British Virgin Islands: final version of Rules of economic substance adopted

1 January 2019 British Virgin Islands (BVI) has adopted legislation on economic substance requirements applicable to companies incorporated in BVI. As this legislation was adopted in merely short terms, some questions regarding its application have arisen. In this circumstances International Tax Authority (ITA) is preparing a guidance, the first draft of which has been published on 22 April 2019. The final version of this guidance named Rules on Economic Substance in Virgin Islands (the Rules) has been adopted on 9 October 2019.

As distinct from the April draft, the final version of Rules in its introduction states that this document contains the official interpretation meaning of any expression used in legislation and regulations. There is also a reference that the Rules are not intended to be a substitute for legal advice in particular circumstance of individual cases.

Tax residency of BVI companies

The definition of resident firstly appeared in BVI legislation at 1 January 2019. The importance of this concept is that economic substance requirements are applicable only to companies that are deemed to be residents in BVI and carry on relevant activities explicitly named by legislative acts.

Legal entity is deemed to be resident in BVI if it is:

1. Company incorporated in BVI;
2. Foreign company that conducts business in BVI;
3. Limited partnership (as BVI, so foreign) that conducts business in BVI except limited partnership which does not have legal personality.

However, companies and limited partnerships incorporated or registered in BVI may be deemed to be non-residents in BVI if they are tax residents in any foreign jurisdiction (if such jurisdiction has not been included in EU blacklist of non-cooperative jurisdictions). In case of partnerships without legal personality the evidence of non-resident status of partners that form a partnership is required, not the evidence of foreign residency of partnerships themselves.

Status of non-resident company or partnership may be obtained only if a company or a partnership claims itself to be non-resident and submits the following documents to public authorities responsible for enforcement of economic substance rules:

1. certificate of tax residency or similar document issued by the competent authority of the jurisdiction in question stating that the entity itself is considered to be resident for tax purposes in that jurisdiction;

The position stated by ESC makes it possible to conclude that certificate of tax residency issued in some foreign jurisdiction in the name of director of a BVI company, not in the name of company itself, being an evidence of management and control of BVI company exercised from the territory of such foreign jurisdiction cannot be accepted as an evidence of tax residency of BVI company in that foreign jurisdiction.

2. an assessment to tax on the entity, a confirmation of self-assessment to tax, a tax demand, evidence of payment of tax, or any other document, issued by the competent authority of the jurisdiction in question.

As a result, BVI companies which are taxed in foreign jurisdictions on their worldwide income may be recognized as tax resident in such jurisdictions, and, consecutively, may claim to be non-resident in BVI. Such recognition can be made only by competent authority of foreign jurisdiction based on its current legislation (taking into account rules of tax residency of legal entities applicable in such jurisdiction). 

It may occur in practice that documentary evidence of tax residency in foreign jurisdiction does not coincide in its period with financial period of a company in BVI. In these circumstances it will be required to provide documents from foreign jurisdictions that cover the entire financial period of company in BVI. This rule is supported by the following example in ESC:

BVI company has a financial period beginning 1 January and terminating 31 December each year. It claims to be tax resident in a jurisdiction whose fiscal year begins on 1 April and terminates 31 March each year. For the financial period from 1 January 2021 to 31 December 2021, BVI company will need to submit two certificates of tax residency issued in foreign jurisdiction: certificate for period from 1 April 2020 to 31 March 2021; certificate for period from 1 April 2021 to 31 March 2022.

Taking into account difference between financial periods of BVI and foreign jurisdiction and the possibility to obtain documents from such jurisdictions ITA must inform company of submission terms for necessary documents. During this term BVI company continues to be considered as a non-resident in BVI.

If jurisdiction of tax residency of BVI company has been included in EU blacklist and BVI company cannot be exempt from economic substance obligations only due to this fact, ITA may allow this company to have some “reasonable time” to establish compliance with economic substance requirements or to select another foreign jurisdiction to be tax resident in.

Relevant activities

BVI legislation provides for economic substance requirements application only to entities which conduct the following relevant activities:

1. banking business;
2. insurance business;
3. fund management business;
4. finance and leasing business;
5. headquarters business;
6. shipping business;
7. holding business;
8. intellectual property business;
9. distribution and service center business.

