Substance on Substance

In this episode, Partner Joshua Mangeot and Director of Fiduciary and Custodial Kerry Graziola discuss the various amendments in 2021 to the Economic Substance (Companies and Limited Partnerships) Act (the ESA) and the Beneficial Ownership Secure Search System Act (the BOSS Act) and provide an update regarding steps being taken by the International Tax Authority (ITA) to monitor entities’ compliance.

By way of background, the BOSS Act was amended twice in 2021 – first, with effect from 1 July 2021 via the Beneficial Ownership Secure Search System (Amendment) (No. 1) Act, 2021 (the First Amendment) and the Beneficial Ownership Secure Search System (Amendment) (No. 2) Act, 2021 (the Second Amendment and together with the First Amendment the 2021 Amendments). Many of the key changes made via the First Amendment were summarised in our client update of 19 July 2021.

Key takeaways:

• We expect the third version of the ITA economic substance (ES) rules and explanatory notes (the Rules) to be published later this year. We understand that publication has been delayed by the EU Commission and, as a result, the Rules do not yet reflect the 2021 Amendments.
• The main changes made by the Second Amendment relate to limited partnerships without legal personality (which includes foreign limited partnerships without legal personality registered in the BVI) (Relevant LPs) being added to the ES and beneficial ownership (BO) reporting regimes and expand the ES prescribed information to be reported by a “corporate and legal entity” (an Entity) for each ES financial period (FP) beginning on or after 1 January 2022.
• Many Relevant LPs are investment funds – and amendments to the ES Act in 2021 confirmed the industry view that “investment fund business” is not a relevant activity.
• Broadly, the 2021 Amendments:
• significantly expanded the scope of the ES reporting regime for FPs beginning on after 1 January 2022;
• provided that Relevant LPs must report their BO information within 15 days of identifying those matters following 1 January 2022, other than where the Relevant LP is an “exempt person” which does not carry on any ES “relevant activity” (an Exempt Person);
• introduced an obligation to identify, and report certain prescribed information in respect of, any “immediate parent” and “ultimate parent” (as defined) of every Entity, other than an Exempt Person; and
• expanded the scope of jurisdictions which may receive information under the spontaneous information exchange mechanism in Schedule 4 to include the overseas competent authority for each state in which an immediate parent or ultimate parent of the Entity is registered.
• Although the first reports under the new reporting regime for most Entities incorporated or formed prior to 1 January 2019 will be filed in 2023, Entities should ensure they are aware of the new requirements now and may need to discuss the changes with their accountants and legal advisors.
• We are already seeing the ITA take steps to investigate entities to determine compliance. The ITA has broad investigation powers to request any information it reasonably requires from any person to determine compliance and generally has up to six years from the end of an FP to make a determination, subject to some limited exceptions.

The Harneys ES Classification Solution

Our  Classification Solution has already been updated to reflect the 2021 Amendments and provides a cost-effective way for BVI companies and limited partnerships to demonstrate formally that they have considered their position under the ES Act. Our automated Classification Solution helps to classify your entity, provides tailored real-time legal advice, and is accessible through our online platform, at your convenience. Classify your entity here.

If you have any questions regarding the amendments or how they may apply to your BVI entity, contact our team of economic substance specialist lawyers  by emailing [email protected].

In the fourth episode of Substance on Substance season two, Philip Graham, our global head of Investment Funds and Regulatory, and Counsel Joshua Mangeot, our BVI economic substance specialist, consider the ITA’s investigation and enforcement powers under the Economic Substance (Companies and Limited Partnerships) Act 2018 and discuss some expected changes to the legislation, including limited partnerships registered in the BVI without legal personality being brought within the regime.

