Economic Substance Regulation in UAE – Amendments to be Noted for Entrepreneurs

The UAE has implemented the Economic Substance Regulation (ESR), which is now compulsory for all companies operating in the region, provided they meet certain criteria. This regulation introduces an additional compliance requirement for specific business activities in the UAE, ultimately bolstering international investors’ confidence in the country as a thriving business hub.

The implementation of the Economic Substance Regulation has resulted in the removal of the UAE from the European Union (EU)’s blacklist. On 10th October 2019, the Code of Conduct Group on Business Taxation officially delisted the UAE. This development signifies a significant milestone in the UAE’s compliance efforts and enhances its reputation on the global stage.

The Ministry of Finance in the UAE is responsible for the oversight of the Economic Substance Regulation (ESR) filing and reporting for companies. With the goal of establishing itself as a global trade hub, the UAE adheres to the international taxation standards set by the OECD and the European Union.

Likewise, offshore jurisdictions like the Cayman Islands, British Virgin Islands, and Bahrain adhere to ESR legislations, ensuring compliance with regulatory requirements.

Regulations and Guidance on Economic Substance (ES)

The Economic Substance Regulation in the UAE encompasses the comprehensive documentation of all economic activities undertaken by companies. This includes branch companies and representative offices, including those situated in any of the UAE’s Free Zones. The regulation extends its purview to ensure compliance and transparency across the board.

The scope of ESR Regulatory requirements encompasses various business activities. Companies engaged in these activities must regularly file the ESR report with the authorities.

• Banking
• Insurance
• Fund Administration
• Finance and Leasing
• Headquarters
• Shipping
• Holding Company Business
• Intellectual property business
• Distribution centers

Furthermore, companies engaging in activities beyond those listed above fall outside the purview of ESR regulations. Nevertheless, all companies in the UAE, regardless of their involvement in relevant activities, must furnish regulatory authorities with company information upon request.

ESR Timelines

• ESR Notification – maximum of 6 months after fiscal year
• ESR Reporting – maximum of 12 months after fiscal year

Economic Substance Regulation in UAE: Enhancing Distribution and Service Center Businesses

All companies engaged in the specified business activities are required to submit their Economic Substance reports to the authorities in the UAE, in accordance with the provided guidelines. These business activities fall into two main categories: Distribution and Service Center businesses for ESR.

• Purchasing goods from a Foreign Connected Person and importing, and storing them in UAE.
• The purchase can take various forms, including components, finished goods, and goods ready for sale, with the option to resell the parts or goods outside of the UAE.
• Providing Services to Foreign Connected Persons in connection with a business outside of UAE.

Detailed Activities that fall under the Distribution and Service Center Business

The following activities fall under the category of Distribution and Service Center business, in accordance with the guidelines set forth by the Economic Substance Regulation:

• Import Export from Foreign Connected Person to UAE – Transporting and storing parts, materials, and goods ready for sale
• Managing inventories in a UAE warehouse – Checking stock levels, managing the frequency of stock replenishment, etc.
• Taking orders – Order processing, fulfillment of products, and distribution of goods in UAE
• Providing consulting or other administrative services to entities in UAE and Outside

Who falls under the ambit of the Economic Substance Regulations?

Business entities in the UAE must adhere to the Economic Substance Regulations and meet specific criteria. The regulatory authority for ES requires companies to submit their ESR documentation in various scenarios, including:

• Whether they conduct any of the relevant activities in the UAE?
• Whether part of their income is taxable outside UAE?
• Is the core business income generation taking place in the UAE?

Organizations falling under the aforementioned categories are required to submit the ESR Report to the regulatory authority. Moreover, the report must encompass all the necessary information in accordance with the compliance standards set forth by the Economic Substance Regulations.

Criteria for the Economic Substance Test

To comply with the Economic Substance Test, companies are required to provide all necessary information and complete the questionnaire accurately.

