Lockdown Lowdown (Part 2): Economic Substance Compliance in a time of COVID 19

This is the second part of our series dealing with novel legal issues that arise around lockdown (please the first here).

In this note we will discuss some of the key economic substance issues related to reporting and documentation as well as compliance with the directed and managed test, and how this can be managed in the current climate.  Although our comments below refer to time-sensitive matters that companies in the BVI need to be mindful of, they are useful in the wider context of economic substance compliance.

1. Preparing for the End of the First Financial Period

Given the current circumstances and the additional pressures placed on directors and shareholders, it is sometimes easy to lose sight of upcoming deadlines.

The vast majority of BVI legal entities will be approaching the final weeks of their first financial period (ending on 29 June 2020). A legal entity’s financial period is crucial as it is the period of time over which compliance with economic substance and reporting requirements is assessed.

To prepare for the end of this first financial period (and the start of the next financial period), all BVI companies should consider the following:

• Check and where necessary update any “legal entity/relevant activity” classifications.
  
  
• For those legal entities whose financial period ends on 29 June 2020, certain information (under the BOSS Act 2017) must be reported by 29 December 2020 via the Beneficial Ownership Secure Search System (BOSS). This information is set out in section 10(3) of the BOSS Act, and is referred to as the “prescribed information.”
  
  
• Both the legal entity and the legal entity’s Registered Agent have obligations in respect of the prescribed information. In short, the Registered Agent needs to take reasonable steps to collect the prescribed information but it is the legal entity which has the obligation to identify whether it carries on one or more relevant activities, and if so which relevant activities and to ascertain the prescribed information. The Registered Agent has no duty to identify the prescribed information for itself, or to ascertain its truth but is under a duty to enter particulars of the prescribed information collected on its RA database and through BOSS.
  
  
• A legal entity’s financial period (for economic substance purposes) will often not be the same as its financial year (although it is possible to align them). Where this is the case, legal entities should ensure that any financial statements and/or management accounts are up-to-date as at the end of the financial period.

It is important to be aware that legal entities will have to report in relation to all relevant activity carried out in the financial period, even if the relevant activity is not ongoing at the end of the financial period.

2. If I am Not Prepared – What Then?  

Most legal entities should already have taken steps to establish whether they are carrying on a relevant activity and to take action accordingly (including identifying and collecting the prescribed information as highlighted above).

However, some legal entities may not be so far advanced and as the Rules[1] note, “an entity which does not take steps either to take its relevant activity outside the scope of the legislation, or to bring it into compliance with the legislation, can expect to be the subject of enforcement proceedings”.

With this in mind, we recommend the following:

a.   Where a legal entity has established that it is carrying on a relevant activity and is in the process of discontinuing the activity (or modifying it so it no longer falls within the scope of a relevant activity) this process should ideally be completed before the new financial period starts on 30 June 2020.  If this is not completed before this date, the legal entity will be carrying out that relevant activity during that following financial period, and will have to comply and report on that relevant activity.  This will translate into additional compliance and reporting costs.  This may also have an impact on the International Tax Authority’s (ITA) determination of any penalties to be applied where a legal entity has failed to comply with the economic substance requirements in its first and second financial periods.

b.   Where a legal entity has not yet taken steps to establish whether they are carrying on a relevant activity, it will be important to classify themselves as a matter of urgency. This needs to occur well in advance of 30 June 2020 to allow time if any necessary steps need to be taken prior to this date.  Running a classification exercise now may also determine that a legal entity is tax resident in a jurisdiction outside of the BVI (provided that jurisdiction is itself not on the EU taxation “blacklist”) and therefore not subject to the economic substance requirements.

3. Directors Take Note..… 

Earlier in March, the ITA announced that it proposed adopt a reasonable and practical approach where legal entities needed to make adjustments as a result of Covid-19 and that they would not seek to penalise those legal entities (from an economic substance compliance perspective) where they had made those adjustments.  Remedial actions were recommended covering the following:

• where possible, recourse should be had to the appointment of alternate directors in the BVI in order to meet substance requirements;
  
  
• all directors do not have to attend Board meetings in the BVI - only as many as required to make the meeting quorate and virtual meetings, given social distancing protocols, may be preferred.
  
  
• not all Board meetings need to be held in the BVI - only those related to core income generating activities must occur there;
  
  
• where it is still not possible to have a Board meeting in the BVI or to meet some other substance requirement due to restrictions (whether in the BVI or otherwise) due to the Covid-19 outbreak, then entities are urged to retain documentation to be able to support such claims for the applicable periods of time affected;
  
  
• requests should be made to the ITA for any extension of time within which to comply with Notices, along with any supporting evidence.

The ITA also noted that BVI companies should take note that this is only a temporary arrangement and every effort should be made to otherwise comply with full substance requirements (including filing deadlines). The practical and reasonable approach described above can only be used where entities need to make adjustments to their usual operating practices and so far as these are necessary to manage threats from the Covid-19 outbreak.[2]

4. Final Thoughts 

With the above in mind and given that travel restrictions are likely to continue for some time, we recommend that action is taken now to ensure that company constitutions and corporate practices allow for remote or virtual meetings to take place.  Written records should also be kept of national and international travel policies restricting travel for directors and officers, and the periods for which those restrictions are in place.  This will be helpful as supporting documentation in the future should queries be posed by the ITA.

Remembering that it is the strategic decisions for the relevant activity which are required to be taken in the BVI, entities should also think about what these are and whether any are upcoming.   Boards may wish to delay (and plan to do so) some of these decisions if it is appropriate to do so in the circumstances. If this is not possible, consideration should be given to decisions being taken by written resolution or telephone meeting or temporarily appointing alternate directors who are physically resident in the BVI. 

For more information on this topic please contact Rupert Ramsay at rupert.ramsay@crsblaw.com or on +41 43 430 02 02.

Please note that this article is intended to provide a very general overview of the matters to which it relates. It is not intended as legal advice and should not be relied on as such.