Economic Substance and the 1% Tax rate
Based on the information provided in the relevant legislation, if a Business Company or BC (previously known as IBC) makes the 1% tax election under Section 180(2) of the BCA, it would be subject to tax in SVG at a rate of 1% on its profits and gains. The BC would not be subject to any other direct taxes in SVG by virtue of this election.
However, the 1% election only addresses the BC’s tax liability in SVG. It does not necessarily exempt the BC from taxes that may be imposed in other jurisdictions outside of SVG.
The tax treatment of the BC’s income in other countries would depend on several factors, including:
- The nature and source of the income
- The domestic tax laws of the foreign country
- Any applicable tax treaties between SVG and the foreign country
- The extent to which the income may be attributable to a permanent establishment or taxable presence of the BC in the foreign country
For instance, if the BC has an office, employees, or is otherwise conducting business in another jurisdiction, it may be considered to have a taxable presence there under that jurisdiction’s domestic laws and tax treaties. In that case, the foreign jurisdiction may assert the right to impose tax on the BC’s income attributable to that taxable presence, notwithstanding the BC’s 1% election in SVG.
Similarly, if the BC earns certain types of income that are sourced from another jurisdiction (e.g., rental income from real property, royalties, interest, or dividends), that income may be subject to withholding taxes or other taxes in the source country, regardless of the BC’s tax status in SVG.
Therefore, while the 1% election provides certainty regarding the BC’s SVG tax liability, it does not necessarily insulate the BC from taxes that may be imposed in other countries.
I. Introduction
This memorandum analyzes the tax and economic substance implications for a business company (“BC”) incorporated under the laws of Saint Vincent and the Grenadines (“SVG”) that makes an irrevocable election to pay taxes at a rate of 1% on its profits and gains pursuant to Section 180(2) of the Business Companies (Amendment and Consolidation) Act, Cap. 149 (“BCA”).
II. Tax Implications
A. Default Tax Exemption for BCs
By default, a BC is exempt from direct taxes in SVG under Part XII of the BCA. Specifically, Section 180(1) exempts BCs from estate, inheritance, succession, or gift tax payable by non-residents with respect to the BC’s shares, debt obligations, or securities.
Additionally, Section 180(2) exempts BCs from stamp duty on instruments relating to transfer of property to/by the BC, transactions in the BC’s shares/securities, the BC’s assets/activities, and legalization of BC documents. BCs are also exempt from import duties on office furniture/equipment necessary for conducting business under Section 180(3).
Upon incorporation or continuation, the Registrar provides the BC with a Certificate of Exemption from Import Duties (Form 25) and, absent a 1% tax election, a Certificate of Exemption from Direct Taxes (Form 26).
B. 1% Tax Election
Notwithstanding the default tax exemptions, a BC may make an irrevocable election under Section 180(2) to pay taxes at a rate of 1% on its profits and gains. This election is made in the BC’s Articles of Incorporation (Form 3).
If a BC makes this 1% election, it forgoes the Certificate of Exemption from Direct Taxes. The BC will be subject to tax in SVG, albeit at a very low 1% rate on its profits and gains. The term “profits and gains” is not explicitly defined in the BCA, but presumably refers to the BC’s net income or profit.
The 1% tax, once elected, is irrevocable. The BC cannot later opt out and revert to tax-exempt status.
III. Economic Substance Implications
A. Economic Substance Requirements for BCs
The International Tax Cooperation (Economic Substance) Act, 2020 (“ESA”), which took effect on January 1, 2021, imposes economic substance requirements on certain BCs that carry on “relevant activities” as defined in the ESA.
A BC that undertakes relevant activities must have adequate substance in SVG related to that activity, including: (a) being directed and managed in SVG, (b) having adequate employees, expenditure, and physical assets in SVG, and (c) conducting core income-generating activity in SVG. Relevant activities include banking, insurance, fund management, financing and leasing, shipping, holding company activities, intellectual property activities, and more.
Failure to comply with applicable substance requirements can result in significant financial penalties, spontaneous disclosure of information to overseas authorities, and potentially strike-off or liquidation of the BC.
B. Interaction with 1% Election
Making a 1% tax election does not, in and of itself, exempt a BC from the economic substance requirements if it carries on a relevant activity. The substance requirements apply regardless of whether the BC is tax-exempt or pays the 1% tax.
However, the 1% election may impact the analysis of whether a BC’s income is “accrued directly or indirectly from sources in Saint Vincent and the Grenadines”, which in turn affects whether the BC is carrying on relevant activities subject to the substance requirements.
