The British Virgin Islands (BVI) recently passed legislation strengthening transfer pricing rules, amid international criticism for its status as a tax haven.
The new law – the Economic Substance (Companies and Limited Partnerships) Act 2018 (the Act) – requires certain entities registered in the BVI to demonstrate economic substance to maintain their status and benefits in the region.
The Act is the latest piece of legislation to strengthen the international Base Erosion and Profit Shifting (BEPS) campaign to tackle international tax evasion. China, Hong Kong, and a number of other areas have participated in this program, putting out their own measures to align with best practices.
Businesses registered in the BVI should analyze the Act to ensure that they meet the new higher standards.
What’s the change?
The Act, which came into force on January 1, was introduced to address concerns raised by the Organization of Economic Cooperation and Development (OECD) off the back of its BEPS program.
The BVI – along with other jurisdictions like the Cayman Islands and Bermuda, and to a lesser degree Singapore and Hong Kong – have long come under international pressure for their relaxed tax rules. Critics argue that businesses nominally registered in these regions escape from paying taxes in countries where they carry out the brunt of their economic activity.
The Act imposes new requirements on companies to ensure that they are carrying out real business activities in the BVI.
A limited partnership registered in the BVI as a foreign entity must now prove if it is carrying out any of the following activities:
- Holding company business;
- Headquarters business;
- Funds management business;
- Banking business;
- Insurance business;
- Shipping business;
- Finance and leasing business;
- Intellectual property business; and
- Distribution and service center business.
This can broadly be done through exercising management and control in the BVI, having employees and a physical place of work (an office) in the BVI, and incurring other expenditures in the course of generating income, among other things.
Entities that do not carry on a relevant business activity may still be subject to certain reporting obligations. It is expected that authorities will issue further guidance explaining how the legislation is applied in such cases.
Implications for China-based businesses
Many multinational companies with operations in China also have entities in low or zero tax jurisdictions like the BVI. Oftentimes, profits from the group are diverted to these entities, which are largely maintained with little or no commercial substance. Management may be under the assumption that they can maintain their existing structures without the need to prove real business activity or to avoid compliance.
However, new laws like the BVI’s Economic Substance Act, 2018 will make it harder for companies to indulge in tax avoidance strategies. Many multinational groups have already begun adjusting the legal structure of their operations in known tax-friendly regions like the BVI or actively removing them altogether as BEPS measures get increasingly accepted worldwide.
Similar laws and regulations seeking to curb tax avoidance have also been introduced in Jersey, Guernsey, the Isle of Man, the Cayman Islands, and Bermuda.
China itself, while not a tax haven, has introduced a number of new transfer pricing regulations in recent years to bring itself in line with international standards. Even Hong Kong – which is well-known for its low-tax environment – has introduced stricter than expected transfer pricing regulations in the past year.
Together, these new laws will have a significant impact on how multinationals operate. It is important for groups that have entities in these locations to evaluate whether they are now required to build up economic substance, as well as how and by when this needs to be done.
International tax planning is done by multinationals of all stripes to optimize tax obligations. However, this process must be done carefully and transparently to ensure compliance in multiple jurisdictions, especially as regulators begin to take the issue more seriously.
Going forward, multinationals will need to build up and maintain economic substance and devote greater resources to reporting and compliance regardless of their registered location.