The United States Virgin Islands (‘USVI’) is an unincorporated territory of the United States acquired from Denmark in 1917. As an unincorporated territory, it has a special tax status that has permitted it to enact targeted tax incentives to attract businesses engaging in certain economic development activities in the territory and to serve as the headquarters for foreign-owned holding companies with international operations. The USVI is the home to exempt international insurance companies and more recently the University of the Virgin Islands Research and Technology Park created to foster the development of a technology sector in the USVI. Certain economic benefits can be taken by USVI residents who meet criteria enacted by the U.S. Congress in 2004 and further defined by the Internal Revenue Service (‘IRS’) in subsequently issued regulations and notices. The USVI also has legislation for trusts and for various entities including a flexible limited liability company statute. This article will discuss the unique aspects of doing business in the USVI, including tax incentives where available.
I. Income, Estate and Gift Tax Overview
The USVI has used the Internal Revenue Code of 1986, as amended (the ‘Code’), as its tax code since shortly after its acquisition, pursuant to the Naval Appropriations Act of 1922. References to the Code in this article are references to the Internal Revenue Code of 1986, as amended, as applicable in the United States. At times, this article may reference the Code as applicable in the USVI, in which case the words “the Virgin Islands” are substituted for “the United States” and vice versa under what has been called “the mirror” system of taxation. “Congress intended that each territory should apply within its geographical jurisdiction a separate income tax system having the same basic structure as the income tax system applied by the United States within its geographical jurisdiction.” This process has been referred to as ‘mirroring,’ hence various permutations such as ‘mirror codes.’ Income taxes imposed under this system are payable to the Virgin Islands Bureau of Internal Revenue (‘BIR’) rather than to the IRS. Under the mirror theory, “any changes to, interpretations of, regulations and revenue rulings on and court interpretations of the substantive tax provisions of the Internal Revenue Code are applicable to Virgin Islands tax cases as long as the particular provision at issue is not manifestly inapplicable or incompatible with a separate territorial income tax?.” Pursuant to the Code, the USVI asserts jurisdiction to tax nonresident alien individuals and foreign entities only if they are engaged in business in the USVI or receive income from sources within the USVI. Nonresident alien individuals and foreign entities that are engaged in a trade or business in the USVI are subject to net-basis income tax on any of their income that is “effectively connected” with that business. In addition, all corporations, including foreign corporations, are subject to a 10 percent corporate surcharge imposed by the USVI. Specifically, the USVI has enacted a 10 percent surcharge on “all corporations that have a liability to pay Virgin Islands income tax” equal to “each such corporation’s total income tax liability.” If a foreign corporation is engaged in a trade or business in the USVI but fails to file an income tax return, it is taxed on its gross income instead of on a net income basis. In addition, partnerships, and limited liability companies that are taxable as partnerships, formed in the USVI have a return filing obligation, generally Form 1065, U.S. Return of Partnership Income, with the BIR whether or not they have effectively connected income or USVI source income. However, because a partnership’s or limited liability company’s income is attributable to its partners or members, nonresident alien partners or members of such entities will not have an income tax filing obligation with the BIR so long as the partnership or limited liability company does not have USVI source income and the partner or member does not have any other income from USVI sources.
(A) USVI Residency
Every ‘bona fide resident’ of the USVI must file a tax return with and pay all taxes due thereon to the BIR. Those persons who are not bona fide residents of the USVI but who have USVI source income are required to file their Forms 1040 with the IRS and the BIR and allocate taxes between the USVI and the United States on IRS Form 8689. The test for determining bona fide residency in the USVI for income tax purposes requires a taxpayer to (i) be present in the USVI for at least 183 days (the ‘physical presence test’); (ii) not have a closer connection to the United States or a foreign country than to the USVI (the ‘closer connection test’); and (iii) not have a tax home outside of the USVI for the taxable year (the ‘tax home test’). An individual must meet all three tests in order to be a bona fide resident of the USVI for tax purposes.
(i) Physical Presence Test:
The physical presence test is satisfied if a taxpayer satisfies one of five alternative tests:
(a) 183-Day Test An individual can satisfy the physical presence test by meeting the strict 183-day rule codified in Code section 937, that is, spending at least 183 days a year in the USVI (including days of travel to and from the USVI as long as part of the day of travel is spent in the USVI).
(b) 183-Day Rolling Average Second, an individual can satisfy the physical presence test by being present in the USVI for at least 549 days during a three-year period consisting of the current taxable year and the two immediately preceding taxable years, provided that the individual is also present in the USVI for at least 60 days during each taxable year of the three-year period. In other words, this alternative to the physical presence test requires an individual to be present in the USVI for a simple nonweighted three-year average of 183 days per year so long as a minimum of 60 days of presence is met in each of those three years.
(c) No More Than 90-Day Test An individual can satisfy the physical presence test by spending no more than 90 days in the United States during a taxable year. This test may permit persons who spend significant time for business or pleasure in Europe, South America, or elsewhere in the Caribbean to meet the physical presence test for residency in the USVI.
(d) More Time in the USVI and Earned Income Not Exceeding $3,000 Test An individual can satisfy the physical presence test by spending more days in the USVI than in the United States and having earned income in the United States not exceeding $3,000. ‘Earned income’ is composed of wages, salaries, professional fees and other amounts received as compensation for personal services actually rendered, but does not include a distribution of earnings and profits by a corporation.
(e) No Significant Connection to the United States Test An individual can satisfy the physical presence test by having no significant connection to the United States. However, this exception may not encompass any individual who has full-time access to any residence in the United States even if the residence has never been the individual’s tax home, such as a vacation home. In addition, the individual’s spouse, and any dependents under the individual’s custody cannot live in the United States and the individual must not be registered to vote in the United States.
(ii) Closer Connection Test
The closer connection test requires that a taxpayer be able to demonstrate that he or she does not have a closer connection to the United States or a foreign country than to the USVI. The applicable regulations list ten factors that are considered in determining whether a closer connection exists. These factors include, but are not limited to, the: (i) location of the individual’s permanent home; (ii) location of the individual’s family; (iii) location of personal belongings, such as automobiles, furniture, clothing, and jewelry owned by the individual and family members; (iv) location of social, political, cultural or religious organizations in which the individual has a current relationship; (v) location of the individual’s personal bank accounts; (vi) location where the individual conducts business activities other than those that constitute the individual’s principal business; (vii) type of driver’s license held by the individual; (viii) country of residence designated by the individual on forms and documents; (ix) types of official forms and documents filed by the individual; and (x) where the individual votes. The preamble to the residency regulations provides that the very nature of this facts-and-circumstances test does not allow for weighting of factors because a factor with respect to one set of facts and circumstances may be less important than with respect to another set of facts and circumstances. Moreover, the preamble provides that the regulations do not designate specific factors as primary, adopt a weighting of factors, or adopt a rule that counts a majority of the factors to determine a closer connection. Furthermore, the preamble states that because the list of factors is not exclusive, other factors, including whether the individual was born or raised in the relevant possession, may be considered in the closer connection determination. The preamble also provides that although the location of an individual’s family is often a very important factor, it is one of many factors to be evaluated qualitatively under the facts-and-circumstances test, and in a particular case it may not be an important or overriding factor. Finally, the preamble concludes that unlike the no significant connection alternative to the physical presence test, the closer connection test can be satisfied, depending on an individual’s particular facts and circumstances, even if the individual’s spouse resides in the United States. A person who meets the ‘no significant connection’ test set forth in section I(A)(i)(e) above with regard to the United States would usually meet the closer connection test for the USVI unless the person has a closer connection to one or more foreign countries than to the USVI.