Marianne Rajic and Lisa Penn-Lettsome consider the impact of the shift in supranational initiatives towards Tax Transparency on the BVI.
It is quite clear that the more recent past has seen a notable shift in the debate from various supranational initiatives implemented over the years, designed to curtail the activities of smaller offshore financial centres, towards the real issues of tax transparency, regulatory cooperation and managing systemic risk in the global economy. Alongside this change, the reputation of the British Virgin Islands - and its regulatory regime - has been significantly enhanced, as the BVI government has demonstrated its unwavering commitment to transparency and a determination to do everything required to satisfy international regulators and policymakers.
Whether one is an avid follower of the financial news or just simply the average individual who skims the printed media, it has been hard to ignore the rhetoric surrounding the global push for tax transparency. In the now infamous statement before the US Senate, Senator Levin declared that US tax dodgers were costing the Federal Treasury US$100 billion a year and in an effort to reduce such tax evasion, the Foreign Account Tax Compliance Act (or FATCA), part of the US Hiring Incentives to Restore Employment Act, 2010 (HIRA), was born in March 2010.
FATCA targets tax non-compliance by US taxpayers with foreign accounts. To put it in simple terms FATCA requires foreign financial institutions or FFIs to enter into an agreement with the US Internal Revenue Service (IRS) and report information on accounts of US persons. A 30 per cent withholding tax is imposed on US source income and other US related payments of the FFI which fails to enter into the necessary reporting arrangements with the IRS. With the US equity and bond markets being the biggest in the world, in practice FATCA has a wide reaching extraterritorial effect.
Whilst FATCA has been the main focus of international media attention, it is important to note that the United Kingdom has also implemented an equivalent reporting regime in relation to UK citizens (UK FATCA). UK citizens are not subject to blue-sky taxation and the definition of UK specified persons is not as broad as its FATCA equivalent. The UK FATCA, whilst similar to its US cousin, does not impose withholding on UK source income and accordingly has somewhat less punitive extraterritorial application.
A Burdensome Regime?
The reach of FATCA is wide and definitions are broad. Essentially FATCA forces foreign financial institutions and foreign governments to collect data on US citizens at their own expense and transmit it to the IRS. Unsurprisingly, the regime has met significant criticism for its far reaching and extraterritorial implications.
Under FATCA, foreign banks will be required to verify the citizenship of every existing account holder and identify to the IRS anyone with US tax status. Customers who refuse to divulge the information to the bank, could have 30 per cent of any US income, such as earnings from mutual funds, flowing into their accounts withheld, regardless of their nationality. In jurisdictions where banks have no legal means to demand proof of citizenship or immigration status, compliance with FATCA might necessarily force an amendment of privacy laws.
There is a commercial alternative, of course; faced with the ramifications of having "recalcitrant account holders", many banks are simply closing accounts of those customers who refuse to provide the required information. In case of a hedge fund, if it has recalcitrant account holders or cannot provide enough information to satisfy the IRS, it will have to apply the withholding tax on its US assets. BVI funds would generally be prohibited from applying the 30 per cent penalty only to the relevant investors, so the effect will be to penalise all investors. The threat of a withholding tax of 30 per cent on funds transferred from the US may also result in foreign financial institutions withdrawing from US securities and investments. There are also reports of many foreign banks refusing to open accounts for, or closing accounts held by Americans, making it harder for Americans to live and work abroad.
Still, notwithstanding the widespread criticism, FATCA and UK FATCA, with more similar regimes to follow, are here to stay. So what are the implications of the latest global tax transparency regimes on the British Virgin Islands (BVI) as a leading offshore jurisdiction?
Implementation of FATCA and UK FATCA in the BVI
In order to facilitate reporting under FATCA, the BVI, along with some 109 other countries has entered into an intergovernmental agreement with the US. On 30 June 2014, BVI government entered into a model 1 B inter-governmental agreement with the US in connection with the implementation of FATCA (the US IGA). The BVI government also entered into a model 1 inter-governmental agreement with the United Kingdom on 28 November 2013 (the UK IGA). On 30 September 2014, the British Virgin Islands government passed the Mutual Legal Assistance (Tax Matters) (No 4) Order, 2014 to implement the provisions of both US IGA and UK IGA.
The US IGA allows a BVI FFI to report directly to the International Tax Authority of the BVI (ITA), instead of having to enter into an agreement with, and report to the IRS directly. The ITA will automatically pass the information to the IRS. Provided a BVI FFI complies with the relevant BVI procedures and reporting obligations, it will be treated as a deemed compliant FFI and will not be subject to the automatic withholding on US source income and other US related payments.
Implications for BVI Entities
FATCA will not materially affect typical BVI holding companies or joint venture vehicles, which should be classified as either active or passive non-financial foreign entities (or NFFEs) under FATCA. BVI NFFEs will generally not be subject to registration or reporting requirements, but they will be required to self-certify their status to financial institutions and other withholding agents with whom they maintain accounts to avoid FATCA withholding.
FATCA will, however, have significant implications for BVI entities that are FFIs, which will include banks, custodians, hedge funds and private equity funds (with the exception of funds with more than 50 per cent of the gross revenues derived from real estate or other non-financial assets), trust companies, trusts and other regulated entities. How much of an impact FATCA will have on a BVI FFI, will depend on whether it is a Reporting FFI or a Non-Reporting FFI.