Entities engaging in activities within the UAE are required to meet the following criteria:

• Does the company conduct core income-generating activities within the UAE?
• Is the business having directors and management in the UAE?
• Does the company have an adequate number of qualified staff to perform activities physically present in the UAE?
• Is the company incurring an adequate level of operating expense in the UAE
• Does the company have an adequate physical asset in the UAE?

The Influence on Corporate Entities in the UAE

Companies that have a well-established operational structure, staff, and office space in the UAE will experience minimal impact from ESR. It will serve as additional documentation for the accounts or finance team, ensuring smooth compliance.

International companies with minimal staff, operating in compliance with ESR regulations, need to thoroughly evaluate their governance structures. It is imperative for business entities to ensure that financial management is carried out in strict accordance with ES requirements.

Corporations engaged in relevant business activities must also ensure proper accounting standards. Failure to comply with reporting standards and meet physical and economic presence requirements may result in penalties imposed by authorities. It is crucial for such companies to be proactive and prepared.

What advantages will the UAE gain from the implementation of the Economic Substance Regulations?

The UAE is striving to establish itself as a fully compliant global financial hub, equipped with impeccable taxation mechanisms. The newly introduced ESR regulations are in alignment with the inclusive framework of the OECD BEPS (Base Erosion & Profit Shifting), ensuring a robust financial environment.

Base erosion and profit shifting (BEPS) is a tax planning strategy employed by multinational corporations to minimize their tax liabilities. However, this practice leads to substantial revenue losses for many countries.

Consequently, the OECD framework has been established as a collaborative effort among more than 130 countries to address tax avoidance. This initiative aims to enhance international tax regulations and foster a transparent tax landscape.

The UAE offers numerous advantages for entrepreneurs looking to start and expand their businesses. With state-of-the-art technology, widespread internet access, a skilled workforce, a thriving business ecosystem, and other beneficial factors, it provides a conducive environment for trade and growth.

The latest advancements will not only attract greater foreign investment but also bolster the UAE’s reputation as a prominent business hub in the Middle East. These developments signify a significant step towards enhancing the country’s image on a global scale.

Key Amendments to Note for Entrepreneurs: Understanding the Economic Substance Regulation in UAE

The UAE Cabinet of Ministers amended the Economic Substance Regulation in August 2020. These Amendments have brought about certain relaxations in the regulations governing the Economic Substance filing for Companies operating in the UAE, particularly those falling under specific categories (known as Relevant Activities as per ESR Compliance). These changes primarily pertain to the requirements related to physical presence and operations in the UAE.

Definition of a Licensee

The revised ES Regulations solely pertain to Licensee – legal entities and unincorporated partnerships engaged in relevant activities within the UAE.

Changes to the Economic Substance Regulation in UAE

• Natural persons, sole proprietors, trusts and foundations are no longer considered as ‘Licensees’ under the scope of ES regulations (Previously these groups were added).
• Companies or owners under the specified group need not file a notification or satisfy the Economic Substance Test.
• There are amendments to ESR on the way of treating UAE based branch of a company and Foreign Branches.

Applicable Exemptions from Economic Substance Regulation

• Entities that are Tax Resident outside the UAE
• Investment Funds does not come under ES regulation filing.
• Businesses that are completely owned by UAE Residents and not part of any Multi-National Group and only operates in UAE
• UAE Branches of a foreign company whose income is subjected to tax in the home country of the foreign company

To avail of the exempt status, all eligible entities are required to submit a notification along with relevant supporting documents. This ensures compliance and enables the benefits associated with the exempt status.

Companies in the UAE are required to possess a Tax Residence Certificate. This certificate serves as proof of tax residency in the respective country where the business operates for foreign companies based in their home country.

Government or Semi-Government Entity – Exempt from ESR

ES regulations in UAE do not apply to any government or semi-government entities in the UAE.

Changes to Definition of “Relevant activities”

1. Distribution and Service Center Businesss

Companies in the UAE are not obligated to import and store goods in order to be recognized as a “Distribution and Service Centre Business.”

Furthermore, it is not necessary for the company to offer services to foreign-related parties outside of the UAE in order to be recognized as a “Distribution Service Centre Business” within the UAE.

