The British Virgin Islands seem to lose the offshore edge: the EU pressure forced the country to introduce new requirements for businesses. The rulebook compels paper-presence companies to show more substance in the tax haven.
We examine if this new legislation is a game changer and why.
What’s Special About the BVI?
The British Virgin Islands are a British Overseas Territory in the Caribbean. The BVI have almost no taxes: no effective income tax, no capital gains, inheritance, gift, sales, or even value-added taxes. This classic ‘tax haven’ pattern allowed the country to derive income from payroll taxes, land taxes, and various fees.
The regulatory environment in the BVI has always been opaque. For example, there is no obligation for companies to publicise their incorporation, no regulatory pre-approval is required, and nominees are central to the business model. The register of directors and register of members are not publicly available, and no company is obliged to file public accounts.
Thus, BVI attracted businesses seeking anonymity and the BVI-registered shell companies are frequently featured in tax-evasion and corruption cases. For example, half of the nearly 250,000 companies set up by Mossack Fonseca that the Panama Papers identified were incorporated in the BVI.
However, the laws introduced may now put an end to the paper-present companies.
What’s the New Order?
The British Virgin Islands want the resident companies and limited partnerships to carry out real business activities on the islands. Businesses will either have to pass annual economic substance tests or prove their tax residency in another country.
These measures result from the Economic Substance Act conceived as a remedy after the EU grey-listed the BVI due to a lack of tax transparency.
To pass the tests and avoid fines, a company must exhibit a certain behaviour:
- It must carry out the core income generating activities there, in the Virgin Islands.
- The activities must be managed on spot.
- The company must have a physical office in the Virgin Islands. This office must have an adequate number of suitably qualified employees.
- If the company’s activity requires additional premises, there must be some. For example, a company selling jarred jelly has to have a warehouse.
- If a company is involved with the intellectual property requiring specific equipment, such equipment must be located in the Virgin Islands.
- Every company must spend amounts of money in the Virgin Islands adequate to the company’s activity: a giant multinational can’t spend $100 a month.
The BVI authorities have the right to shut down a company that fails to comply with the economic substance requirements. If a company ignores the deadlines and subsequently fails to play by the rules, graduated penalties will be applied following each notice. The maximum fine is $200,000. For a high-risk IP legal entity, the penalty can be as big as $400,000.
The Act came into force on January 1, 2019. The existing companies received 6 months to harmonize their business activities with the new Act. The transitionary period expires on July, 1.
Which Companies Are Affected?
The new requirements apply to BVI-registered legal entities involved with banking, insurance, fund management, finance, leasing, shipping, intellectual property, or distribution/service centres. Holding businesses and headquarter businesses are also subject to the new rules.
The Act applies to all BVI companies and BVI limited partnerships carrying out any of the activities above unless they can demonstrate that they are tax residents in another jurisdiction.
The new requirements are unfeasible — too many companies are registered in the BVI. While the archipelago has less than 23,000 inhabitants, it hosts around 400,000 active companies — roughly 18 for each resident. The islands simply can’t accommodate the offices of all the legal entities that are now obliged to be physically present in the BVI.
The new legislation also brings uncertainty. In the Act, there is no definition of how much economic substance is actually ‘adequate’. Thus, it could be open to wide interpretation. No common definition might make compliance harder, so the experts expect a massive outflow of businesses.
BVI-incorporated SMEs are considering the costs and benefits of maintaining the entity in the offshore jurisdiction versus migrating the residence and incorporating a legal entity in a place like Singapore, Hong Kong, Malta, Liechtenstein, or another ‘mid-shore’ jurisdiction.
However, the situation might be different for multinationals with immense turnovers. “Potential tax savings may be so large that companies are willing to allocate whatever resources are needed to pass a substance test, however unproductive they truly are in that use”, claims the 2019 Oxfam research.
Is the BVI Case Exceptional?
The BVI’s new piece of legislation chimes with the trend for increasing offshore transparency. Besides the BVI, other UK territories (Anguilla, the British Virgin Islands, the Cayman Islands, Guernsey, Jersey, the Isle of Man) also faced the risk to be put on the EU blacklist, and Bermuda ended up there.
The European Union created its tax havens blacklist after major revelations of tax avoidance, such as Lux Leaks and the notorious Panama Papers. It released its first version in 2017.
KMPG experts point out that being blacklisted is painful for a state: it means higher withholding taxes, denied tax deductions, and controlled foreign company attribution. Consequently, all the UK territories collaborated with the EU and enacted laws designed to ensure fair taxation.
Further steps targeting anonymous shell companies are being taken. In May 2019, the UK House of Commons approved radical new measures forcing the overseas territories to disclose the ownership of companies based there. As soon as the House of Lords passes this amendment to the anti-money-laundering bill, the BVI and other overseas territories will face the obligation to set up public registers by the end of 2020.
All in all, the EU and the UK both seem committed to forcing offshore zones into transparency, so further actions are to be expected. The companies registered in the UK territories have taken the new requirements seriously and are preparing for the transformations.
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