As there was almost no tax levied on the companies in the United Arab Emirates, some of the companies abroad started taking undue advantage of this fact. They may have production of goods in some other country, but to save money, they will reroute the entire shipment through the United Arab Emirates by setting up a company and park the profit in UAE and will pay no corporate tax in the country of production. This was a very easy way for the companies to transfer profit to a country where tax is nil or less but had a huge monetary impact on the economy of the home country.
The UAE introduced Economic Substance Regulations to honor the UAE’s commitment as a member of the OECD (Organization for Economic Co-operation and Development) Inclusive Framework on BEPS (Base Erosion and Profit Shifting) and in response to a review of the UAE tax framework by the EU which resulted in the UAE being included on the EU list of non-cooperative jurisdictions for tax purposes (EU Blacklist). The issuance of the Economic Substance Regulations on April 30, 2019, and the subsequent release of the Guidance on the application of the Regulations on September 11, 2019, was a requirement for the removal of the UAE from the EU Blacklist on October 10, 2019.
Twelve jurisdictions (including the UAE) were required to introduce economic substance requirements in their domestic legislation. Jurisdictions that fail to apply substantial activities requirements will be categorized as ‘harmful’ tax jurisdictions.
The purpose of the Regulations is to ensure that UAE entities (both onshore and free zone companies) that undertake relevant activities are not used to artificially attract profits that are not commensurate with the economic activity undertaken in the UAE.
The UAE has passed the following Federal Legislation which applies across the UAE in every jurisdiction, including all Free Zones and Financial Free Zones (such as the DIFC and ADGM):
- UAE Cabinet of Ministers Resolution No. 31 of 2019 concerning Economic Substance
Regulations, issued on April 30, 2019;
- UAE Cabinet Resolution No. 58 of 2019 determining the Regulatory Authorities concerned with the Business mentioned in Cabinet Decision No. 31 of 2019 concerning Economic Substance Regulations issued on September 04, 2019; and
- The Ministerial Decision No. 215 for the year 2019 on the Issuance of Directives dealing with the Implementation of the Provisions of the Cabinet Decision No. 31 of 2019 concerning Economic Substance Regulations issued on September 11, 2019.
Let us understand more about Relevant Activities mentioned in the ESR.
What are the ‘Relevant Activities’?
There are certain business activities that have been regarded as ‘Relevant Activities,’ and the companies in the United Arab Emirates need to disclose if they are conducting these business activities on the premises. The list of the relevant activities is provided below:
- Banking Business as licensed in the State, including Banking Business licensed in a Free Zone or any Financial Free Zone in the country.
- Insurance Businesses that have been licensed in the State, including Insurance Businesses licensed in Free Zone or a Financial Free Zone.
- Investment Fund Management Business which are licensed in the State and includes Investment Fund Management Businesses licensed in a Free Zone or any Financial Free Zone in the country .
- Lease Finance Businesses that are licensed in the State and includes Lease-Finance Businesses licensed in a Free Zone or any Financial Free Zone in the country.
- Headquarters Businesses that are licensed in the State, including Headquarters Businesses licensed in a Free Zone or any Financial Free Zone in the country .
- Shipping Businesses that are licensed in the State, including Shipping Businesses licensed in a Free zone or any Financial Free Zone in the country .
- Holding Company Businesses that are licensed in the State, including Holding Businesses licensed in a Free Zone or any Financial Free Zone in the country .
- Intellectual Property Businesses that are licensed in the State, including Intellectual Property Businesses licensed in a Free Zone or any Financial Free Zone in the country .
- Distribution and Service Centers Businesses that are licensed in the State, including Distribution and Service Centers Businesses licensed in a Free Zone or any Financial Free Zone in the country .
The Economic Substance Regulation (ESR) is applicable to all the legal entities which carry out and any one or more of the above mentioned relevant activities and also mention this to the concerned authorities.
Once it is established that the business carries out one or more of the relevant activities, the company must conduct an ESR test and submit the report to the concerned authority within the time specified. In this case, the last date of submission of the report is before 31 December 2020.
If a company does not comply with the rules and regulations of the Economic Substance Regulation (ESR), the company will have to face penalties. To know more about the various penalties which will be faced by a company in case of non-compliance, read our blog ‘ESR Reporting for DMCC – Consequences of Non – Compliance’.
Purpose of the Implementation of ESR
The main aim of implementing ESR in the United Arab Emirates was to bring in a modicum of transparency for the various companies as well as the government of the country. These regulations will help ensure that a healthy tax regime is being followed by all the businesses and these companies report the correct amount of profits so that they pay up the right amount of taxes to the country.
This would be very beneficial for the country as well as the companies as the economy of the country would flourish and there will be no cheating among the various businesses which will, in turn, promote healthy competition among the companies
