particular areas – intellectual property and holding companies.

Companies that are considered a “high risk intellectual property legal entity” are automatically presumed to be non-compliant under the Economic Substance Act. These companies are required to prove these presumptions do not apply. The primary method of doing this is by ensuring that the strategic decisions and principal risks of the intellectual property asset and any underlying revenue-generating trading activities are managed or undertaken from within the BVI.

In the case of holding companies, stricter economic substance requirements are not applicable if the enterprise:

  • Does not perform any other relevant activity other than holding equity stakes in other companies
  • Complies with its basic statutory obligations
  • Has adequate employees and premises in the BVI for holding and managing those equity participations

If these three conditions are met, then the company is considered to have fulfilled the economic substance requirements.

How to Navigate the BVI’s Economic Substance Requirements
Given that the BVI is primarily an offshore destination, the requirements relating to conducting core income-generating activity and maintaining staffed premises in the BVI would seem time consuming.

Fortunately, there are “workarounds” that can be used to navigate these conditions.

“Workaround” Options
The rules state that companies need to conduct their core income-generating activity (e.g., banks that provide loans) in the BVI. However, these activities can be outsourced as long as they are monitored and controlled by the legal entity. Such a workaround allows companies to fulfil this economic substance requirement without moving their main operational base to the BVI.

The language of the legislation also provides some leeway to the third requirement on situating physical premises and employees in the BVI and incurring adequate expenditure in the territory. The word “adequate” may be subject to interpretation, as businesses come in different sizes. There could be significant flexibility in what would be permitted (or possibly argued) under the legislation.

Compliance and Reports – The Need to Plan
The economic substance requirements in the BVI present an interesting challenge for the island nation. Overly strict rules would cut off the lifeblood of its economy, but at the same time, the BVI authorities need to comply with the OECD BEPS framework and the global trend toward greater tax transparency. Therefore, a measure of flexibility within the legislation allows most companies to continue operating in the BVI mainly as before – though additional compliance requirements are to be expected.

From a company perspective, careful planning is a practical necessity. Businesses should closely examine the legislation to establish the true nature of their position, then take make any structural adjustments that may be required. This will ensure that they continue to operate within the legislative boundaries while adhering to all compliance and reporting demands.

[1] http://www.bvi.gov.vg/pub/Economic_Substance_Act_Unofficial_Consolidation.pdf

[2] http://www.bvi.gov.vg/media-centre/legislation-passed-address-eu-economic-substance-concerns

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