British Virgin Islands' Economic Substance Act - The Answer to the EU's grey-list

Tax haven

A tax haven is a country that offers foreign individuals and businesses little or no tax liability in a politically and economically static environment. Tax havens also share limited or no financial information with foreign tax authorities. Tax havens do not require residency or business presence for individuals and businesses to benefit from their tax policies.

Tax haven status benefits the host country as well as the companies and individuals maintaining accounts in them. Individuals and corporations benefit through tax savings resulting from rates ranging from zero to the low single digits versus higher taxes in their countries of citizenship or domicile.

The list of traditional tax haven jurisdictions includes Andorra, the Bahamas, Belize, Bermuda, the British Virgin Islands, the Cayman Islands, the Channel Islands, the Cook Islands, The Isle of Man, Mauritius, Lichtenstein, Monaco, Panama, and St. Kitts, and Nevis. While Luxemburg, Hong Kong and Singapore are considered as the modern tax haven jurisdictions.

EU and tax haven

New European Parliamentary research has outlined the bloc’s new system of blacklisting countries considered to be non-cooperative jurisdictions on tax matters, and explains some of the thinking behind the listing of tax havens.

Jurisdictions that considered to be tax havens usually refute the label, insisting that their structures are compliant with global regulatory standards. The report, titled Listing of tax havens by the EU, however, states: “One might ask why establishing a list of tax havens or high-risk countries is useful … however tax havens are referred to, they all have one thing in common: they make it possible to escape taxation”.

Blacklist and greylist launched

After repeated calls for more transparency in the blacklisting process, on 5 December 2017, EU Code of Conduct Group (CCG) adopted the first EU list of non-cooperative jurisdictions for tax purposes – dubbed as the blacklist – or Annex 1.

The list consisted of 17 jurisdictions outside the EU that is considered as the ‘non-cooperative in tax matters.’

Another 48 jurisdictions were put on a watch list – dubbed as the grey list or Annex 2 – meaning their implementation would be closely monitored by the CCG.

As of 28 October 2018, there are 6 jurisdictions that still under the blacklist of the CCG:

1. American Samoa
2. Guam
3. Namibia
4. Samoa
5. Trinidad and Tobago
6. US Virgin Islands

There are additional 16 jurisdictions from earlier list that made in the greylist, notably these jurisdictions:

1. British Virgin Islands
2. Bahamas
3. Bermuda
4. Cayman Islands
5. Jersey
6. Labuan
7. Hong Kong
8. Seychelles
9. Malaysia

Economic substance

CCG claims that these jurisdictions facilitate offshore structures which attract profits without real economic activity. Due to the CCG’s concern, several offshore jurisdictions have prepared bill/legislation to overcome the economic substance in their respective jurisdiction. Economic substance refers to a transaction that has a purpose besides the reduction of a tax liability. The concept is used in the examination of tax shelters to see if the particular companies/private clients are abusing the tax laws.

BVI’s economic substance

One of the country that committed to the CCG’s claims is British Virgin Islands (BVI). The BVI’s Economic Substance (Companies and Limited Partnerships) Act, 2018 (the Act) came into force on 1 January 2019. It addresses the concerns of the CCG and recent OECD guidance around the economic substance of entities in jurisdictions with low or zero corporation tax. The Act demonstrates the BVI’s continued commitment to international best practice in business taxation.

Applicability of the Act

The Act applies to all “legal entities” carrying on “relevant activities”, other than non-resident companies, non-resident limited partnerships and limited partnerships which have elected not to have legal personality.

A legal entity is subject to the economic substance requirements if it conducts any of the following “relevant activities”:

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

The Economic Substance Test

Each legal entity which is not tax resident outside the BVI is said to comply with the economic substance requirements if:

1. the relevant activity being directed and managed in the BVI;
2. there are an adequate numbers of suitably qualified employees who are physically present in the BVI (whether or not employed by the relevant legal entity or by another entity and whether on temporary or long-term contracts);
3. there is adequate expenditure incurred in the BVI;
4. there are physical offices or premises in the BVI for the cre income-generating activities; and
5. where the relevant activity is intellectual property business and requires the use of specific equipment, the equipment is located in the BVI.

Reporting Obligations

All legal entities are required to provide information to enable the International Tax Authority in the BVI to monitor its economic substance requirements. The information will be provided via the BVI’s existing Beneficial Ownership Secure Search (BOSS) system. Failing which could lead to substantial fines and up to 5 years’ imprisonment and the particular legal entity may be struck off.

Conclusion

The move made by CGG has a clear intention, to provide more transparent activities among the businesses especially those incorporate in the tax haven. After the unprecedented leaking of breach data of Panama and Paradise Papers, the world is shocked by numerous potential tax evasions by the leaders of the world. Therefore, a new Act that covers the transparency of the business activity in the jurisdiction (like the BVI) is important so that there are no peculiar business activity and extraordinary wealth management across the tax haven.