Section 10 of the Income Tax Act defines income deemed to accrue from sources in SVG. For instance, this includes income from employment exercised in SVG (regardless of where payment is made), business profits attributable to a Permanent Establishment, office or branch located in SVG, rental income from property in SVG, and royalties or premiums paid by a person resident in SVG.
Making a 1% election could impact the size of the BC’s tax footprint in SVG and the extent to which its income and activities may be deemed to accrue from sources within SVG for these purposes. While the analysis will depend on the BC’s specific facts and circumstances, a 1% election would bolster the nexus between the BC and SVG in a tax context and likely increase the chance of the BC being found to have income accruing from SVG sources. This in turn could subject the BC to economic substance requirements on a larger portion of its activities.
In light of this, a BC that is conducting “relevant activities” should carefully evaluate the implications of making a 1% election on its economic substance profile and compliance obligations. While a 1% tax rate may appear attractive, the election could also have the effect of broadening the scope of the BC’s income that is deemed to accrue from SVG sources and thus subject to substance requirements.
IV. Conclusion
While the BCA provides a default tax exemption for BCs, a BC may make an irrevocable election to instead pay tax at a 1% rate on its profits and gains. This 1% election does not supersede the ESA’s economic substance requirements that apply to BCs carrying on certain activities. In fact, the 1% election could have the effect of strengthening the nexus between the BC and SVG from a tax perspective, thus potentially subjecting a larger portion of the BC’s income and activities to economic substance requirements.
Therefore, prior to making a 1% tax election, a BC should carefully analyze the potential implications not just from a tax liability perspective, but also in terms of economic substance compliance obligations. The specific impact will depend on the nature and scope of the BC’s activities.
V. Specific Economic Substance Requirements
Under the ESA, a BC that is a “relevant entity” carrying on a “relevant activity” must meet economic substance requirements in relation to that activity. The specific substance requirements vary depending on the type of relevant activity undertaken.
A. Relevant Entities and Activities
A “relevant entity” under the ESA includes BCs incorporated or registered under the BCA, unless the BC is tax resident outside of SVG. The relevant activities subject to substance requirements are:
- Banking business
- Insurance business
- Fund management business
- Finance and leasing business
- Headquarters business
- Shipping business
- Holding company business
- Intellectual property business
- Distribution and service center business
B. Core Income-Generating Activities
For each type of relevant activity, the ESA defines the “core income-generating activities” (CIGA) that the BC must conduct in SVG. For example:
- For banking business, CIGA includes raising funds, managing risk, taking hedging positions, providing loans or other financial services to customers, etc.
- For insurance business, CIGA includes predicting and calculating risk, insuring or re-insuring against risk, providing insurance business services to clients, etc.
- For holding company business, CIGA includes all activities related to that business.
A BC must conduct the CIGA in SVG to the extent that the relevant activity is carried on in SVG. CIGA may be outsourced to another SVG service provider if the BC is able to demonstrate adequate supervision of the outsourced activities.
C. Directed and Managed in SVG
A BC carrying on relevant activities must be directed and managed in SVG. This requires:
- The BC’s board of directors must meet in SVG at adequate frequencies given the level of decision making required.
- During each board meeting in SVG, there must be a quorum of directors physically present in SVG.
- Strategic decisions of the BC must be made at the board meetings held in SVG and the meeting minutes must reflect those decisions.
- The directors must have the necessary knowledge and expertise to discharge their duties.
- All meeting minutes and records that the BC is required to maintain under the BCA must be kept in SVG.
D. Adequate Employees, Expenditure, and Premises
Having regard to the nature and scale of the BC’s relevant activity, the BC must have:
- An adequate number of suitably qualified employees physically present in SVG (whether or not employed by the BC itself or by another entity and whether on temporary or long-term contracts)
- Adequate expenditure incurred in SVG
- Adequate physical offices or premises in SVG
What is “adequate” for these purposes will depend on the particular facts and circumstances of the BC’s business. The BC should maintain sufficient records to demonstrate the adequacy of its employees, expenditure, and premises in SVG.
E. Reduced Substance Requirements for Pure Holding Companies
The ESA provides for reduced substance requirements for a BC that is a “pure equity holding entity”, meaning an entity that only holds equity participations in other entities and earns only dividends and capital gains.
A pure equity holding entity is subject to a reduced test whereby it meets the substance requirements if it: (a) complies with its statutory obligations under the BCA, and (b) has adequate human resources and premises in SVG for holding and managing its equity participations.
F. Enhanced Substance Requirements for IP Companies
If the BC carries on a relevant “intellectual property business” and is deemed a “high-risk IP legal entity”, it is subject to enhanced substance requirements under the ESA.
