January 1, 2019, was truly a red letter day for businesses in Barbados, both local and international. On that day, in response to requirements of the Organisation of Economic Cooperation and Development (OECD), Barbados officially dismantled a decades old tax structure that had allowed international businesses to be taxed at far lower rates than local companies.
In effect, as well as abolishing a number of incentives to international businesses that the OECD considered to be harmful tax practices, Barbados took down the so- called ‘ring fence’ that had maintained two separate tax rates for local and international business companies.
As a result, a one-tiered tax rate system now rules them all. Furthermore, there is now no such thing as an International Business Company as we once knew it. For tax purposes, all companies are now Regular Barbados Companies, regardless of where their customers are and if they are foreign owned.
But there is a specific piece of legislation contained in the new tax regime that foreign investors wanting to establish businesses in Barbados need to be aware of, and that is the newly implemented rules that demand ‘economic substance’ from any entity wishing to do business here.
In simple terms, economic substance means that any company wanting to do business in Barbados or from Barbados has to demonstrate that it is genuinely conducting business. For example, it needs to employ people here, be managed from here and occupy physical premises in Barbados, among other things.
Put another way, companies can’t enjoy the benefits and incentives of doing business in a low-tax jurisdiction by operating behind a brass plate, at least not here.
To be precise, the new legislation is the Barbados Business Companies (Economic Substance) Act. The Act has introduced an economic substance test. It further stipulates that an ‘entity’ which is engaged in ‘relevant activities’ and is a tax resident of Barbados must satisfy the test in respect of each relevant activity.
An entity would be seen to meet the Economic Substance test where:
- It is directed, managed and controlled, or in other words tax resident, in Barbados in relation to a relevant activity
- It has an adequate level of employees who are physically present in Barbados, adequate expenditure and premises in relation to the relevant activity
- It conducts its core income-generating activities in Barbados
- When core income-generating activities are outsourced, it must monitor and control the carrying out of the activities in Barbados
Let’s deal with residency first. An entity is considered to be resident in Barbados when it is directed, managed and controlled in Barbados. In effect it must meet the following criteria:
- The Board of Directors meets in Barbados at an adequate frequency to satisfy the amount of decision-making called for at that level
- A quorum of directors must be physically present at the meetings
- The Directors have the necessary knowledge and expertise needed to discharge the duties of the Board
- Strategic decisions are made at the meetings and are reflected in the minutes of the meetings
- Those minutes, together with the records of the company, are kept in Barbados.
As for ‘relevant activities’, the list is as follows:
- Banking business
- Insurance business
- Fund management business
- Finance and leasing business
- Headquarters business
- Shipping business
- Holding company business
- Intellectual property business
- Distribution and service-centre business
As an example, a Barbados tax resident company whose core income generating activities arise from a finance and leasing business must ensure that the following activities are conducted in Barbados:
- Agreeing funding terms
- Identifying and acquiring assets to be leased
- Setting the terms and duration of any financing or leasing
- Monitoring and revising any agreements
- Managing any risks
Entities also have to show that they comply with the rules, which means they must make an annual declaration to the Barbados Director of International Business (the Director) confirming that they meet the economic substance test. The annual declaration should be backed up by documentary evidence to support the company’s claims. These documents must be kept by the company and provided to the Director for inspection when requested.
There are fines for non-compliance.
For example, companies that fail to meet the test in one year are liable to a penalty of up to US$150,000. Failure to meet the test the following year means another US$150,000 penalty will be added to the first. There is a penalty of US$75,000 for withholding information or providing inaccurate information.
Apart from these financial penalties, information on the income of the Barbados entity can be exchanged with the tax authorities of the country in which its parent company is tax resident.
It is expected that the Act will be revised to include the ability for the Registrar to strike off any non-compliant companies. Regulations and guidelines are also to be issued. Barbados is not the only jurisdiction in the Caribbean to implement economic substance legislation, but we were the first to address it. It can also be said that we have set the pace for others.
Both the current administration and members of the international business sector moved quickly to develop the Act in time to meet the deadline. It was a coordinated effort that will hopefully serve as a template for any future necessary refinements to the island’s tax legislation.