For general background on The Economic Substance (Companies and Limited Partnerships) Act, 2018 (the "Economic Substance Act"), the related draft International Tax Authority Economic Substance Code that was issued on 22 April 2019 (the "Guidance") and for the meaning of 'legal entity', please click here
This update assumes that an entity has already been determined to be a 'legal entity' under the Economic Substance Act and that the 'legal entity' is now considering whether it is carrying on one of the nine categories of geographically mobile 'relevant activities' - in particular, under the 'Holding Company business' category.
What is 'Holding Company Business'?
Holding business' in the Economic Substance Act is defined to mean 'the business of a pure equity holding entity' which itself is defined to mean a 'legal entity that only holds equity participations in other entities and only earns dividends and capital gains'.
Economic Substance Test
If a 'legal entity' only carries on a 'relevant activity' that is the 'business of a pure equity holding company', it will be subject to a reduced economic substance test as set out in Section 8(2) of the Economic Substance Act (the "Reduced Economic Substance Test"). The Reduced Economic Substance Test can be satisfied if the legal entity:
(a) complies with its statutory obligations under the BVI Business Companies Act, 2004 or the Limited Partnership Act, 2017 (whichever is relevant);
(b) has, in the British Virgin Islands, adequate employees and premises for holding equity participations and, where it manages those equity participations, has, in the British Virgin Islands, adequate employees and premises for carrying out that management.
The Guidance further provides that condition (a) described above is met by complying with the legislative requirements imposed by the Business Companies Act or the Limited Partnerships Act, as appropriate.
For condition (b), the Guidance provides that what is required for compliance, as with economic substance generally, will be a fact sensitive question, dependent on the nature of the activity being carried on. At one extreme, the requirement for being a pure equity holding entity is simply holding equity participations. If this is all the legal entity does during a given financial period, the relevant activity will be entirely passive in nature and the requirements for adequate and suitably qualified employees and for appropriate premises will be applied accordingly. Any legal entity will of course retain the services of a registered agent, and the performance of those services will be taken into account when assessing economic substance for pure equity holding entities. On the other hand, the entity may actively manage its equity participations, in which case it should have adequate and suitably qualified employees, and appropriate premises, in the British Virgin Islands to carry out this function.
In addition, the Guidance clarifies that for a pure equity holding entity there is no requirement that the entity is directed or managed in the British Virgin Islands. Nor is there a requirement that the entity carries on core income generating activity in the British Virgin Islands (as there is no core income generating activity relating to holding business).
The Guidance also states that there are no restrictions on the extent to which a pure equity holding entity may outsource its activity. Where activity is outsourced, the extent of the outsourcing will be taken into account in assessing the adequacy of the employees in the British Virgin Islands, but only if the outsourcing is itself to a person operating in the British Virgin Islands.
The Guidance on 'Holding Company Business'
The Guidance contains some additional sector specific provisions in respect of 'holding business'. It provides that
(a) a legal entity will only fall within the definition if it holds nothing but equity participations, yielding dividends or capital gains. The ownership of any other form of investment (such as an interest bearing bond) will take the legal entity outside this definition;
(b) equity participation includes shares in a company, but is wide enough to encompass other forms of investment in an entity which give the investor the right to participate in the profits of the entity. The interest of a general partner in a limited partnership will usually be of this quality. The word 'dividends' will be construed broadly to encompass any payments made to an investor in respect of an equity participation;
(c) entities which own other forms of asset (e.g. bonds, government securities, legal or beneficial interests in real property) will not be pure equity holding entities (even if they also own equity participations) and will not be treated as carrying on holding business;
(d) because it is possible for an entity to carry on more than one relevant activity, the fact that an entity is a pure equity holding entity does not preclude the possibility that it may carry on one or more other relevant activities; and
(e) entities which hold assets which consist of or include assets which are not equity participations will not be pure equity holding companies, but likewise may be found to carry on other relevant activities.
What to do if a Legal Entity is Carrying on the 'Relevant Activity' of 'Holding Company Business'
It is worth noting that there are a range of consequences for breaches of the Economic Substance Act (including financial penalties and potential striking-off). If you would like help by outsourcing your economic substance requirements in an affordable and turnkey manner, please visit us at www.economicsubstancesolutions.com