The European Union continues to push out new rules aimed at offshore financial centers. Specifically, the Code of Conduct Group (CCG) within the EU’s Economic and Financial Affairs (ECOFIN) Council has determined that jurisdictions that fail to satisfy the CCG’s requirement to end “preferential treatment” for non-resident companies are to be deemed ‘non-cooperative’ and effectively blacklisted. Those that meet most CCG requirements and show an effort to resolve shortcomings are “grey-listed”, while those that meetall requirements are ‘whitelisted.’

Substantially, the BVI meets the three main criteria—tax transparency, fair taxation, and compliance with the EU’s Base Erosion and Profit Sharing policies. However, the EU has reported that on “fair taxation” the BVI and other low tax jurisdictions need to do more by adhering to the principle that jurisdictions “should not facilitate offshore structures or arrangements aimed at attracting profits which do not reflect real economic activity in the jurisdiction.”

To address the CCG’s requirements, in December 2018 the BVI passed the BVI Economic Substance (Companies and Limited Partnerships) Act, 2018 (ESA) which came into force on January 1, 2019. The ESA sets out a framework for determining when certain BVI entities, or foreign entities operating in the BVI, may claim tax residence in the BVI.

The ESA makes several new, important distinctions that may impact BVI companies and limited partnerships. As always, the jurisdiction remains user-friendly and pro-business. Overall, navigating the ESA is relatively straightforward.

Which Entities Are Caught by the ESA?

Two prongs are used to determine whether an entity is subject to the ESA—the entity type and its activity.

Entity types

Entities considered to be subject to the ESA (in-scope entities) include:

1. Any foreign company registered in and operating in the BVI
2. BVI companies
3. Any foreign limited partnership registered in and operating in the BVI*
4. BVI limited partnerships with legal personality

*Non-resident limited partnerships or limited partnerships that have elected not to have legal personality are excluded.

Regulated Activities

The second consideration is whether the entity is carrying on a “relevant activity;” and if so, it must meet the economic substance requirements set out in the ESA, unless it is tax resident in another jurisdiction that is not on the EU’s blacklist.

The Act regulates Nine 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

What are the Qualifications for Tax Residency?

To claim a valid tax residency in the BVI, an in-scope entity must meet the economic substance requirements set out in the ESA, which include:

1. Directing and managing the relevant activity in the BVI.
2. Engaging adequate and suitable employees, premises, and expenditure in the BVI to carry out core-income generating activities in the BVI.
3. Conducting core income-generating activities in the BVI.

Allowance for outsourcing is made if the entity to whom any core income generating activity is outsourced is based in the BVI and the core income generating activity can be linked to the entity claiming BVI tax residence.

Special treatment for intellectual property business and pure equity holding business

• Intellectual Property Business: In-scope entities conducting intellectual property business are treated slightly differently, and most will be subject to a rebuttable presumption that they are not carrying out core income generating activities in the BVI and therefore do not have sufficient economic substance in the BVI.

However, the presumption can be rebutted by, for example, showing that the entity in question takes strategic decisions and manages the principal risks related to the acquisition, development, and exploitation of the IP asset in or from the BVI.

• Pure Equity Holding Business:If the entity is conducting pure equity holding business, then it satisfies the economic substance requirements, as long as
  • it complies with its statutory obligations under the Limited Partnership Act or the BVI Business CompaniesAct, as appropriate; and
  • it has adequate employees and premises in the BVI for holding or managing the equity interests it holds or manages.

What are the reporting requirements?

An entity’s financial year is the period during which ESA considers an entity’s activities. A company that is carrying on any relevant activity during its financial year must also comply with the economic substance requirements during that period.

All companies and limited partnerships to which the ESA applies are required to report at the end of their financial year regarding activities carried out during the financial year. New companies and limited partnerships (i.e., those incorporated or formed after January 1, 2019) must select a date within 12 months of incorporation or formation as the end of its financial year. An existing entity’s financial year will begin on a date no later than June 2019. In either case, the entity’s financial year and reporting responsibilities run for one year from that initially selected date.

How do entities report?

All in-scope entities report to the BVI International Tax Authority (ITA). The ITA is responsible for determining whether an entity is in compliance with the economic substance requirements, and has the power to request documentation and information from in scope entities and to impose fines where there is a breach.

The entity’s registered agent will enter its report in the BOSS system, including information such as the entity’s total turnover; number of employees engaged in the relevant activity, both in and outside of the BVI; the entity’s BVI address; and the names of the persons responsible for the management and direction of the entity and whether they are located in the BVI.

How is the ESA Enforced?

Enforcement of the ESA falls under the ITA, which may determine that an entity has not complied with economic substance requirements for any financial period ending on or after December 31, 2019.

If ITA determines there is non-compliance, it must issue a notice and may impose a fine. The fines escalate if the entity does not remedy a non-compliance breach identified by the ITA.

Entities have the right to appeal to the BVI High Court. The court can vary, cancel, or confirm the ITA’s determination and fines.

Final Word

The BVI is considered a responsible member of the global financial community and has a history of ensuring compliance with global taxation and transparency norms. As such, in preparing this legislation, its draftsmen have sought to follow closely the principles put forward by the EU Code of Conduct Group.

At its recent meeting held on March 12, 2019, the EU decided to retain the BVI (as well as Cayman and the Bahamas) on its grey list owing to concerns relating to economic substance in the area of collective investment funds. The BVI has until the end of 2019 to amend the ESA and to meet the EU’s concerns on this point. As this is only issued raised by the EU, it appears that the ESA is otherwise in line with the EU’s recommendations and guidance. Additionally, the BVI will shortly publish its draft Economic Substance Code will which will provide further clarity about ESA and its application in practice.

The author of this article, Kerry Anderson, invites you to contact him directly with any questions or assistance you may need.[email protected].

Mr. Anderson leads O’Neal Webster’s New York City office and is Head of the Investment Funds & Regulatory Department. He advises domestic and international clients on complex, multijurisdictional corporate and commercial matters and is deeply experienced in the initial structuring of investment vehicles or amendments to investment vehicles and often provides continuing legal advice and support throughout their operation. His clients include U.S.- and EU-based fund managers, closed-ended funds, open-ended funds, public funds, and segregated portfolio company funds, and other law and professional services firms. He also advises on joint venture deals and acquisitions for select international private and public corporations in various industries including logistics, food, and technology.