British Virgin Islands economic substance: investigation and enforcement procedures

Joshua Mangeot

Harneys, Tortola

joshua.mangeot@harneys.com

Edward Lacey

Harneys, Tortola

edward.lacey@harneys.com

Background

Alongside all other major zero- and low-tax international financial centres, the British Virgin Islands (BVI) introduced an economic substance (ES) regime in 2019 following European Union and Organisation for Economic Cooperation and Development (OECD) requirements.

The ES regime is set out in various pieces of legislation and official guidance. Broadly:

• the Economic Substance (Companies and Limited Partnerships) Act (the ES Act) and the Beneficial Ownership Secure Search System Act (the BOSS Act) and related regulations set out the ES compliance and reporting requirements, respectively, and create various civil and criminal penalties for non-compliance;
• further guidance appears in ES rules and explanatory notes (the Rules) published by the BVI International Tax Authority (ITA); and
• the administrative mechanism for imposing the penalties created by the ES Act and BOSS Act was introduced via amendments to the International Tax Authority Act (the ITA Act) and under the International Tax Authority (Administrative Penalties) Regulations (the Regulations) in June 2022.

ES obligations

The ES requirements were outlined in Harneys’ previous article for the IBA of 22 April 2022[1].

All companies and limited partnerships (including foreign entities) registered in the BVI (Entities) are subject to certain ongoing obligations in connection with the ES regime. However, the extent and nature of those obligations varies widely depending on the activities and tax status of the relevant Entity.

Broadly, every Entity must do the following:

• classify itself, to identify whether it is carrying on or receiving gross income from any ‘relevant activity’ under the ES Act, noting that:
  • if the answer to this is ‘no’ throughout the relevant ‘financial period’, the Entity will not be subject to ES compliance requirements during that period (but must still consider its reporting obligations); and
  • if the answer is ‘yes’, the Entity should consider whether it has a tax status allowing it to claim exemption if from ES requirements under Part 4 of the Rules (broadly, certain Entities may qualify for exemption as tax resident, tax ‘transparent’ or otherwise subject to tax outside the BVI).
• comply with any applicable ES requirements under the ES Act (if it cannot claim and evidence exemption due to its tax status); and
• report certain prescribed ES information under the BOSS Act to the ITA via its BVI registered agent within six months of the end of each financial period – even if this is effectively a ‘nil return’.

Monitoring compliance

If an Entity carries on a ‘relevant activity’ and is not exempt due to its tax status, it will need to ensure compliance with the applicable ES requirements on a continuing basis. While this may be fairly straightforward in the case of an entirely passive ‘pure equity holding entity’, this may well require specialist advice in other cases – particularly in the case of any ‘intellectual property business’. Ultimately, responsibility for ensuring compliance falls on the Entity – and therefore its director(s) or general partner(s), as applicable.

We recommend that an Entity maintains robust written evidence (for example board minutes) supporting its classification under the ES Act and demonstrating how it has complied with applicable compliance and reporting requirements.

Following amendments in June 2022, the ITA Act requires an Entity to establish and maintain adequate systems and controls to ensure compliance with applicable requirements and obligations under the ES Act and the BOSS Act (as well as under a third act, the Mutual Legal Assistance (Tax Matters) Act, which is beyond the scope of this article).

As currently drafted, the ITA Act also introduces a requirement for Entities to establish and maintain a compliance procedures manual. The ITA has indicated that this is only expected to be implemented by the end of 2023, and that it will publish advance guidelines on compliance with this requirement. As of the date of this article, such guidance has not yet been published.

ITA investigations

The ITA generally has six years from the end of a financial period to determine that an Entity has not complied with the ES requirements, subject to some limited exceptions.

We do not expect that every Entity will be investigated by the ITA. We understand the ITA will take a risk-weighted approach based on various factors – this may include ‘spot checks’ to examine the basis on which Entities have classified themselves for the purposes of the ES Act as well as investigating potential ‘red flags’ in reports.

Following an initial review, the ITA may determine either that:

• the Entity was compliant (in which case the ITA will not typically notify the Entity of such fact);
• the Entity was non-compliant; or
• that further information is required for the ITA to reach a determination.

Where the ITA requires further information, it may serve notice on any person, requiring the person to provide, within the period specified in the notice and at such place as is specified in the notice, such documents and information as the ITA may reasonably require for the purpose of facilitating the ITA’s exercise of its functions under the ES Act. The ITA cannot request information that is subject to legal professional privilege.

In practice, we would generally expect the ITA to request information from an Entity, its director(s) or general partner(s) (as applicable) or its registered agent, in the first instance.

The ITA also has broad physical investigatory powers under the ITA Act, such as the power to undertake physical compliance inspections, to examine persons under oath and to obtain search warrants, if required.

Enforcement powers

Failure by an Entity to identify whether it is carrying on relevant activity or to report the prescribed ES information without reasonable excuse, or the intentional provision of false information, is an offence carrying significant penalties. In limited circumstances, such offences may be committed by a director, officer or senior manager of the Entity, if they connive in or consent to the offence or fail to exercise all reasonable diligence.

Provided an Entity properly identifies and reports the prescribed ES information, there are broadly three ‘tiers’ of enforcement:

• On a first determination of non-compliance with applicable ES requirements, the consequences are generally limited to civil penalties. Those penalties are subject to minimum and maximum amounts prescribed by the ES Act. A determination of non-compliance under the ES Act is also one of various circumstances triggering spontaneous information exchange by the ITA with overseas tax and other competent authorities under Schedule 4 of the BOSS Act;
• If the ITA makes a second determination of non-compliance, the minimum and the maximum penalties increase significantly. The maximum penalties on a first or second determination of non-compliance are also significantly increased in the case of certain ‘high risk IP legal entities’; and
• In extreme cases, an Entity may be liquidated and dissolved for non-compliance by court order. Generally this option will be taken as a last resort or if an Entity has been guilty of clear, deliberate or egregious breaches of the ES requirements. The ITA may also apply to court for liquidation following a first determination of non-compliance if it determines an Entity has no prospect of becoming compliant.

The ITA may take a wide range of other enforcement action (including issuing a warning letter or imposing an administrative penalty under the Regulations) in various circumstances under the ITA Act. Broadly, these are:

• if the ITA is of the opinion that an Entity has:
  • contravened the ES Act or the BOSS Act – including by late filing, for example;
  • failed to comply with an ITA directive;
  • provided the ITA with any false, inaccurate or misleading information;
  • refused or failed to cooperate with an ITA compliance inspection; or
  • refused to take actions required to comply with an ITA compliance report; or
• if an Entity fails to pay an administrative penalty imposed under the Regulations on or before the due date.

The ITA may also require a person to bear its costs and expenses incurred in conducting an investigation or taking enforcement action.

Right of appeal

There is a procedure to appeal to court under the ES Act and the ITA Act. Broadly, the appeal must be filed with the court within 30 days of the penalty notice stating the ground(s) for appeal and notice of the appeal must be served on the ITA, which is entitled to appear and be heard at the appeal hearing.

The Court has the power to confirm, vary or revoke an administrative penalty or decision. However, filing an appeal will not operate as a stay on the obligation to pay any penalty imposed by the ITA.