As per the Cabinet of Ministers Resolution No.31 of 2019, the UAE has introduced Economic Substance Regulations (ESR) on 30th April 2019. Guidance on applying the Regulations was issued on 11th September 2019 pursuant to Ministerial Decision No. 215 of 2019. Amendments to the Regulations were made on 10th August 2020 by the Cabinet of Ministers Resolution No. 57 of 2020 (“Regulations”), and updated Guidance was issued on 19th August 2020.
The Regulations required the companies and other business forms registered in the UAE that carry on one or more “Relevant Activities” to have economic substance in the UAE in relation to those activities and to comply with the return filing and notification obligations. These businesses are referred to in the Regulations as “Licensees.”
The ESR Regulations apply to financial years starting on or from 1st January 2019. The Entities that are within the scope of the Regulations have to submit an annual Notification form to the Ministry of Finance portal within six months from the end of their financial year and also submit an Economic Substance Report within 12 months from the end of the financial year (e.g., entities with financial year ending 31 December 2019 are required to file Economic Substance Report by 31 December 2020). An entity does not need to fulfill the Economic Substance Test and submit an Economic Substance Report for a financial period in which it has not derived revenue from a Relevant Activity or if it fulfills the conditions for being exempt. However, a Notification form is required to be filed regardless.
Failure to comply with the Regulations can cause administrative penalties, exchange of information of Licensee or Exempted Licensee with the Foreign Competent Authority (as defined in Article 1 of the Regulations), and other administrative sanctions such as the revocation, suspension, or non-renewal of the entity’s trade license or permit.
Information to be filed with Authority- Economic Substance Notification
All Licensees and Exempted Licensees are required to comply with the ESR Regulations from the earlier of: (i) their financial year starting on 1st January 2019, or (ii) the date on which they start carrying out a Relevant Activity (for a Financial Year starting after 1st January 2019).
ESR Notification Form should be filed within six months from the end of Financial Year of Licensee or exempted Licensee annually with the following details:
- Start and end date of Financial Year
- Relevant Activity carried out
- Whether Revenue derived from such Relevant activity during the Financial year
Other information as mandated by the Regulatory Authority
Exempted Licensee needs to provide all the information and documents for claiming the status of the Exempted Licensee.
A penalty of AED 20,000 shall be levied on Licensee or Exempted Licensee, who do not submit the Notification Form or any information or document required to be filed.
What are The Relevant Activities?
The below-listed business activities are considered as “Relevant Activities” under the Regulations:
- Investment Fund management
- Holding company
- Intellectual property (IP)
- Distribution and service center
Licensee Exempted as per Cabinet Resolution 57/2020
As per Cabinet Resolution No. 57/2020 below entities falls in Exempted Licensee:
- A licensee who is Tax Resident in a Jurisdiction outside UAE
- An Investment fund
A licensee that is the branch of a foreign entity for which Relevant Income is subject to tax in a jurisdiction outside UAE.
- A licensee who is wholly owned by one or more UAE Resident and meets the following conditions:
An entity should carry out business only in the UAE
- An entity should not be a part of the MNE Group
How to meet the Economic Substance Test?
UAE businesses are expected to apply a ‘substance over form’ approach to determine whether or not they conduct a Relevant Activity and, therefore, are within the ambit of the Regulations. In order to determine this, UAE businesses would require to not only consider the activities stated under their commercial license or registration certificate but also to make an assessment of the activities conducted during a financial period.
In order to be considered as carrying on a Relevant Activity, the UAE business does not necessarily require to actively engage in any of the above business categories. As an example, the passive receipt of income under a finance lease arrangement would be considered as carrying on a Lease-Finance Business.
More than one Relevant Activity can be conducted by Licensees during the same financial period. In this case, economic substance is required to be demonstrated by Licensees for each Relevant Activity, unless the other Relevant Activities are pertinent to a main Relevant Activity. In certain cases, to prevent duplicate reporting, the Licensee can consolidate the ancillary Relevant Activities under the main Relevant Activity.
In order to demonstrate an economic substance, the economic substance return is required to be filed by a Licensee in respect of those financial periods in which any gross income was earned from a Relevant Activity.
One of the requirements to meet the Economic Substance Test is that a Licensee needs to undertake the Core Income Generation Activities (CIGAs) in relation to its Relevant Activity (or Relevant Activities) in the UAE. The CIGAs are those activities through which the Licensee generate the gross income from its Relevant Activity. Where the CIGA includes making relevant decisions, then the majority of the decision-makers must be available in the UAE at the time of decision making in order to consider that a decision is made in the UAE. With reference to the level of activities conducted in the UAE:
- Must incur an adequate amount of operating expenditure in the UAE
- Must have a sufficient number of full-time qualified employees in the UAE
- Must have adequate physical assets in the UAE
- If CIGA is undertaken by another entity for the relevant licensee, then check whether the Licensee has full control and be able to monitor the activities of another entity.
Competent Authority will provide information on Licensee or Exempted Licensee to Foreign Competent Authority that has not met the Substance test. Information in relation to high-Risk IP Business Licensee will also be provided to Foreign Competent Authority.
How can we support you?
Our consultants conduct a thorough business analysis of our client for a preliminary check on the applicability of the Economic Substance Regulation.
Upon confirmation of applicability, we support and guide you to check whether the criteria on the satisfaction of Economic Substance is met.
In case the criteria are not met, then we identify the gaps and provide recommendations to ensure the compliance of the Economic Substance Regulation.
We assist in ensuring timely compliance with the notification filing requirements and reporting requirements of the Licensee to file the ESR Notification Form and Annual Substance Report to the Ministry of Finance.