A Non-Reporting FFI is any FFI that falls within any of the exemptions set out in the US IGA or under FATCA Regulations. Many Non-Reporting FFIs will not need to register with the IRS and obtain a Global Intermediary Identification Number (GIIN) or carry out the due diligence and reporting requirements under the US IGA. Such Non-Reporting FFI will be required to provide certification to a relevant withholding agent as to its status through the modified W8 certification.
BVI FFIs that do not qualify for any such exemptions will be classified as Reporting FFIs and will be required to comply with the reporting and registration obligations imposed under the US IGA and BVI legislation, most notably to: (a) identify US Reportable Accounts; (b) report annually to the ITA certain specified information with respect to any US Reportable Accounts; and (c) register with the IRS to obtain a GIIN, even if the Reporting FI has no US Reportable Accounts, no later than 31 December 2014. Failure to register for a GIIN by this date, will result in the inability of the relevant FFI to benefit from the US IGA after 1 January 2015 and it will be subject to withholding from US payors and other FFIs.
UK FATCA requires BVI FFIs to start carrying out due diligence on its accounts and identify UK specified persons now, although the first reporting date for UK FATCA is not until 31 May 2016. On the first reporting date, specified information on the accounts of specified UK persons and non-UK entities controlled by UK specified persons must be reported to the ITA.
Implications for the BVI financial services industry
Undoubtedly, to say the least, it is a very costly and resource-intense effort to continuously negotiate and administer efforts like FATCA and UK FATCA. Compliance with international standards is essential for a leading international financial centre like the BVI and the benchmark continues to rise with each round of country evaluation from the various standard setters.
That said, the plethora of transparency initiatives do have many positive aspects to them. One such significant area of note is that the BVI has made several small but important changes to its cache of regulatory legislation to mirror globally acceptable standards. Many of the major legislative changes were actually outside of the BVI core suite of financial services legislation (covering investment business, banking, trust, insurance and company management and AML/CFT and which were already quite effective) and extended to new areas such as handling dormant bank accounts, the registration of non -profit organizations, and modern trade mark laws. Very recent developments have also led to the political support for improved legislation in regard to deposit insurance, which is timely in the light of the National Risk Assessment being undertaken as a response to the global initiatives.
The initiatives, and BVI reaction to them, have also helped to solidify what had always been the contention of the BVI - that well regulated offshore financial centres can be legitimately and effectively used in financial planning and that the BVI will never encourage the use of the jurisdiction other than for such purposes. Rather ironically, isolated incidents of hacking into client lists maintained by BVI service providers served to underscore that service providers who man the gates actually complied fully with BVI AML/CFT requirement in terms of client acceptance procedures.
A further by-product of the various initiatives is that collectively over the past decade, they have helped form the bedrock of a new culture or discipline of international cooperation – one which creates new and alternative career options in financial services. The uptake of human resources needed to support the regulator, the Financial Investigations Agency, the Courts, the International Tax Authority and the National Risk Assessment, all in the name of the international initiatives cannot be overlooked.
Through implementation and compliance with various initiatives, the BVI has also been able to demonstrate its resolve to do what is reasonable and necessary to cooperate on the world's stage with regards to information sharing, regulatory cooperation, and compliance. For instance, the BVI, to date, has already entered into 26 Tax Information Exchange Agreements. The BVI has a long history of cooperation with international standards. The fact that the BVI has opted for a Model 1B FATCA model also meant that it had to invest heavily in establishing the necessary infrastructure and administration protocols in order to make FATCA work.
From the perspective of the BVI as a leading offshore jurisdiction, the current global push for tax transparency is a natural cycle of progression and a positive indication of development, challenging though it may to constantly strive to keep up. So, as the too well-known proverb says, when life gives you lemons....make lemonade!
 11 Cong. Rec. S1635-36 (daily ed. Mar 17, 2010, Vol. 156 No. 39)
 USA Today (September 27, 2012). "European banks shut Americans out over U.S. tax rules". Yan, Sophia (September 15, 2013); http://usatoday30.usatoday.com/money/business/story/2012/09/27/european-banks-oust-americans/57849014/1.
"Banks lock out Americans over new tax law". CNN; http://money.cnn.com/2013/09/15/news/banks-americans-lockout/index.html?hpt=hp_t3
The Wall Street Journal (September 11, 2014). "Expats Left Frustrated as Banks Cut Services Abroad"; http://online.wsj.com/articles/expats-left-frustrated-as-banks-cut-services-abroad-1410465182
Lisa Penn-Lettsome is an associate in the Finance & Corporate Group.
Marianne Rajic is a partner in Walkers' Global Finance and Corporate and Investment Funds Groups. Marianne joined Walkers' British Virgin Islands office in 2008 where she heads up the BVI funds practice. She focuses on investment funds and in particular structure and operation of hedge funds, real estate funds, private equity arrangements and other alternative investment products, including innovative hybrid and crossover funds, investing in a diverse range of assets.
Bermuda, British Virgin Islands, Cayman Islands, Dubai, Guernsey, Hong Kong, Ireland, Jersey, London and Singapore.