• Companies and other legal entities which have not yet classified themselves or which have missed their first reporting deadline (which was 30 December 2020 for the majority of BVI companies incorporated before 2019) should take urgent action.
• “Nil returns” are required for each financial period even where an entity did not carry on any “relevant activity”.
• Deadlines have not been extended despite the Covid-19 pandemic.
• Failure to identify relevant activity or report without reasonable cause is an offence (and offences committed by a body corporate may lead to personal liability for directors and other individuals in limited circumstances).
• If an entity is determined to be non-compliant with economic substance requirements, it will be liable to civil penalties and this may trigger a spontaneous exchange of its beneficial ownership and economic substance information held on the registered agent “BOSS” database with overseas competent authorities.
• The ITA’s investigation powers are broad and may extend to other persons associated with the entity (for example, directors, officers or the registered agent).
• Failure to provide information to the ITA without reasonable excuse (or the intentional provision of false information) is an offence, so we recommend that entities and their operators use this as an opportunity to ensure that books and records are up-to-date and comply with BVI law requirements.
• If you receive an ITA notice or information request, we recommend taking advice if you are at all uncertain.
• Draft legislative changes were published on Friday 12 March – we expect the drafts will be amended but it appears likely that limited partnerships registered in the BVI without legal personality will be brought within the regime (in line with EU requirements) and that there may be changes to some of the fines and penalties. Previously only limited partnerships with legal personality were affected.

Our full guide regarding the ITA’s investigations and enforcement powers can be found here. This and our other client guides may need to be updated as appropriate if the legislative amendments are brought into force.

In a bumper episode for the holiday season, Phil and Josh venture into the weeds of the ES reporting requirements, giving a "deep-dive" into the reporting criteria and their long-awaited discussion of tax non-residence claims and Part 4 of the International Tax Authority (ITA) Rules.

Key takeaways

• Reports must be filed by every "corporate and legal entity" (which includes all BVI companies) under the Beneficial Ownership Secure Search System Act 2017 via the registered agent within six months of the end of the financial period.
• The format of reporting via the BOSS(ES) database is prescribed by the ITA and reflects EU and OECD requirements.
• Every entity must file a report within the deadline - even if this just a "nil return".
• There are special regimes for "pure equity holding entities" (which only need to report on their "employees" and premises) and for "intellectual property business" - the latter is extremely complex and persons considering IP business are recommended to seek legal advice.
• Entities with other relevant activities, which are not tax "non-resident", are subject to the "general economic substance requirements" and must broadly report on:

1. Turnover (or revenue/gross income) from the relevant activity.
2. The person(s) responsible for direction and management of the relevant activity.
3. Expenditure incurred on the operation of the relevant activity (both total and within the BVI).
4. "Employees" (which includes individuals managed as employees, if employed by someone else) engaged in the relevant activity (both total and physically present within the BVI).
5. Premises used in the relevant activity in the BVI.
6. Details of "core income generating activity" (CIGA) carried on in the BVI.
7. Further prescriptive details if any CIGA have been outsourced to any entity in the BVI.

• The ITA has encouraged entities to make use of professional services and other providers in the BVI to provide substance - particularly given the Covid-19 pandemic.
• Entities which carry on relevant activities may be treated as tax "non-resident" and exempted from ES requirements if, during the financial period:

1. they are tax resident in another jurisdiction;
2. they are "transparent", meaning all of the profits and gains are attributable to and taxable all some or all of the participators or partners in the entity; or
3. they are not a "pure equity holding entity" and all of their income from relevant activities is subject to tax in another jurisdiction,

provided in each case the relevant jurisdiction does not appear on the EU's tax "blacklist".

• These rules can be complex to apply in the case of territorial, sectoral or source-based tax regimes and persons considering such regimes or making such claims are recommended to seek legal advice.
• Entities making such a claim must report on any "parent" and provide evidence of their tax status with their report - there is a mechanism to be treated as provisionally non-resident by the ITA in certain circumstances where evidence cannot be provided within the six-month reporting window.
• Making a non-residence claim will trigger spontaneous information exchange with the relevant overseas tax authorities (and any EU member state within which a beneficial owner or legal owner of the entity resides) to ensure the claim is valid.
• BVI entities which do not carry on any ES relevant activity do not need to report on (but should still ensure they have considered) any foreign tax status or obligations.

In the second episode of our Substance on Substance Season two, Philip Graham, our global head of Investment Funds and Regulatory, and Joshua Mangeot, our BVI Economic Substance specialist, give an update on points directors and operators of BVI entities should be aware of regarding the economic substance reporting deadlines.

