Economic Substance Regulations (the “ESR”) are a mandatory filing for most UAE companies.
As part of the UAE’s objective to combat harmful tax practices, such as tax evasion and tax avoidance, in compliance with the OECD Inclusive Framework, and in response to the EU Code of Conduct Group assessment of the country’s tax framework, the UAE adopted in April 2019 the Economic Substance Regulations (Cabinet of Ministers Resolution No 31 of 2019). Together with the Guidance on the implementation of the Regulations, issued in September 2019 (Ministerial Decision No. 215 of 2019). Amendments to the Regulations were made by Council of Ministers Resolution No. (57) of 2020 on 10 August 2020, and updated Guidance was issued on 19 August 2020 (Ministerial Decision No. 100 of 2020).
What is the purpose of the ESR in the UAE?
The ESR in the UAE oblige Onshore and Free Zone companies, along with other forms of business carrying out economic activities in the country, to demonstrate that they maintain the economic activity they declare, along with a real economic presence in the UAE. This makes it possible to link the profits they report to sufficient business activity.
Who is a Licensee under ESR in the UAE?
A Licensee is any type of business carried on by a legal person or incorporated partnership that is registered in the UAE and/or carries on a Relevant Activity for financial years beginning on or after 1 January 2019.
What is considered a juridical person or an unincorporated partnership?
A juridical person is considered to be a corporate legal entity with separate legal personality from its owners. While unincorporated partnership is understood to be a limited partnership (which is not a juridical person) or a general partnership, that is registered in the State, including in Free Zones or in Financial Free Zones.
In graphic summary:
|Private and public shareholding companies||Sole proprietorships|
|Partnerships (LLP, LP, GP, etc.)||Trusts (no carrying Relevant Activities)|
|Any other entity legally independent of the owner||Foundations (no carrying Relevant Activities)|
Who are the exempted Licensees?
Notwithstanding the above, the ESR contain four exceptions in which parties are not obliged to demonstrate the substance of their economic activity. These are:
- Non UAE resident entities.
- Investment funds and their underlying special purpose vehicles (SPVs) / investment holding entities.
- Wholly UAE resident owned UAE entities with domestic transactions only (that are not part of a multinational group).
- UAE branches of foreign companies that are subject to tax on all their Relevant Income in a foreign jurisdiction.
However, Exempted Licensees are obliged to prove their exemption. If they fail to do so, they will have to complete the Economic Substance Report and undergo the Economic Substance Test, as if they were non-exempted Licensees.
Which are the Relevant Activities of the Licensees?
As described above, there are a number of Relevant Activities which, if carried out by the Licensees, oblige them to demonstrate their economic substance by complying with reporting and filing obligations in respect of the actual economic activity they carry out. Therefore, the ESRs will apply to all UAE companies, including those registered in Free Trade Zones or Financial Zones, that carry out one or more of the following Relevant Activities:
- Banking Businesses
- Insurance Businesses
- Investment Fund Management Businesses
- Lease-Finance Businesses
- Headquarters Businesses
- Shipping Businesses
- Holding Company Businesses
- Intellectual Property Businesses
- Distribution and Service Centre Businesses
What are the obligations of Licensees and Exempted Licensees under the ESR in the UAE?
All Licensees (including also those exempt or not earning incomes during the relevant periods) are obliged to notify that they carry out a Relevant Activity, through the Filing Portal of the Ministry of Finance, no later than 6 months after the end of their Financial Year.
While Licensees who are not exempt and earn income during the relevant periods are liable in two ways. On the one hand, to meet the Economic Substance requirements. On the other hand, to submit the Economic Substance Report to the Filing Portal of the Ministry of Finance within 12 months of the end of their financial year.
In the notification applicable to all Licensees carrying out a Relevant Activity, the following must be included:
- General information about the Licensee.
- The Relevant Activity being carried out.
- The possible applicable exemptions.
In the case of the Economic Substance requirements, which basically consist of demonstrating the economic substance of the activities, the Licensee must demonstrate that meets the following conditions:
- The Licensee has adequate employees, physical assets and expenditure in the UAE.
- The Core Income-Generating Activities (CIGA) are undertaken in the UAE.
- The Relevant Activity must be directed and managed in the UAE.
Finally, the information reported in the Economic Substance Report must include the activities conducted, the Relevant Income earned, the operating expenditure incurred, the location and assets uses, the employee details, as well as other relevant details.
What are the consequences of non-compliance?
In the case of non-compliance, we can divide the different sanctions or consequences depending on the stage of the procedure in which they have been linked:
1. Failure to File
Firstly, in the case of non-compulsory notification for all Licensees carrying out Relevant Activities, a penalty of AED 20,000 is imposed.
Secondly, in case the mandatory report is not submitted by non-exempt Licensees who earn incomes, a penalty of AED 50,000 will be imposed. Also the company shall be deemed failed to demonstrate Economic Substance in the UAE.
2. Failure to provide accurate information
This figure includes the case in which the corresponding notification is made and the file is submitted to the MOF, although the information provided is not accurate. A penalty of AED 50,000 will apply and the company shall be deemed failed to demonstrate accurate information about its Economic Substance in the UAE.
3. Failure to demonstrate sufficient Economic Substance in the UAE for the relevant period
In the first year of non-compliance a penalty of AED 50,000 will be imposed, together with the exchange of information with the foreign competent authority of parent company, ultimate parent company, and ultimate beneficial owner.
In the case of repeated non-compliance in a second year, a penalty of AED 400,000 will apply, together with the exchange of information with the foreign competent authority of parent company, ultimate parent company, and ultimate beneficial owner. In addition, the legislator includes for this figure of non-compliance an even greater consequence: the possibility of suspend, withdraw or not process the renewal of the trade/commercial licence of the company.
The filing of notice and report of ESR in the UAE are deadlines not to be missed.
Please ensure you obtain expert assistance in preparation. For those brave readers eager to know more about the ESR, you may find comprehensive information here. For full information on our services please visit our services section here.
**This publication is not intended to serve as legal advice but rather a publication of general application.