The British Virgin Islands (“BVI”) has long been regarded as a tax haven for intellectual property (“IP”) businesses. In particular, Hong Kong entities have commonly registered ownership of their IP businesses with a BVI entity, so that any royalty income generated from the IP would be classified as tax-free in BVI.
However, several tax reforms have recently been implemented in both Hong Kong and BVI. Under these tax reforms, does BVI remain a tax haven for IP businesses?
Before a conclusion can be made, we first need to look at the following tax reforms:
- The BVI Economic Substance Law
- Section 15F of Hong Kong’s Inland Revenue Ordinance (“IRO”)
- Disclosure requirements for the Hong Kong Profits Tax Return
The BVI Economic Substance Law
The BVI Economic Substance (Companies and Limited Partnerships) Act, 2018 (the “Act”) became effective on 1 January 2019. The Act was implemented in response to global efforts at enhancing tax transparency initiated by the European Union and the Organisation for Economic Co-operation and Development.
BVI entities that carry out IP businesses (including entities incorporated in BVI and foreign entities registered in BVI) have to fulfil one of the following requirements in order to comply with the Act:
1. Prove that the IP was physically created and developed in the BVI; or
2. Demonstrate that they are tax resident in the tax jurisdiction (e.g. Hong Kong) in which the IP was created and developed.
Companies incorporated in BVI on or after 1 January 2019 have to comply with the Act immediately. For companies incorporated before 1 January 2019, the first reporting period runs from 30 June 2019 to 29 June 2020. BVI companies could encounter the following penalties for non-compliance with the Act:
1. A fine of up to US$400,000 for a high-risk IP legal entity;
2. The possibility of the entity being struck off the register by the BVI International Tax Authority;
3. Disclosure of information about a BVI company in breach of the economic substance requirements to the relevant overseas tax authorities (e.g. Hong Kong’s Inland Revenue Department (“IRD”)); and
4. Potential imprisonment of up to five years if fraudulent or misleading
information is reported.
In view of the above, and to avoid all potential penalties, it is advised that BVI entities plan and take appropriate action with all speed to comply with the Economic Substance Law.
Section 15F of the IRO
For the year of assessment beginning on or after 1 April 2019, to align value creation with taxation of IP rights, recently introduced Section 15F of the IRO deems income from an IP that accrues to an associated non-resident IP owner, but which is attributable to functions performed and assets deployed in Hong Kong, to be taxable receipts of the Hong Kong enterprise.
It is important to note that the implications of Section 15F are very wide. Any contribution in relation to development, enhancement, maintenance, protection or exploitation (“DEMPE”) in Hong Kong potentially falls within the charging scope of this Section.
As a consequence, even though ownership of an IP rests with a BVI entity, the IRD still has the right to impose tax in cases where a Hong Kong entity has performed DEMPE functions for the IP in Hong Kong.
Disclosure requirements for the Hong Kong Profits Tax Return
With effect from 1 April 2019, Hong Kong entities must disclosure the following in relation to an IP:
1. Supplementary Form S2 of the Profits Tax Return
Supplementary Form S2 must be completed and submitted together with the Hong Kong Profits Tax Return if a Hong Kong entity has entered into transactions with non-resident associated persons.
In this regard, Hong Kong entities that receive royalty income from their BVI associated entities are required to submit Supplementary Form S2 and disclose to the IRD any related party transactions relevant to the royalty fee received from the BVI associated entities.
2. Box 8.1.3 of the Profits Tax Return
If a Hong Kong entity has performed DEMPE functions in Hong Kong for an IP of a non-resident associated person, the Hong Kong entity must declare such arrangement in Box 8.1.3 of the 2019/20 Hong Kong Profits Tax Return.
Remedial actions for IP businesses
Under the new tax reforms, it is clear that the traditional approach of arranging for an IP to be held by a BVI company will no longer alleviate the tax burden on that business. Instead, such an arrangement will significantly increase the compliance costs for the BVI company.
Based on our experience, it is difficult in practice to prove that the IP was created and developed in the BVI. We therefore recommend that ownership of the IP is transferred from the BVI entity to a Hong Kong entity, in cases where the Hong Kong entity has performed DEMPE functions for the IP in Hong Kong. Alternatively, the IP enterprise could register the IP in Hong Kong and report all IP related income (i.e., royalty income, etc.) to the IRD.
There are numerous advantages to becoming a Hong Kong tax resident and to reporting tax in Hong Kong, in comparison with other tax jurisdictions. The key benefits are as follows:
- Hong Kong is a jurisdiction with one of the lowest tax rates in the world. The profits tax rate is 8.25% to 16.5%, as compared with a tax rate of 25% in the People’s Republic of China (“PRC”).
- Hong Kong tax residents can enjoy lower withholding tax rates on royalty income under applicable double taxation agreements (from 10% to 7%, in the case of the PRC).
- Certain income is not subject to tax in Hong Kong (e.g. offshore royalty income, dividend income and capital gains on subsequent disposal of an IP).