Key takeaways

• Directors need to first assess where they are in the compliance reporting cycle - most BVI companies incorporated before 2019 will have to file their first report by early December 2020
• Obligations depend on the classification and greatly vary in what is required
• Allowing a company to incur fines or penalties for non-compliance may be a breach of directors’ duties, which can expose the director to personal liability
• There are also specific offences under the Beneficial Ownership Secure Search System Act 2017 that can occur when a company has failed without “reasonable cause” to: 
• Identify any “relevant activity” it carries on
• Identify prescribed information regarding any such activities and its beneficial ownership
• Report the prescribed information to its BVI registered agent within the relevant deadline
• Penalties include significant criminal fines and penalties (and even personal liability where intent or failure to exercise all reasonable diligence can be shown), subject to a limited defence of “reasonable cause”
• We can help manage the classification, compliance and reporting process by: 
• Performing a scoping exercise and working through the initial classifications
• Establishing whether or not there is relevant activity and advising next steps
• Advising the directors and the company to show they have discharged their duties
• Working with directors and companies to establish and carry out the next steps that need to be taken

We are able to offer a suite of online tools to make this process easier.

Harneys’ Economic Substance Classification Solution which provides real time formal legal advice to any BVI company or limited partnership for a low fixed fee can be found here. This solution offers users access to high quality legal advice on their entity’s status and obligations within minutes.

More information about Harneys' Economic Substance reporting tools we have developed to assist registered agents and service providers coordinate reporting can be found here.

Our BVI economic substance specialists Counsel Joshua Mangeot and Director of Client Services Amy Roost address some FAQs regarding the reporting process, which are relevant to all BVI companies.

Key Takeaways:

• The reporting deadlines for most BVI companies and other relevant entities are imminent - and in some cases have already passed. Most BVI entities must ensure reports are submitted by their registered agent (RA) before 30 December 2020 or face significant fines and penalties - and even personal liability.
• Deadlines have not been allowed to be extended by the EU despite COVID-19 but the regulator has issued practical guidance in this area. Please click here for our alert on this topic.
• Compliance is assessed by “financial period”. Entities incorporated before 1 January 2019 have a default first financial period of 30 June 2019 to 29 June 2020. Companies incorporated from 1 January 2019 onwards have a first financial period of 12 months from incorporation. After the end of the financial period, entities have six months in which to arrange reporting into the BOSS(ES) system via their RA.
• The ES financial period may not be the same as the entity’s tax or accounting financial year. The entity needs to review its individual non-consolidated accounts to determine its assets and sources of gross income over the financial period - this may require discussion with the entity’s accountants.
• Since most BVI companies were incorporated before 2019 (and may not have changed their default financial period), their first report will have to be filed by their RA before 30 December 2020. 
• Where any relevant activity was carried on during the financial period, entities either need to claim and evidence exemption due to their tax status under the “non-resident” exemption or submit reporting information demonstrating how they had adequate BVI substance over the period.
• There are special regimes for pure equity holding entities (holding business) and intellectual property business - the latter regime is extremely onerous and entities with any potential IP business should seek BVI legal advice. For entirely passive holding businesses or entities without any relevant activity, compliance and reporting should be quite straightforward. Nil returns are required even where there is no relevant activity.
• The tax non-resident exemption can also apply to transparent/disregarded entities and certain entities subject to tax on their income from relevant activities. Care needs to be taken when dealing with territorial or sectoral tax regimes and objective evidence will need to be provided to back up a claim. There is a mechanism to apply for provisional non-resident treatment, where such evidence cannot be obtained within the 6-month reporting window. This can be complex and may need tax advice. 

Josh and Amy’s practical guide to BVI ES reporting is available by clicking here.

In the fifteenth and final episode of Harneys’ Substance on Substance series for 2019, Philip Graham and Joshua Mangeot (plus special guest George Weston) examine the journey of economic substance in the BVI to date, from the inception of the Act to the final ITA Rules and discuss how BVI entities are coming to terms with these developments. 

