Economic substance in the BVI: why is it so important and ways of dealing with it

The past decade turned out to be challenging for the global economy. The main reasons for this are financial, raw and political crises, as well as hot and trade wars, mutual sanctions and that sort of things. Only in the last weeks of 2018, the S&P 500, Dow Jones and NASDAQ indices lost almost all of their half-year growth. Oil prices have fallen again to $50 a barrel.

Any instability reduces economic growth and revenues to the treasury. Since instability has gone worldwide, almost all states lost tax revenues, and this can entail diminishing the quality of life, savings in social expenditures and in other key budget items such important for politicians to maintain their power.

To replenish budgets, they enhance the tax burden, which is increasingly putting pressure on business. Previously any business could simply change jurisdiction to a more favorable one, but currently banks and even governments of offshore countries, such as the British Virgin Islands (BVI), have already joined the process of “tax tourists” hunting.

The concepts of tax avoidance, tax evasion and economic substance are firmly established in the business vocabulary. This is a growing global trend. Today we are talking about the last term, since its interpretation, as well as its literal translation into Russian, pose a quite complicated task. The process of working with substance requires explanation, especially for the BVI, because it is one of the most popular offshore jurisdictions in the world.

What is substance and why is it so important?

To make the explanation as simple as possible, the criterion called “economic substance” means the presence or absence of real economic activity of a company in the territory of a particular state, i.e. “economic presence”.

Thus, previously offshore states allowed a quick and inexpensive formation of legal entities in their territory. Along with it, such companies were not entitled to conduct economic activities in the territory of this country. Indeed, the whole world was opened to this company. Actually, this is called a classic offshore zone, since substance is not available there.

But the problem is that, due to BEPS, the position of the OECD and the leaders of the largest economies, banks have ceased to allow transactions of companies that do not conduct real economic activity in a country, in which they are formally residents. Moreover, there is a risk to be included into the black lists of the regulatory authorities, to get fines or even withdrawal of a license.

Without a fixed and proven substance, banks believe that you use tax evasion. If you can prove that you are conducting real economic activity, for example, in the BVI, then it is no longer referred to as tax evasion, but a completely legal tax avoidance. As you can see, the difference is very significant;  for some companies it amounts to billions of dollars.

Interpretation of economic substance by the BVI government

Above, we have described the essence of substance, but there are a lot of important nuances that arise when it is interpreted in different jurisdictions. In particular, we will discuss this term in relation to the BVI 2019 Economic Substance (Companies and Limited Partnerships) Act, which entered into force on January 2, 2019.

Let us list the key moments:

- In 2019, all companies and partnerships will be required to obtain/confirm the status of a tax agent for the BVI;

- Under the new rules, in order to become a tax agent for the BVI, it is necessary to confirm the economic activity (the very same substance) in the territory of the state;

- Not all companies and partnerships must confirm the status of the BVI resident.

All information about companies applying for the BVI resident status will be stored in the BOSS electronic system (Beneficial Ownership Secure Search). These are the following data:

- names and personal data of the responsible persons;

- staff in the BVI and in the whole;

- financial reporting;

- equipment and fixed assets located at the BVI;

- address of the company's representative office in the BVI.

Let us emphasize an important point: the media slightly distort information and find a splash where it is absent. So, you can often read that all (!) offshore companies working with the BVI jurisdiction must prove their economic presence there. This caused a real panic among non-residents, but in fact everything is not so categorical.

The press release indicates that only representatives of particular industries must have the status of resident, and the rest may be residents of other states, including the EU countries (more on that later). These branches are as follows:

- finance (banks, stock exchanges, insurance companies, etc.);

- shipping;

- intellectual property management;

- distributing activities;

- holding activity (including the management company activities).

The last point can be regarded as the key one. For holding companies, it transforms the BVI from a classic offshore into a low-tax jurisdiction; the other industries are of less significance.

Is it possible to remain a non-resident in the BVI after the entry of the Act into force?

If your activity is not included in the list specified in the previous block, then you can remain a non-resident. But you should be attentive, since so far it is not yet clear what kind of documentation must be provided, what the tax burden will be, etc. Probably, the very authors of this Act have not yet decided, hence there is a delay in the implementation of the reform.

It is not yet clear what kind of information will be entered into the BOSS system, but it is known that data on residents of the European Union will be immediately transferred to European regulatory authorities. Regulatory authorities from other countries will be able to receive this information through the filing of a formal request to the competent authority of the BVI (FIA, ITA, FSC, etc.).

It is difficult to say what consequences it will entail for the beneficiaries, directors and employees of non-resident legal entities. But one thing is clear: it will be difficult even for non-EU residents to conceal their belonging in case of a specific interest of authorities from any state.

To sum up

Let us note the key innovations and trends at the end of this article:

- trend for economic substance is global, and sooner or later it will cover all offshore jurisdictions, the BVI is not an exception. The question is whether they can then be considered offshore jurisdictions;

- the main difficulty is that from now on it is required not only to imitate the activity, but actually to conduct it in the territory of the BVI, earlier Belize and other offshore territories concurred with the initiative. This entails a number of purely practical issues, such as hiring specialists with citizenship of these states, functioning of offices, etc.;

- earlier substance was one of the requirements of banks and financial institutions before opening an account, but now it has moved to the government level. That is, the process will not be ceased by itself, and it is unlikely to succeed in hiding for a long time in another jurisdiction. We will have to adjust to the new conditions, that is possible only under the condition of working with highly qualified lawyers, such as in Law&Trust.

We continue to monitor innovations in key jurisdictions and will inform you about the most significant of them.