The OECD Base Erosion and Profit Shifting (“BEPS”) project concerning companies operating internationally was endorsed by the G20 in 2015.
BEPS Action 5 (Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance) is one of the four BEPS minimum standards applicable to all members of the Inclusive Framework on BEPS and any jurisdictions of relevance.
The OECD considers that low or zero effective tax rates on the relevant income is a necessary starting point for an examination of whether a preferential tax regime is harmful. When a preferential regime benefits income from geographically mobile activities and meets this factor, it is in scope for the Forum on Harmful Tax Practices (“FHTP”). However, the tax rate factor alone does not imply that a preferential regime is harmful; rather it is a gateway criterion that if met means that the FHTP will continue the review process to determine if one or more of the other key factors are implicated. …
Since the start of the BEPS project, the FHTP has reviewed a significant number of preferential regimes. In 2017, commitments were made in respect of more than 80 regimes to be made compliant with the BEPS Action 5 minimum standard.
The BVI was an early adopter of the OECD’s Common Reporting Standard (CRS) for the automatic exchange of tax information, and also exchanges information under the US Foreign Accounts Tax Compliance Act (FATCA).
The BVI is a party to the multilateral Convention on Mutual Administrative Assistance in Tax Matters. Through its commitment to the BEPS process the BVI is a member of the Inclusive Framework on BEPS. In 2015 it was rated “largely compliant” for its approach to tax transparency and exchange of information in the Peer Review report published by The Global Forum on Transparency and Exchange of Information for Tax Purposes, as taskforce set up by the OECD.
As part of the BEPS Project, the FHTP has also reviewed the work done to produce the OECD 1998 Report on Harmful Tax Competition: An Emerging Global Issue (“the 1998 Report” (OECD, 1998) which set out the framework to identify harmful tax practices, with specific criteria for assessing harmful preferential regimes and for assessing “tax havens” (as they were then called). As a result of this review the FHTP considered that they had not taken a strict enough approach at the time and decided to elevate the “substantial activities factor”. As such, the substantial activities factor has been elevated from being an “other factor” to a “key factor.”
In the context of IP regimes (which include any regime that provides benefits to income from any type of IP asset), this factor mandates that jurisdictions must provide no more benefits than those permitted under the “nexus” approach. In the context of non-IP regimes, the FHTP requires substantial activities whereby:
1) jurisdictions must require core income generating activities to be performed and establish mechanisms to review compliance with this requirement, and
2) the FHTP will monitor the jurisdiction’s effective implementation of the substantial activities requirement.
In terms of the activities that jurisdictions must require, the FHTP agreed that jurisdictions must require taxpayers to have an adequate number of employees with necessary qualifications and to incur an adequate amount of operating expenditures to undertake the core income-generating activities associated with the income that may benefit from a regime.
In 2018/19 the OECD has focused on this new “global standard” on substantial activities in no or only nominal tax jurisdictions. At the same time the European Union’s Code of Conduct Group has been assessing low or no-tax jurisdictions on tax transparency, fair taxation and compliance with the BEPs project.
Under the threat of being added to the EU’s list of non-cooperative jurisdictions (yet another black-list) the BVI committed to adopt, in a very short timeframe, economic substance requirements for businesses based there. The Economic Substance (Companies and Limited Partnerships) Act, 2018 was passed. The EU is undertaking further work during 2019 to define appropriate economic substance requirements for collective investment vehicles. The BVI Government have expressed their commitment to continuing to work cooperatively with the EU to deliver a satisfactory outcome.
Similar legislation is being introduced in each of the British Crown Dependencies and British Overseas Territories.
The legislation generally applies so that the economic substance requirements are applicable to legal entities carrying on the “relevant activities” below:
- banking business
- insurance business
- fund management business
- finance and leasing business
- headquarters business
- shipping business
- holding business (defined as “pure holding companies”
- intellectual property business
- distribution and service centre business
Trusts are not in scope but corporate trustees are in scope depending on the circumstances.
If the entity does not have adequate substance in the territory it may be possible to confirm that the business is being undertaken elsewhere, which is subject to certain levels of proof being required. It is specifically worth noting that the place of effective management will be included in the BVI BOSS registry. The information concerning non-compliance may be exchanged with the jurisdiction where the “real” economic activity is being undertaken, leading to tax enquiries in that country.
If the substance requirements are not met, or if the company is not seen to be managed elsewhere then there may be sanctions and penalties imposed, with the company eventually being struck off.
The deadlines for application and implementation of the law will vary locally. For the BVI the legislation is effective from 1 January, 2019 for newly incorporated entities.
The legislation in the BVI will generally apply to relevant entities existing before 1 January 2019 with effect from 30 June 2019. The period of assessment is over periods of time of not more than 12 months. Default reporting periods apply but an entity subject to the Act should consider whether it wishes to align its economic substance reporting period with its own financial year (or any other date). For relevant BVI entities formed in 2019, the first reporting period will start from the date of incorporation, formation or registration and, by default, run for 12 months. By default, the first reporting period for entities existing before 1 January 2019 is for 12 months from 30 June 2019.
The Beneficial Ownership Secure Systems Act, 2017 (BOSS Act) created the updated beneficial ownership data collection regime that was implemented in the BVI in 2018. This legislation was amended to include the new economic substance filing requirements when the Economic Substance (Companies and Limited Partnerships) Act 2018 was passed.
The BOSS Act amendments were planned to come into force on 30 June 2019. However, a notice issued by the BVI Government has indicated that these amendments will now enter into force on 1 October 2019.
Rosemont International can assist you with analyzing whether or not a specific entity is affected by this Economic Substance legislation, and can also help you to consider what action may be required to ensure compliance with the local legislations. This may involve the allocation of additional resources to the entity to ensure substance in the jurisdiction, or another option may be to consider relocating the core income generating activity.
With offices in key jurisdictions Rosemont is ideally placed to help you analyze the effects of such relocation of the business activities, not only from a tax point of view, but by helping you understand the practical aspects of doing business in these alternative jurisdictions.
For more background information on the global move towards requirements for businesses to have Economic Substance where they are based please read our new article here.