Each relevant activity has its own legal definition established by different BVI laws, the analysis of which will help to ensure if any BVI company is subject to economic substance requirement in each case.

• In particular, finance and leasing business means the business of providing credit facilities of any kind for consideration (including consideration by way of interest). In accordance with ESC a company which provides credit as an incidental part of a different sort of business must not be treated as conducting finance and leasing business. Thus, for example, a builder’s merchant which supplies goods on account, thereby offering short term credit, will not be carrying on a finance and leasing business.
• Shipping business means the operation of a ship (except a fishing vessel, a pleasure vessel or a small ship) anywhere in the world other than solely within BVI waters for the following purposes:
  1. the business of transporting, by sea, persons, animals, goods or mail;
  2. the renting or chartering of ships for the purpose described in paragraph “a”;
  3. the sale of travel tickets or equivalent, and ancillary services connected with the operation of a ship;
  4. the use, maintenance or rental of containers, including trailers and other vehicles or equipment for the transport of containers, used for the transport of anything by sea;
  5. the management of the crew of a ship.

ITA will apply comprehensive approach for analysis of company’s activity, that is formal correspondence with only one criteria of shipping business will not be considered as sufficient basis of qualification of company as a shipping business company. For example, travel agency that sells tickets for passenger cruises amongst other things, or manufacture company that supplies goods by sea transport will not be treated as carrying on shipping business.

• Holding activity is defined as holding of equity participations in other entities and earning of dividends and capital gains as the only activity of legal entity. Also, this definition includes interest of general partner in a limited partnership.

ESC expressly states that holding of securities and assets which are not shares or participation interest of affiliated companies (bonds, government securities, real property) will not be deemed as holding activity.

• Distribution and service center business. It includes of purchasing from foreign affiliates component parts or materials for goods, or goods ready for sale, and reselling such component parts, materials or goods; also provision of services to foreign affiliates.

Foreign affiliate means a company affiliated with another company if being in the same group as such other company.

ESC provides that the following activities do not constitute distribution and service center business:

1. the business of purchasing and reselling assets from, or providing services to, entities in the same group if it is located in the BVI;
2. the business of purchasing and reselling assets from, or providing services to entities which are not part of the same group;
3. occasional transactions within the description which do not form part of a business, but are undertaken ancillary to a different business.
4. Intellectual property (IP) business. IP is intellectual property right in intangible assets, including copyright, patents, trademarks, brand, and technical know-how, which are used by the owner of IP to generate income. Such income may be royalties, capital gains and other income from the sale of an intellectual property asset, income from license and franchise agreements.

Core income generating activities

In accordance with BVI legislation relevant activities include core income generating activities. For purposes of determination whether each particular company is subject to economic substance requirements in BVI both legal definition of relevant activity and the list of its core income generating activities must be analyzed simultaneously:

1. Banking business. The core activities of such business are:

• 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;
• preparing regulatory reports and returns.

Insurance business. It must be carried out in a form of:

• predicting and calculating risk;
• insuring or re-insuring against risk;
• providing insurance business services to clients.

Fund management business. The core activities of this business are:

• taking decisions on the holding and selling of investments;
• calculating risks and reserves;
• taking decisions on currency or interest fluctuations and hedging positions;
• preparing relevant regulatory or other reports for government authorities and investors.

Finance or leasing business, represented by the following core activities:

• 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;
• managing any risks.

Headquarters business that includes:

• taking relevant management decisions;
• incurring expenditures on behalf of affiliates;
• coordinating group activities.

Shipping business. It includes the following core activities:

• managing the crew (including hiring, paying and overseeing crewmembers);
• hauling and maintaining ships;
• overseeing and tracking deliveries;
• determining what goods to order and when to deliver them;
• organizing and overseeing voyages.

Holding activity. It is deemed to be holding of equity participations in other entities and earning of dividends and capital gains as the only activity of legal entity.