The ESA defines an intellectual property business as the business of holding, exploiting, or receiving income from intellectual property assets.
A high-risk IP legal entity is presumed not to carry out CIGA in SVG, even if it meets all other substance requirements. This presumption can only be rebutted by showing that there is and historically has been a high degree of control over the development, exploitation, maintenance, enhancement, and protection of the IP asset, exercised by an adequate number of full-time employees with the necessary qualifications that permanently reside and perform their activities in SVG.
G. Outsourcing
The ESA allows a BC to outsource some or all of its CIGA to third party service providers in SVG, provided the BC is able to demonstrate adequate supervision of the outsourced activities.
However, the ESA makes clear that outsourcing does not circumvent the need for the BC itself to meet the substance requirements. The BC must still be directed and managed in SVG, have adequate employees, expenditure and premises in SVG, and conduct CIGA in SVG to the extent it carries on relevant activities there.
H. Reporting Obligations
A BC that carries on a relevant activity during a financial period must prepare and submit to the SVG authorities a report for the purpose of the ESA. The report must be in the approved form and must include information such as:
- Whether the BC is carrying on relevant activities and if so, the type of relevant activities
- The amount and type of income from the relevant activity
- The amount and type of expenses and assets relating to the relevant activity
- The location of the place of business and plant, property, or equipment used for the relevant activity
- The number of full-time employees with qualifications and the number of employees who are SVG residents
- Information showing the BC’s CIGA in SVG
- A declaration as to whether the BC satisfies the economic substance requirements.
The filing deadlines and precise information required in the economic substance report is set out in regulations issued pursuant to the ESA.
I. Conclusion
A BC that is a relevant entity carrying on relevant activities must carefully analyze and document how it meets the applicable economic substance requirements in SVG. The requirements are detailed and specific, varying based on the type of activity carried on.
The BC should have robust processes and procedures in place to ensure it maintains adequate substance in SVG on an ongoing basis. It should also maintain detailed records to support its position in the event of any audit or enforcement action by the SVG authorities.
Among the up and coming offshore jurisdictions is St. Vincent and the Grenadines (SVG). At this point in time, the SVG IBC is not required to make public filings or disclosures of its directors, shareholders/members or beneficial owners. The SVG IBC is useful for asset protection, tax planning, or succession planning. SVG also offers international trusts, hybrid companies (limited by guarantee but also having a share capital), and mutual companies (limited solely by guarantee without a share capital).
In the international tax space, it is not unusual to hear buzzwords such as transparency and information exchange. Buzz words aside, the days of “hidden” or “secret” accounts are now over. Having said that, tax planning is still, and always will be, a useful exercise.
Below is an extract from SVG legislation –
EXEMPTIONS FROM TAXES AND DUTIES – International Business Companies Act 2007
Section 180.
(1) Notwithstanding any provisions of the Income Tax Act an international business company which complies with the provisions of section 7(1) shall not be subject to any corporate tax, income tax, withholding tax, capital gains tax or other like taxes based upon or measured by assets or income originating outside the State or in connection with matters of company administration which may occur in the State.
(2) Notwithstanding subsection (1) an international business company which complies with the provisions of section 7(1) may irrevocably elect in its articles filed with the Registrar upon its incorporation or continuation, to be liable to income tax at a rate of 1% on its annual gains and profits.
(3) An international business company which exercises the election under subsection (2) shall also be subject to sections 149 and 154 of the Companies Act and to the Income Tax Act.
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For those considering structures involving other Caribbean jurisdictions, it is noteworthy that there are DTAs in place –
AGREEMENT AMONG THE GOVERNMENTS OF THE MEMBER STATES OF THE CARIBBEAN COMMUNITY FOR THE AVOIDANCE OF DOUBLE TAXATION AND THE PREVENTION OF FISCAL EVASION WITH RESPECT TO TAXES ON INCOME, PROFITS OR GAINS AND CAPITAL GAINS AND FOR THE ENCOURAGEMENT OF REGIONAL TRADE AND INVESTMENT (1994)
The Governments of the Member States of the Caribbean Community desiring to conclude an Agreement for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income, profits or gains and capital gains and for the encouragement of Regional Trade and Investment:
The intra-regional Double Taxation Agreement protects self-employed CARICOM Nationals from paying taxes twice on the same earnings. This Agreement is currently enacted in Antigua and Barbuda, Barbados, Belize, Dominica, Guyana, Jamaica, Saint Lucia, St. Vincent and the Grenadines and Trinidad and Tobago.
