Do I need to create substance in the BVI? Or do I not?

The Economic Substance (Companies and Limited Partnerships) Act, 2018 came into force in the BVI on 1 January 2019. It requires all BVI companies and partnerships that carry on a “relevant activity” to have economic substance unless they are tax resident in a jurisdiction outside the BVI (provided that such jurisdiction is not on the EU list of non-cooperative countries).

This legislation is not always properly understood and interpreted. Whereas a careful review and analysis of the Act may very well lead you to conclude that it does NOT apply to your company at all. According to the BVI Association of Registered Agents, only 5% of the 420,000 companies incorporated in the jurisdiction are affected by the Act and must build economic substance in the BVI. Assumption can be made that in reality the figure is even smaller – not more than 1%.

The text of the Act left many questions, especially regarding how the new requirements will work in practice. It was therefore not surprising that the publication of the Act was followed by the release of Guidance Notes and a draft Economic Substance Code, as well as by various educational events and seminars aimed at clarifying the new requirements.

What can be said based on these explanations and simply a careful reading of the Act.

The “relevant activities” identified in the Act include the following:

• banking business;
• insurance business;
• fund management business;
• finance and leasing business;
• headquarters business;
• shipping business;
• holding business;
• intellectual property business;
• distribution and service centre business.

1. First, this is an e x h a u s t i v e list, it does not leave room for a potential broad interpretation with a phrase such as “and other activities...”. Thus, we can speak with a fair degree of reliability about the stability of the selected pattern.

2. Second, it contains activities such as banking, insurance, fund management, and shipping that require a licence or special permission, i.e. essentially are conducted by a very small number of companies.

3. Third, it is necessary to carefully read the definition of the activity (and not just its name) given in the Act. For example, distribution and service business means purchasing from foreign affiliates and subsequently reselling components or materials for goods or goods ready for sale, and/or providing services to foreign affiliates in connection with such business. The crucial point here is affiliation, meaning that the same operations performed with third parties do not make a company liable to have economic substance.

Finance and leasing business in the Act means the activity of providing any kind of credit facilities for consideration, including in the form of interest, and finance leases in respect of any assets other than land. This also applies to intra-group financing. But since the main accent in the definition is on consideration received in return for a loan, interest-free loans should not fall under this scope, nor does receiving security for a loan or investing in debt financial instruments.отвечает

Headquarters business is understood as providing the following services to other companies within the same group:

• provision of senior management,
• assumption or control of material risk for activities of any of the group companies, or
• provision of substantive advice regarding such risks.

Holding business means the business of being a pure equity holding entity – a company that only holds equity participations in other entities and only earns dividends and capital gains from that.

This approach generally appears logical: since holding companies are perceived as low-risk, they are subject to “reduced” substance requirements.

Intellectual property business means the business of holding intellectual property assets, i.e. intellectual property right in intangible assets, including but not limited to copyright, patents, trade marks, brand, and technical know-how, and receiving income from these.

The Act also introduced the concept of a high-risk IP company – apparently, the IP sector is seen as the most vulnerable to various abuses, which is signaled by the largest fine imposed for failure of such a company to comply with the economic substance requirements.

A high-risk IP company is a company that acquired the intellectual property asset from an affiliate or in consideration for funding research and development by another person situated outside the BVI and licenses the intellectual property asset to its affiliates or otherwise generates income from the asset in consequence of activities performed by foreign affiliates.

4. And finally forth, it is important not just what kind of activity a BVI company is engaged in, but also whether it receives i n c o m e from it! Thus, if a company carries on a relevant activity but does not derive income from it, the company is not affected by the Act and is not required to establish economic substance in the jurisdiction.

So, what conclusions can be drawn from all that.

The activities listed in the Act require the creation of substance, but this requirement is not always unconditional and categorical.

The introduction of economic substance requirements will not affect the operation of the following companies as they do not need substance:

• holding companies (that only hold shares);
• companies holding assets (real estate, securities, bonds);
• operational companies doing business with third parties (the type of goods and services is irrelevant, unless these are intellectual property assets).

Indeed, there is no requirement for a holding company to have substance in the BVI, given the current interpretation of the Act by its creators. Though strictly speaking, this is not obvious from the text of the Act itself. It states that a holding company has adequate substance if it:

1. complies with its statutory obligations under the BVI Business Companies Act, 2004, and

2. has in the BVI adequate employees and premises for holding equity participations (where the activity is passive holding) or for managing those equity participations (where the activity involves such management).

The draft Economic Substance Code explains that in the case of passive holding, the appointment of a local registered agent – which is actually mandatory for every company – already covers the substance requirement. However, if we are talking about active management of shares, then this function will still require a company to have employees (as many as necessary and with appropriate qualification) and an office. But even in that case, the substance requirements can be considered as less stringent because the company will be exempt from a whole series of other conditions such as being managed from and having adequate expenses in the BVI, etc.

Besides in your specific case, it seems that substance is not needed also because you do not derive income from holding activities (dividends).

The need to build economic substance is, of course, the most pressing of the issues arising in connection with the new legislation. But even the absence of such a need does not mean a complete release from other obligations.

The main tool for enforcing the legislation is for government authorities to know whether a company is conducting relevant activities, and if so, whether it has an economic substance in the BVI. It falls to registered agents to collect and report such information. Information will be submitted through the BOSS portal in respect of the company’s each financial year within 6 months of the year-end.

The authority responsible for implementing the Economic Substance Act is the BVI International Tax Authority (ITA). A company has an obligation to provide information that will enable the ITA to determine whether the company is covered by the substance legislation and, if so, whether it meets the substance requirements in the jurisdiction. The registered agent has a duty to take reasonable steps to obtain such information from the company, but does not have a duty to verify its accuracy. In essence, this is a self-reporting regime.

In addition, the ITA has the right to send out requests to individual companies, requiring them to provide information and documents that will allow the Authority to determine the same thing – whether the company is subject to the economic substance requirements and whether it complies with them. Failure to provide information or providing false information in response to such a request may result in a fine of up to USD 75 000 and/or up to 5 years in prison.

Yes, it is possible to do that. But it is better to do it before the start of the first financial period in order to avoid having to comply with substance requirements at all. Also, the BOSS system will likely include some risk indicators (red flags) that will be triggered in cases that potentially require the regulator’s special attention, such as change of tax residence, moving from a relevant activity in one financial period to an activity not covered by the substance legislation in the next period.

It will be necessary to disclose the country of tax residence of a BVI company only if the following conditions are met simultaneously:

• the company carries on a relevant activity;
• the company receives income from a relevant activity;
• the company is not a tax resident of the BVI.

To be more precise, in this case you not only disclose the country of tax residence, but also provide confirmation of this tax residence (though not of tax payments!) outside the BVI. In other words, the key question is ‘Does the company conduct a relevant activity?’ If the answer is ‘no’, this removes all further questions, including tax residence.

If necessary, we can provide services of analysing the activities of your company in terms of economic substance requirements and, also if necessary, either restructure the existing operations or ensure the company has economic substance in the BVI.