Economic Substance Regulations (ESR)
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Economic Substance Regulations
The Economic Substance Regulations (ESR) are laws that regulate the economic activities of businesses in the UAE. On 10 August 2020, the Cabinet of Ministers issued Cabinet of Ministers Resolution No. 57 of 2020 (ESR Regulations), which amended and repealed Cabinet of Ministers Resolution No. 31 of 2019, issued in 2019. The ESR in UAE is part of the UAE’s commitment to the Organisation for Economic Cooperation & Development (“OECD”) Inclusive Framework and the European Union Code of Conduct Group on Business Taxation.
The ESR aims to prevent harmful tax practices and ensure that businesses in the UAE have a significant economic presence in the country relative to the activities they undertake. To comply with the UAE’s laws on business taxation, local companies in the country and the free zones must follow the Economic Substance Regulations (ESR). These regulations apply to companies that do any of the specified ‘relevant activities’. These companies need to send economic substance notifications to the regulatory authorities, which contain basic information about their activities. They also need to submit an economic substance report after they send the notification.
At Farahat & Co., we can assist in navigating the UAE economic substance requirements that are to be met by affected business entities. The firm offers a broad range of services from advisory services on the registration status with regulators to classification checks, full reviews, and report filings
Detailed Assessment of a Business on ESR Applicability
With the help of our team of experts, Farahat & Co. aims to help all of its clients in determining whether their businesses are affected by substance legislation. To find out if a business is fully in compliance with substance requirements set forth by applicable authorities, it is necessary to determine whether it’s within the legislation’s scope or not, which can depend on a variety of factors including the activities of the business, company’s residence, and other important aspects of the business model.
Our team can help you assess the status of your business in the most effective and convenient manner. We can also offer a full understanding on the steps that your business should consider taking to make sure it is fully complying with Economic Substance Regulations.
Relevant Activities
The ESR applies to all UAE onshore and free zone companies and certain other business forms that carry out one or more of the following “Relevant Activities”:
- Banking Business
- Insurance Business
- Investment Fund Management Business
- Lease – Finance Business
- Headquarters Business
- Shipping Business
- Holding Company Business
- Intellectual property Business (“IP”)
- Distribution and Service Center Business.
Each Relevant Activity has a specific definition and criteria determining whether a business falls within its scope. The table summarizes the definitions of Relevant Activity and Core Income Generating Activity per the UAE’s Economic Substance Regulations.
ESR Compliance Obligations
Entities that are within the scope of the ESR are required to comply with the following obligations:
- Submit an annual Notification form to their Regulatory Authority, indicating whether they have carried out a Relevant Activity, earned income from it and whether they are exempt from the ESR.
- Submit an annual Economic Substance Report to their Regulatory Authority, demonstrating that they have met the Economic Substance Test for each Relevant Activity unless they are exempt.
- Retain relevant records and documents for at least six years from the end of its Financial Year all relevant documents, records, and information required by the Licensee to meet their obligations under the ESR Regulations.
Economic Substance Notification
The Regulatory Authorities require every Licensee and Exempted Licensee to send a Notification for each Financial Year that includes the following information:
- the type of Relevant Activity they perform;
- whether they earn Relevant Income;
- the end date of their Financial Year;
- any additional data that the Regulatory Authority may ask for.
An Exempted Licensee must provide enough proof to verify their exemption status for each category they claim to be exempt from. Otherwise, the Exempted Licensee will lose the exemption and must follow the ESR Regulations fully, including passing the Economic Substance Test.
The deadlines for sending a Notification are different from those for sending an Economic Substance Report. The Licensee or Exempted Licensee must send the Notification within six months after the end of their Financial Year. For example, if the entity’s financial year ends on 31 December, the notification form must be submitted by 30 June of the following year.
The Notification must be sent online through the Ministry of Finance Portal Licensees who have already sent a Notification to their Regulatory Authorities directly must send it again through the Ministry of Finance Portal according to the ESR Regulations once it is available.
