It is crucial for companies operating in the UAE to know new Economic substance regulations which may impact the business. Let us know more about the impact of the Economic substance regulations.
Economic Substance Regulations (ESR)
The UAE Government has brought the Economic Substance Regulations (Cabinet of Ministers Resolution No. 31 of the year 2019) on 30th April 2019 and released Guidance.
(cabinet Ministerial Decision 215 of the year 2019) on the application of the Regulations on 11th September 2019. The Regulations and Guidance apply to all UAE jurisdictions, including all economic free zones such as the Dubai International Financial Centre (DIFC). The ESR also appoints the Federal Tax Authority as the official National Assessing Authority to examine if an entity meets the Economic Substance Test and issues penalties for any possible infringements of the regulations.
The government has recently made amendments to the ESR Regulations by Cabinet of Ministers Resolution No. (57) of 2020 on 10th August 2020, and an updated new Guidance issued on 19th August 2020 (Cabinet Ministerial Decision No. (100) of 2020). These regulations require all the UAE onshore and free zone companies and other business forms that conduct any of the defined “Relevant Activities” listed by the ESR to maintain and prove an adequate “economic presence” in the UAE relative to the activities undertaken the entities.
As per Cabinet Resolution No. 31 of 2019 regarding the ESR, the companies operating in the specified sectors must have adequate economic substance within the country to access the country’s tax regime. The changes made under pressure and directive from the European Union (EU) on several countries. The recommendations of the EU Code of Conduct Group could apply for financial years starting from 1st January 2019 or after. The principal activities under the ESR that are identified by the Code of Conduct Group of EU include:
- Banking
- Collective investment vehicles
- Insurance
- Intellectual property
- Fund management
- Financing and leasing
- Shipping
- Any Holding companies generating the income from any of the above-mentioned financial activities
In the United Arab Emirates, the Ministry of Finance has issued Cabinet Resolution No. (57) of the year 2020 regarding the ESR after detailed consultation with the Organisation for Economic Cooperation and Development (OECD) and the European Union Group. The ESR was passed to engage companies in more relevant activities under the radar of the rules and regulations to prevent any money laundering. Also, as per the amended economic substance regulations (ESR), it will no longer be applicable for firms registered as sole proprietorships, natural persons or any other business forms which are not judicial entities.
The UAE branch of any foreign company that conducts a relevant activity is mandated to comply with the ESR like the branch office was a separate legal person unless the relevant income of the foreign company branch is in the scope of tax laws falling under the jurisdiction of the foreign parent company or head office. The tax has adhered where the income of the foreign company’s UAE branch is taken into consideration while calculating the taxable income of the parent company/ head office or any other relevant group company reporting the relevant income of the UAE branch office for corporate income tax purposes, irrespective of whether the taxable income of the UAE branch can benefit from an exemption or other form of corporate tax relief in the foreign jurisdiction of the company under domestic tax law or any relevant double tax agreement.
Adherence to ESR Requirements
In the UAE, the economic substance requirements test needs the relevant Licensee company to demonstrate the following things:
- Licensee and the related Activity as mentioned under the Economic Substance Regulation (ESR) are being directed and managed in the UAE territory.
- All the required Core Income Generating Activities (“CIGAs”) covered under ESR are conducted exclusively in the UAE
- The Licensee company has an adequate number of employees and relevant physical assets and expenditures in the country.
Also, it makes sense to note that companies carrying out a holding company business or any high-risk Intellectual Property businesses are subject to different economic substance test requirements. Also, CIGAs vary for each relevant Activity, and a non-exhaustive list is included in Cabinet Resolution No. 31/2019.
The UAE Federal Government issued the ESR to ensure that the annual reports submitted by the companies engaging in specific fields are fair and accurate. It helps the government be confident of its economic conditions and tax transparency in its jurisdiction and have fair & robust tax compensation throughout the country. Companies failing to comply with the ESR will end up incurring penalties, spontaneous exchange of required details with the Foreign Competent Authority, as well as other administrative sanctions such as the suspension or non-renewal of the company’s trade license or permit.
In the UAE, any company failing to provide notifications or necessary documentation or any relevant information will be charged around AED 20,000 as a penalty. Companies that provide inaccurate information will also be fined AED 50,000, and the failure to submit the Economic Substance report in time can result in a fine of AED 50,000 in the first year. The fine will be increased to AED 400,000 in the second consecutive year.