Intellectual property business, including:

• where the business concerns intellectual property assets such as patents, research and development;
• where the business concerns non-trade intangible assets such as brand, trademark and customer data, marketing, branding and distribution.

Distribution and service center business, the core activities of which are:

• transporting and storing goods;
• managing stocks;
• taking orders;
• providing consulting or other administrative services.

As it is mentioned in the ESC, core income generating activities are not confined to ones listed by the legislative acts and may include other activities. It is assumed that company’s activity may be qualified as relevant activity even if it does not carry on core income generating activities that constitute particular relevant activity as per BVI laws.

Economic substance requirement

The economic substance requirement is defined as:

1. Management and control of the company’s activity is exercised in the territory of BVI. In this provision it is essential that one of nine relevant activities is directed and managed in the BVI, not the legal entity which carries on the relevant activity itself. Thus, company must be managed and controlled from BVI (e.g. by director resident in BVI) only in case if it conducts one or several relevant activities.

In such case, there must be an adequate number of board meetings held in BVI necessary for carrying on of particular relevant activity, and decisions made in such meetings must be minuted. Minutes of meetings must be kept in BVI.

2. For purposes of carrying on relevant activities mentioned above, the company must:
1. have an adequate number of suitably qualified employees in relation to that activity who are physically present in BVI (whether or not employed by the relevant legal entity or by another entity and whether on temporary or long-term contracts);
2. incur adequate expenditure in BVI;
3. have physical offices or premises as may be appropriate for the core activities;
4. where the relevant activity is an IP business and requires the use of specific equipment, have such equipment located in BVI.

ESC does not indicate the precise number of employees and volume of expenditure which are deemed to be “adequate”, as well as it does not provide requirements to premises due to fact that such parameters depend on size of the business.

Nevertheless, ESC establishes the following rules of computation of the number of employees engaged in relevant activity:

• an employee who has worked for only part of the financial period must be counted as part of an employee, proportionate to the amount of time he has worked during the financial period;
• a part-time employee must be counted as part of an employee proportionate to the amount of time he has worked in the financial period when compared with a full-time employee of equivalent grade;
• where an employee spends only part of his time working in connection with the relevant activity in question and part of his time working in connection with other activities, he must be treated as a part-time employee, as regards the amount of time spent on the relevant activity;
• an employee who is based in the BVI may be treated as physically present in the BVI throughout the period of his employment, notwithstanding that part of his duties fall to be performed outside the BVI;
• an employee who is not based in the BVI may not be treated as physically present in the BVI at any time notwithstanding that part of his duties fall to be performed within the BVI;
• an employee will be treated as based in the BVI if he spends the majority of his working time in the BVI.

3. Carrying on only that core activities that are prescribed by BVI laws.

In relation to this requirement ESC states that core income generating activity is deemed to be carried on in the BVI if it is carried on by employees working in the BVI, or is outsourced to a person whose own employees work in the BVI.

4. In case of core activity carried out for one company by another company, no such core activity is carried out outside BVI, and the first company is able to monitor and control the carrying out of the activity by the other company that acts in its interest.

Simplified economic substance requirement is applied to holding companies, so that they must:

1. be incorporated in BVI in accordance with relevant legislation;
2. have adequate employees and premises for holding or managing equitable interests or shares. Holding companies are not required to have offices and employees in the territory of BVI.

As for high-risk IP companies, there is a presumption of non-compliance with economic substance requirements by such companies. High risk status is attributed to IP company if it holds IP assets acquired from its affiliates or generates income by way of provision of IP assets to affiliates. Such presumed non-compliance may be rebutted if company provides evidence of making strategic decisions and managing of risks in the territory of BVI.

Financial period

Compliance with economic substance requirements must be assessed for each financial period of particular company separately. Financial period is a year. For companies incorporated on or before 1 January 2019 it is permitted to select the date on which the financial period should start: it can be any date before 30 June 2019.

For companies incorporated after 1 January 2019 the financial period must start on its registration (incorporation) date. A company is entitled to select the end date of financial period that will be earlier than one year from incorporation date if it provides a written notice to ITA within three months of the date of incorporation (or within three months following 30 June 2019 for existing companies).