Key takeaways

-We are seeing an increasing level of conversancy with the key concepts of economic substance, following the draft ITA Code being released in April and the final Rules being released in October

-We are seeing an increasing amount of entities classifying in order to ensure they are compliant with the new requirements – many entities are finalising their classifications, finding out whether they are affected at all or whether they are exempt or are passive “pure equity holding entities”, in which case no or very few changes will be required

-Based on user feedback, we have updated our BVI Economic Substance Classification Solution (which is available at https://economicsubstance.vg), building out the functionality and expanding Harneys’ legal advice given to users throughout the process and to provide board resolution template wording for more straightforward cases

-A large number of entities have progressed passed the classification stage and it is encouraging to see how many people are putting substance solutions in place (such as holding board meetings, appointing local directors and developing their presence in the BVI)

-Ultimately, it is companies’ and other legal entities’ obligation under BVI law to identify whether they have relevant activity and if so, to take steps to ensure compliance – if entities have not yet considered this and classified themselves, we strongly recommend that they do so

Whilst this is the last episode of the Substance on Substance series, more updates and a new podcast series will be coming your way in the new year; stayed tuned and thanks for listening!  If you would like to subscribe to our client alerts on economic substance, please visit https://www.harneys.com/newsletter/.

SOS Substance on Substance: Episode fourteen – Timing of compliance and reporting obligations 

In the fourteenth instalment of Harneys’ Substance on Substance series, Philip Graham and Joshua Mangeot discuss timing for compliance and reporting and address the ongoing obligation on BVI companies and other legal entities to identify “relevant activities”.  This obligation came into effect from 1 October 2019 but is distinct from the reporting obligations which will generally commence in 2020 (except in the case of previously “exempt persons”, who now need to be reporting beneficial ownership information if they carry on any relevant activities).

Key Takeaways

• The amendments to the Beneficial Ownership Secure Search System 2017 (the BOSS Act) enacted on 1 October 2019 included an ongoing obligation to identify relevant activities (and failure to do so without reasonable cause is technically an offence)

• As of the 1 October amendments, previously “exempt persons” under the BOSS Act which carry on any relevant activity have ceased to be exempt from reporting beneficial ownership information – this must generally be reported within 15 days (so potentially from 16 October 2019 at the earliest)

• This bolsters any compliance obligations under the main economic substance legislation which came into effect for BVI companies and legal entities earlier in the year

• All entities should generally have identified any “relevant activities” by now, if they have not already done so – although many BVI legal entities will be exempt from requirements to demonstrate substance either (i) because they are not carrying on any relevant activity or (ii) due to their tax status under non-BVI law

• Conversely, reporting of the prescribed economic substance will generally commence in 2020 and is expected to be done via an entity’s BVI registered agent

• The ITA is generally expected to commence an audit and investigation of entities’ compliance with the economic substance requirements under its broad power following the first round of reporting in 2020 but this will be on a “backwards-looking” basis in respect of the first compliance “financial period” – so entities should be maintaining robust books and records for the first financial period to be ready to report and comply with any ITA information requests

• Where entities have taken legal advice on their position under the economic substance legislation, we recommend that they consider taking steps to preserve legal advice privilege in the advice itself (particularly if this will be provided to their registered agent or other third-parties)

• Generally, the ITA has six years from the end of the relevant financial period to make a determination of non-compliance (but this timeframe is unlimited in cases of deliberate misrepresentation or negligent or fraudulent action)

SOS Substance on Substance: Episode thirteen – What should directors and fiduciary service providers be considering?

In the thirteenth instalment of Harneys’ Substance on Substance series, Joshua Mangeot and special guest George Weston discuss BVI directors’ duties in the context of the Economic Substance (Companies and Limited Partnerships) Act 2018 (the ES Act) and provide an update on amendments to the Beneficial Ownership Secure Search System Act 2017 (the BOSS Act).

