|Introduction of Economic Substance Regulations in UAE
- Earlier this year, the Cabinet of Ministers in the United Arab Emirates (UAE) released Resolution No 31 of 2019 (Resolution) on Economic Substance Regulations (ESR) that would apply with immediate effect.
- ESR was introduced to ensure that entities that are doing business in UAE, pursuant to trade license obtained from authorities (Licensee), meet the Economic Substance Test. Interestingly, the resolution provides useful guidelines/ parameters to conduct such substance tests.
- This Resolution is also a step to meet the European Union’s requirement to remove UAE from the EU Blacklist i.e. EU list of non-co-operative jurisdiction for tax purposes. Subsequently, on 10 October 2019, the EU has removed UAE from its Black List.
- ESR applies to all UAE entities who have obtained a trade license or permit from relevant authorities to carry out ‘Relevant Activity,’ including Free Zone and Financial Free Zone.
- However, the Resolution shall not apply to companies owned by the Government of state, Emirate of the state or other Government authority/ body, directly or indirectly.
Relevant businesses and corresponding core income generating activity
|Relevant Activity/ Business
Illustrative Core income generating activity
- Managing crew/ voyages
- Overhauling and maintaining ships
- Overseeing and tracking shipments
- All activities related to business
- For income other than dividend/ capital gains, any activities to earn that other income
- Raising funds and managing risk
- Taking hedge positions
- Providing loans or credit
- Predicting and calculating risk
- Insuring/ re-insuring against the risk
- Underwriting insurance/ re-insurance
|Investment Fund Management
- Deciding upon holding/ selling
- Calculating risk and reserve
- Agreeing funding terms
- Identifying and acquiring assets to be leased (for leasing activity)
- Managing risks
- Taking management decisions
- Incurring operating expenditure on behalf of group entities
- Coordinating group activities
|Intellectual Property (IP) (where IP is patent/non-trade intangible) and it is High-Risk IP Licensee*
- Taking strategic decisions and managing the risk related to developing (or acquiring)/ exploiting/ protecting of intangible assets
- Carrying out ancillary trading activities for exploiting intangible assets
|Distribution and Service Centre
- Transporting and storing
- Managing inventories
* High-Risk IP Licensee is a licensee who
- Did not create IP held for business and acquired IP from Connected persons, in consideration for funding research and development by another person situated outside UAE and licenses such IP to connected persons or generates income
- Does not carry out research and development or branding, marketing and distribution as part of core income generating activity
Key parameters for Economic Substance Test
Licensee must satisfy the following criteria to meet Economic Substance Test in relation to Relevant Activity
- Conduct core income-generating activities in UAE
- Licensee shall be directed and managed in UAE
- Adequate frequency of Board of Directors meeting in UAE
- Directors should possess the necessary knowledge/expertise to discharge duties
- To employ adequate number of qualified full-time employees, or adequate outsourcing expenditure incurred for third party service provider
- To possess adequate physical assets in UAE
- Notification to be submitted
Licensee shall annually notify Authority on following
- Whether or not it is carrying on Relevant Activity
- If yes for above, gross income for Relevant Activity is subject to tax outside UAE
- Financial year followed by Licensee
- Report to be submitted
If Licensee is carrying out the Relevant Activity, it is required to submit a detailed report annually within 12 months from end of Financial Year, containing various operations related information, including but not limited to Employee details – experience, type of contract, qualifications, duration of employment etc. and also information on intangible related details of the Licensee.
What are the offenses and penalties prescribed
The Resolution has prescribed the following offenses and corresponding penalties as under
||Quantum of penalty
|Failure to meet Economic Substance Test
||AED 10,000 – AED 50,000 (First Year)
|AED 50,000 – AED 300,000 (Subsequent Year)
|Failure to provide information or inaccurate information
||AED 10,000 to AED 50,000
However, before levying a penalty, the Authority must issue a notice (i.e. opportunity of being heard) to Licensee.
Further, the Authority may neither determine economic substance test of licensee nor levy a penalty post 6 years from the end of Financial year (unless there is deliberate misrepresentation/ fraudulent action by Licensee or any other person)
- Recently, UAE has introduced Country-by-Country-Reporting (CbCR) Regulations in line with its commitment to implement Base Erosion and Profit Shifting (BEPS) standard for Action Plan 13. Now, with the introduction of ESR, UAE has most certainly sent a positive signal to the sovereigns of its trade partners in other jurisdictions.
- As referred, the introduction of the regulations has already helped UAE in taking their name out of the EU blacklist. However, the implementation of these regulations in UAE, which till date does not have any taxation related law, is likely to pose challenges.
- Despite, the regulations providing useful guidelines, the Licensees would require lot of judgment in a professional capacity to determine if the activity meets the substance test.
- The above regulations also introduce additional compliance requirements on part of the Licensee/ businesses in UAE who are still grappling with the GST related compliances in the region.
- It is recommended for multinationals to be pro-active and revisit their existing operational activities to mitigate/ avoid potential risk of non compliance with the above regulations