Reporting requirements

Information required for compliance with economic substance rules can be provided by companies in self-reporting regime or pursuant to specific information requests from the ITA.

Generally, registered agents must keep the following data of companies that will enable ITA to determine:

1. if particular company is subject to economic substance requirements;
2. if so, whether such company is compliant with them.

The following information about companies incorporated in BVI (except non-residents) must be reflected by their registered agents in reports filed with ITA:

• the total turnover generated by the relevant activity;
• the amount of expenditure incurred on the relevant activity in BVI;
• the total number of employees engaged in the relevant activity;
• the number of employees engaged in the relevant activity in BVI;
• the address of any premises in BVI which is used in connection with the relevant activity and the address of each such premises;
• the nature of any equipment located in BVI which is used in connection with the relevant activity;
• the names of the persons responsible for the direction and management of the relevant activity, together with their relationship to the company and whether they are resident in BVI.

In some cases, the amount of information required can be reduced (e.g. holding companies only have to provide information about number of employees and address of premises) or extended (high risk IP companies must submit the detailed information about the IP assets held, the way of generating income using such IP assets and the place where strategic decision are made).

The reports must be submitted to ITA within one year from the date when the obligation to comply with economic substance requirements became applicable to a company. Thus, companies incorporated after 1 January 2019 must submit such reports within one year from their incorporation date, and existing companies must submit reports before 30 June 2020.

Liability

ESC divides liability measures for non-compliance with economic substance requirements onto two groups:

1. Failure to provide information, or deliberate provision of inaccurate information. Such liability may be imposed not only on companies and their registered agents, but also on any person requested by the ITA to provide information about the company.
   
   In such a manner, the following penalties can be imposed:
   1. For companies and other persons requested by the ITA to provide information about companies – fine in the amount of 40 000 USD and/or imprisonment for a term not exceeding 2 years for natural persons in case of summary conviction;
   2. For companies and other persons requested by the ITA to provide information about companies – fine in the amount of 75 000 USD and/or imprisonment for a term not exceeding 5 years for natural persons in case of conviction on indictment;
   3. For registered agents – fine in the amount of 20 000 USD in case of summary conviction or fine in the amount of 40 000 USD in case of conviction on indictment.
2. Failure to comply with economic substance requirements. The imposition of penalty is designed in the following form:

1. After detection of non-compliance with economic substance requirements ITA must give to a company the first written notice of the fact of non-compliance, its reasons and inform the company of the amount of fine to be paid (in case of first written notice it may vary from 5 000 to 20 000 USD), the deadline to pay this fine and indicates the actions to be done to eliminate non-compliance. For high risk IP companies the maximum amount of fine is higher – 50 000 USD.
2. If a company does not make any action required after the first written notice by the ITA, ITA must give a second notice to such company. Basically, second written notice contains the same information like the first one, plus notification that the ITA may make a report to the tax authorities of the BVI. The amount of fine may vary from 10 000 USD to 200 000 USD (up to 400 000 USD for high risk IP companies).
3. After the second written notice, ITA may strike the company off the register if it considers such measure to be appropriate. After being struck off company is not deemed to be active until the moment of its restoration. Striking off is an extreme remedy.

Conclusion

As a result, the draft of guidance to legislation on BVI economic substance has been provided for further discussion. The most important issues are:

• The clarification of procedure to claim the company to be non-resident in BVI in aspect of required documents (certificate of tax residency, tax payment documents) and cases when financial period in BVI and fiscal period in foreign jurisdiction of tax residency do not coincide;
• List of some particular activities that are not deemed to be relevant activities for purposes of economic substance requirements: currently trading with non-affiliated persons, holding of securities of non-affiliated issuers and tour agent activity do not fall within the scope of economic substance requirements;
• The procedure to compute “adequate” number of employees required for economic substance has been established;
• The minimum amounts of fines for non-compliance with economic substance requirements have been clarified.

It is important that current version of ESC is a draft document and may be amended after discussions if necessary. It is expected that it will be adopted in May 2019 because the economic substance requirements must be complied with starting on 30 June 2019.