On 30 April 2019, the Cabinet of Ministers of the United Arab Emirates issued a Cabinet Resolution regarding Economic Substance Regulations (ESR). On 10 August 2020, the new Economic Substance Regulations were introduced.
The ESR Regulations are issued pursuant to the global standard set by the Organization for Economic Cooperation and Development (“OECD”) Forum on Harmful Tax Practices, which requires entities undertaking geographically mobile business activities to have substantial activities in a jurisdiction. In addition, the European Union Code of Conduct Group (“EU COCG”) also adopted a resolution on a code of conduct for business taxation which aims to reduce harmful tax practices.
The Cabinet of Ministers of the United Arab Emirates enacted the ESR Regulations taking into account the relevant standards developed by the OECD and the EU COCG.
As a result, the new ESR require that the Licensees must met the economic substance test.
Who is defined as a licensee
A licensee can be an entity that is juridical person (incorporated inside or outside the State) or an Unincorporated Partnership registered in the State, including a Free Zone and a Financial Free Zone and carries on a Relevant Activity.
It is noted that Branches registered in the UAE are regarded to be an extension of their “parent” or “head office” and therefore are not considered to have separate legal personality.
Similarly, a branch of a foreign entity registered in the UAE that carries out a Relevant Activity, is required to comply with the ESR Regulations, unless the Relevant Income of such branch is subject to tax in a jurisdiction outside the UAE.
The ESR Regulations exclude certain forms of entities from the requirement to meet the Economic Substance Test.
An Exempted Licensee includes any of the following entities registered in the UAE and which carry out a Relevant Activity:
- an Investment Fund;
- an entity that is tax resident in a jurisdiction other than the UAE;
- an entity wholly owned by UAE residents and meets the following conditions:
- the entity is not part of a MNE Group;
- all of the entity’s activities are only carried out in the UAE;
- a Licensee that is a branch of a foreign entity the Relevant Income of which is subject to tax in a jurisdiction other than the State.
evidencing status as a exempted licensee
Any entity which claims to be an Exempted Licensee must submit to the relevant Regulatory Authority, along with a Notification, sufficient evidence substantiating its status as an Exempted Licensee for each Financial Year in which it claims to be an Exempted Licensee.
A Licensee that claims to be exempt on the basis of being a tax resident in a foreign jurisdiction is required to submit one of the following documents along with its Notification in respect of each relevant Financial Year:
- Letter or certificate issued by the competent authority of the foreign jurisdiction in which the entity claims to be a tax resident stating that the entity is considered to be resident for corporate income tax purposes in that jurisdiction; or
- An assessment to corporate income tax on the entity, a corporate income tax demand, evidence of payment of corporate income tax, or any other document, issued by the competent authority of the foreign jurisdiction in which the entity claims to be a tax resident.
Where an entity fails to provide sufficient evidence to substantiate its status as an Exempted Licensee, the entity will be regarded as a Licensee for the purposes of the ESR Regulations and shall be subject to the requirements of the ESR Regulations.
First Reportable Financial year
All Licensees and Exempted Licensees are subject to the ESR Regulations from the earlier of: (i) their financial year commencing on 1 January 2019, or (ii) the date on which they commence carrying out a Relevant Activity (for a Financial Year commencing after 1 January 2019).
The below are considered to fall under the definition of a Relevant Activity:
- Banking Business
- Insurance Business
- Investment Fund Management Business
- Shipping Business
- Lease-Finance Business
- Distribution & Service Centre Business
- Headquarters Business
- Intellectual Property Business
- Holding Company Business
A Licensee can undertake more than one Relevant Activity during the same financial period. This would require the Licensee to demonstrate economic substance in respect of each Relevant Activity.
An entity is not required to be actively engaged in any of the above business categories for it to be considered as carrying on a Relevant Activity. Any form of passive income from a Relevant Activity would bring the entity within scope of the ESR Regulations.
A Licensee must satisfy the Economic Substance Test having regard to the level of Relevant Income derived from any Relevant Activity.
For the purposes of the ESR Regulations, “Relevant Income” means all of that entity’s gross income from Relevant Activity as recorded in its books and records under applicable accounting standards, whether earned in the UAE or outside the UAE and irrespective of whether the entity has derived a profit or loss from its activities.
Every Licensee and Exempted Licensee is required to submit a Notification to their respective Regulatory Authorities setting out the following for each relevant Financial Year:
- the nature of the Relevant Activity being carried out;
- whether it generates Relevant Income;
- the date of the end of its Financial Year;
- any other information as may be requested by the Regulatory Authority.
A Notification submitted by an Exempted Licensee must be accompanied by sufficient evidence to substantiate the Exempted Licensee’s status for each category in which it claims to be exempt. Failure to provide sufficient evidence to this effect will result in the Exempted Licensee not being able to benefit itself of the exemption and having to comply with the full requirements of the ESR Regulations.
The time frames for compliance with the requirement to submit a Notification are different from the time frames to submit an Economic Substance Report. The Notification must be submitted within six months from the end of the Financial Year of the Licensee or Exempted Licensee.
The Notification must be submitted electronically on the Ministry of Finance Portal.
economic substance report
Every Licensee shall be required to meet the applicable Economic Substance Test requirements and submit an Economic Substance Report containing the requisite information and documentation prescribed under the ESR Regulations within twelve (12) months from the end of the relevant Financial Year.
penalties and hear appeals
If the National Assessing Authority determines that a Licensee or an Exempted Licensee has failed to comply with applicable provisions of the ESR Regulations, the National Assessing Authority may impose various administrative penalties.
how we can help
ConnectedSky Legal & Corporate Consultants Limited, through its dedicated team of business consultants, lawyers, accountants and tax experts will be happy to advise any client as to the ESR Regulations in the most efficient way and to provide support to clients though all stages of the implementation of the ESR Regulations.