2. Licensee of High-Risk Intellectual Property

Businesses meeting the specified criteria fall under the category of ‘High-Risk Intellectual Property Licensee’.

• The business has not created the Intellectual Property (IP) but has acquired the IP Asset.
• The IP Assets can be obtained by either:
  1. Connected Person, or,
  2. For funding research and development by another person situated in a foreign jurisdiction

The IP Company either sells its intellectual property assets to a connected individual or receives identifiable income from a Foreign Connected Person in exchange for the utilization of the IP rights.

Revised definition of “Connected Person” and introduction of a new definition of “Group”.

The revised ES regulations provide a clear definition of a Connected Person as an entity that belongs to the same group as the Licensee or the Exempted Licensee. This clarification enhances the precision and understanding of the regulation while ensuring compliance with the intended purpose.

A group is characterized as “two or more entities connected by ownership or control, necessitating the preparation of consolidated financial statements for financial reporting purposes in accordance with accounting standards.”

3. Treatment of Branches

Branches are not considered Licensees since they do not possess distinct legal personalities separate from their parent or head office company. The Parent or head office companies are required to adhere to the ES regulations by explicitly stating the following:

1. UAE branch of a UAE Company

The UAE Company is required to submit a single notification and an Economic Substance Report (if applicable) to declare the relevant activities of the company and its branches in the UAE. It is crucial to enhance the writing quality, optimize word choice, structure, readability, and eloquence while preserving the original meaning.

2. UAE branches of a Foreign Company

The UAE branch is exempt from ES regulations if the income in question is duly reported in the tax return of the foreign company in its home country.

3. Foreign Branch of a UAE Company

The reporting obligation for relevant activities of a foreign branch in the UAE is not required, given that the foreign branch is subject to taxation on its relevant income in its respective jurisdiction.

Governance of Economic Substance Regulations

The UAE Federal Tax Authority is the Assessing Authority for the ES Regulations. The FTA will rigorously enforce compliance of UAE businesses with the Economic Substance Test, ensuring that all requirements are met.

The Regulatory Authority is responsible for gathering and validating information about the Licensees. They will then update the systems to ensure that entities in the UAE are fully compliant with the ES Regulations.

Exchange of Information

The Ministry of Finance, acting as the competent authority, will exchange information with foreign competent authorities regarding licensees claiming exemption from the ES regulations. This exchange of information is based on the amended ES regulations.

• Being a Tax Resident outside the UAE; or,
• Being a UAE Branch of a foreign entity whose income is subject to tax outside of the UAE

Filing for Economic Substance – Important Notifications

Licensees engaged in relevant activities must electronically file the ES regulations notification on the Ministry of Finance Portal within six months of the financial year-end. Failure to comply with the Economic Substance regulation test within the stipulated time will result in fines.

Additional Clarifications

• The Licensee is not obligated to carry out all of the Core Income Generating Activities as stipulated in the ES regulations for a specific relevant activity. Nevertheless, it is imperative that the income-generating activities are conducted within the UAE.
• There is no requirement for board members/ directors to be physically present in the UAE when taking strategic decisions on daily operations.
• A Licensee may outsource activities that are not Core Income Generating Activities to parties outside the UAE.
• Delegate tasks such as back-office functions, IT support, payroll management, legal services, and expert professional advice to external providers. Access specialist services that enhance efficiency and effectiveness in your operations.
• The revised ES Regulations and Guidance offer precise insights into the extent and implementation of the Economic Substance requirements in the UAE.
• Furthermore, the elucidation regarding the treatment of branches is invaluable for businesses operating in the UAE, as it aids in strategic tax planning and maximizing potential savings.

UAE entities must carefully evaluate their business activities to ensure compliance with the Economic Substance Regulations. It is crucial to meet the requirements of the Economic Substance Test and adhere to the ES regulations to avoid any potential penalties. To learn more about the Economic Substance Regulations and ESR Registration, get in touch with our team of expert Business Consultants today!