Amid further pressure from the European Union to demonstrate that companies registered here have “economic substance,” the Virgin Islands is introducing a new regulatory regime for private equity and other closed-ended funds, which will be required to file for “recognition” from the Financial Services Commission and meet certain criteria in order to operate.
“These types of funds have been unaffected by the Economic Substance Act, which came into effect Jan. 1, 2019,” since being a fund is not considered a “relevant activity” under that act, according to Robert Varley, a partner at Appleby.
However, the EU has now demanded that they be regulated to help make sure they are not used for profit shifting, a practice where multinational corporations use companies in low- or no-tax jurisdictions to issue invoices for work done in high-tax countries.
“It’s ironic that the most notorious examples of profit shifting have all actually taken place in European countries and not the Caribbean,” said Mr. Varley, adding that it is “becoming clear that the vast majority of BVI companies are engaged in business activities which do not involve profit shifting at all.”
Mutual funds — the only funds thus far regulated by the FSC — allow their investors to cash out (“redeem”) their investments at any time. Private investment funds, the class regulated under the new Securities and Investment Business (Amendment) Act 2019, typically do not allow investors to come and go in the same manner: Instead, they are to some extent “locked in” until the fund is able to sell its investments.
“Many [international financial centres] regulate both open and closed-ended funds, so they are in a better position to require their funds to provide information,” Mr. Varley explained. “But the BVI, like other Caribbean IFCs, has only regulated open-ended funds until now.”
Supplementary regulations were Gazetted last month along with the legislation. According to the act, the FSC will recognise a private investment fund if it is satisfied of at least five conditions.
These include being lawful within the VI; abiding by certain provisions within their constitutional documents, such as having a certain number of investors; meeting criteria within the regulations; and not being against the public interest. Mr. Varley noted that any information collected will go to the FSC, not the International Tax Authority or the EU.
“This is about making sure that our own regulator has oversight, but it will not lead to the EU receiving information about, or interfering with, BVI funds,” he explained.
There will be a transitional period, running until July 1, for existing closed- ended funds to make themselves compliant. New funds will get a 21-day grace period to apply for recognition or face certain penalties.
Mr. Varley said he did not expect the legislation to lead to major changes in the VI’s appeal to clients.
“BVI closed-ended funds have historically been offered and operated subject to limits at least as restrictive as those now set out in the law, so it is unlikely that many funds will have to change what they are doing,” he said. “The filing requirement is broadly the same as the one already applying to many open-ended funds in the BVI and other IFCs such as the Cayman Islands, so it’s unlikely to prove too difficult or expensive for funds to comply with in future.”