Due to European Commission concerns, The United Arab Emirates became part of the European Union’s list of non-cooperative tax jurisdictions. In response to this, the Ministry of Finance introduced Economic Substance Regulation (ESR) in UAE vide Cabinet Decision No. 57 of 2020, which came into effect on 1 January 2019. Along with updated guidance, the ESR issued Amended regulation on August 2020 & it requires businesses to maintain a fair “economic presence” relative to the activities they undertake in the UAE.
ESR in UAE says that it is mandatory that every prescribed business (including offshore companies and branches of local and foreign companies) carrying relevant activities and earning an income from Relevant Activities in the country perform an Economic Substance Test. Organizations will be penalized for non-compliance if they do not meet annual filing requirements.
Entities that fulfill the conditions for being “exempt” do not need to prove economic presence in the UAE. However, these businesses need to file a Notice and provide adequate evidence to support their exempt status.
The ESR demonstrates the UAE’s dedication to addressing concerns around shifting profits derived from specific business activities to “no or nominal tax jurisdictions” without interconnecting local economic activities.
Companies will need to evaluate whether and which of their business activities fall within the scope of the ESR in UAE & how to guarantee they meet the economic substance requirements in respect of each relevant activity;
It is both qualitative and quantitative inspection, including operational, financial, and tax considerations or transfers legal, pricing, and administration issues.
If companies do not meet the Economic Substance Tests for a financial period, they are liable to penalties. Companies failing to comply with the ESR regulations are penalized with an amount ranging from AED 10,000 to AED 400,000. Filing of Economic Substance Regulation or Economic Substance Test Declaration submission is within 12 months from the end of the financial year. Also, ESR Licensees should file a notification within six months nearing its Financial Year.
ESR Exemptions:
A few companies carrying Relevant Activities are exempt from the requirement to maintain an acceptable ESR in the UAE.
The exemption on ESR is available to businesses that meet certain conditions like:
- Investment funds.
- A licensee that is a tax resident in a jurisdiction other than UAE;
- A company owner who is a UAE national, & is not part of a multinational group. The business must operate only in the UAE.
- Branches of foreign entities:
People owning a business and are tax residents in another country are exempt from ESR.
An entity is required to file a notification along with the relevant affirming documents to claim an exemption from ESR, & if the authorities deny the claim, such entities should meet the ESR Tests and file a report.
Application of ESR in UAE:
ESR applies to all licenses and exempted licensees carrying on the relevant activities in the UAE, including Free zones.
Relevant activities for ESR in UAE:
- Lease-Finance Business.
- Headquarters business.
- Service & distribution center businesses.
- Holding company businesses
- Shipping businesses.
- Intellectual property businesses
- Investment fund businesses
- Banking & insurance businesses
How do entities perform Economic Substance Test:
- Check if the company performs CIGA(Core Income Generating Activity) in UAE.
- Check if the company is managed & directed in the UAE concerning that activity.
- Check if the company hires the right number of qualified employees or incurs a suitable level of managing expenses & appropriate physical assets in UAE.
- If another company conducts CIGA for the relevant licensee, then check if the licensee has complete control & can monitor the activities of another company.
Importance of assessing activities for ESR:
It is essential to assess whether a company is engaged in relevant activities to determine if it is required to comply with ESR in UAE. Consider the substance-over-form approach to evaluate the Relevant activities. Also, it is essential to understand that even the passive income from any of the activities that come under relevant activities will require the entity to comply with ESR. If you go incorrect with the assessment, you may lead to the filing of inaccurate information with authorities & may have to pay penalties,
What are the details an entity should provide to file for ESR?
A company, whether it is a licensee or an exempted licensee, should provide the following details annually:
- Commencing date & end of the financial year
- Carrying Relevant Activity
- Provide details of revenue generated from a relative activity during a relevant financial year.
- Provide other details as required by the Regulatory Authority.
Exempted licensees should also provide all the documents & details to prove their status of being exempted from ESR in UAE.
ESR in UAE effectively levies a requirement for Companies that operate & make income from the relevant activities to hold economic substance precise to each relevant activity. ESR is implied to ensure that companies operating in the country have a sufficient economic presence in the UAE.