Key takeaways:

• We have received numerous queries from directors and officers of BVI companies and fiduciary and corporate services providers (CSPs) regarding their responsibilities in this area – the majority of questions relate to BVI companies

• Directors of BVI companies are subject to various common law and statutory duties – broadly, the main duties under the BVI Business Companies Act 2004 (the BC Act) are (i) to act bona fide in the best interests of the company; (ii) to exercise their powers for a proper purpose and in accordance with the BC Act; and (iii) to exercise reasonable care and skill

•  Where a director allows or permits a company to incur fines or penalties for non-compliance with the economic substance requirements, this may give rise to potential liability to the company for breach of their general duties

•There are also some specific obligations to be aware of under the ES Act and the BOSS Act – broadly:

o as of 1 October 2019, every BVI company and other corporate and legal entity must identify whether it carries on one or more “relevant activities” under the ES Act (and if so, which activities) – failure to do so without “reasonable cause” is an offence and, in the case of a company, may be committed by directors, officers and other persons in certain limited circumstances by virtue of the BVI’s Interpretation Act (Cap. 136)

o the International Tax Authority (ITA) has broad investigation powers to service notice on any person requiring them to provide such documents and information as the ITA may reasonably require to exercise its functions under the ES Act – failure to provide information without “reasonable excuse” or intentionally providing false information is an offence

o conversely, the general financial penalties for non-compliance with the ES Act do not fall on directors or officers but on the company, subject to the point made regarding directors’ duties generally

• We therefore recommend directors and CSPs providing fiduciary services take appropriate legal and/or tax advice where they are uncertain regarding their companies’ compliance and reporting obligations under the ES Act – legal advice may benefit from legal privilege and, broadly, reliance which has been reasonably placed on such advice may discharge a director’s duties by virtue of specific provisions in the BC Act and may provide “reasonable cause” if the ITA investigates or challenges the basis of the classification

• Directors should ensure they have understood these new obligations and classified their company and may wish to pass resolutions or hold a meeting to record the basis of their determination of their company’s position under the ES Act and the BOSS Act and to record the fact that they took appropriate advice

• Expected amendments to the BOSS Act were published on 31 October 2019 – broadly, these bring the BOSS Act into line with the position anticipated by the ITA Rules of 9 October 2019

This episode was recorded on Monday 4 November 2019.

​Stay tuned for more Substance on Substance.

Economic substance legislation and its impact on liquidations

In the twelfth instalment of Harneys’ Substance on Substance series, Philip Graham and Joshua Mangeot discuss how BVI entities currently in liquidation or considering this option should approach the BVI economic substance (ES) requirements. They also consider the position of liquidators and points they should be aware of in this regard.

Key takeaways:

• We are not seeing many clients move to liquidate BVI vehicles as, once they have classified themselves, many BVI entities find they are either (i) exempt from the ES requirements as they are not carrying on any “relevant activity” or are “non-resident” for tax purposes under the expanded definition in the ES legislation and Part 4 of the International Tax Authority (ITA) Rules, (ii) already compliant as an entirely passive “pure equity holding entity”, or (iii) able to achieve compliance through other simple reorganisational steps

• The ITA will expect that any applicable ES requirements will be complied with during the time an entity is in liquidation – so this is an area of interest to persons undertaking or contemplating a BVI liquidation

• However, if an entity has been dissolved prior to an ES reporting obligation falling due, it will not exist and therefore cannot make a filing (noting that it is conceivably possible for an entity to be restored by a court)

• Accordingly, directors/general partners and liquidators should (i) classify the entity (or confirm its classification remains correct), (ii) determine it is still carrying on, or receiving income from, any relevant activity (or if the business and receipt of income has ceased), (iii) consider the anticipated timetable of the liquidation alongside the entity’s ES “financial period” and reporting obligations, (iv) where necessary, put in place a compliance and/or reporting plan, and (v) ensure that they have maintained appropriate written records – particularly if the entity may still be in existence when a reporting deadline falls due

• Professional liquidators and insolvency practitioners may also wish to review their terms of engagement and ensure that they have sufficient contractual protections and access to information as they will assume primary responsibility for compliance or reporting obligations from the onset of liquidation

• In some cases, it may be desirable to elect or apply to the ITA to amend a “financial period” so there is a clear period for which the liquidator will be responsible for monitoring and, if necessary, reporting on compliance

• We anticipate further guidance and legislative amendments this year regarding the “striking-off” regime under the BVI companies and limited partnership legislation, so will address that topic in future updates

This episode was recorded on 23 October 2019.

Stay tuned for more Substance on Substance.