Failure to comply with the ESR can result in a penalty of AED 50,000 and can result in the Licensee being deemed to have failed the Economic Substance Test for the relevant Financial Year. Therefore, entities subject to the ESR should assess their activities and obligations and take the necessary steps to meet the economic substance test and reporting requirements.
ESR Filing
The ESR Regulations require every Licensee to comply with the Economic Substance Test and send an Economic Substance Report with the necessary data and documents within twelve (12) months after the end of the Financial Year. For example, if the entity’s financial year ends on 31 December, the notification form must be submitted by 30 June of the following year, and the economic substance report must be submitted by 31 December of the following year.
The National Assessing Authority has a six (6) year time limit from the end of the Financial Year to issue its verdict on whether a Licensee has passed the Economic Substance Test.
This six (6) year time limit does not apply if the National Assessing Authority cannot reach a verdict in this period because of gross negligence, fraud, or intentional deception by the Licensee or anyone acting on their behalf.
Economic Substance Test
The Economic Substance Test is the main criterion that determines whether an entity has a sufficient economic presence in the UAE relative to the Relevant Activity it undertakes. The Economic Substance Test consists of three elements. A Licensee that is not an Exempted Licensee, must satisfy the following criteria to meet the Economic Substance Test in relation to any Relevant Activity carried on by it:
- The licensee must conduct the core income-generating activities (CIGA) in the UAE. CIGA are the activities that are essential for generating the income from the Relevant Activity. A Licensee is not required to perform all of the CIGAs listed in the ESR Regulations for a particular Relevant Activity. However, it must perform any of the CIGAs that generate Relevant Income in the UAE.
- The Relevant Activity must be directed and managed in the UAE. This means that there are an adequate number of board meetings held and attended in the UAE. The ‘directed and managed’ test further requires that:
- meetings are recorded in written minutes and such minutes are kept in the UAE;
- quorum for such meetings is met and those attendees are physically present in the UAE; and
- directors have the necessary knowledge and expertise to discharge their duties and are not merely giving effect to decisions being taken outside the UAE.
- having regard to the level of Relevant Activity, as follows:
- There is an adequate number of qualified full-time employees in relation to that activity who are physically present in the UAE (whether or not employed by the Licensee or by another entity and whether on temporary or long-term contracts);
- There is adequate operating expenditure incurred by the Licensee in the UAE; and
- There are adequate physical assets in the UAE.
The Economic Substance Test may vary depending on the nature and type of the Relevant Activity. For example, Holding Company Business and IP Business have different or additional requirements than other Relevant Activities.
Who Must File an Economic Substance Report?
A corporate entity (such as a Limited Liability Company, a Public Joint Stock Company, or a Private Joint Stock Company) or a partnership (such as a Limited Liability Partnership or a General Partnership) that earns Relevant Income from any of the Relevant Activities listed below and is not an Exempted Licensee must file an Economic Substance Report for a Reportable Period.
Definition of a Licensee:
Article (1) of the ESR Regulations defines a Licensee as:
“An entity that is:
- A 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”
What are Exempted Licensees?
The ESR Regulations exclude certain forms of entities from the requirement to meet the Economic
Substance Test. For the ESR Regulations, an Exempted Licensee includes any of the following entities registered in the UAE and which carry out a Relevant Activity:
(a) An Investment Fund;
(b) An entity that is tax resident in a jurisdiction other than the UAE;
(c) 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;
(d) 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.
Why Choose Us
Our ESR solutions provide businesses in UAE with effective and efficient services for them to gain clarity regarding the applicability of the regulations to their businesses, supported by a detailed analysis performed by seasoned professionals and tailored solutions which are prescribed by our team of experts.
our team offers clients a detailed diagnosis of the classification of a business, identifies all the reporting obligations of the business and proposes concrete recommendations on the next steps the business has to take
With a team of in-house experts on legal matters in UAE, we are able to take into full consideration the risks and needs of businesses related to compliance with the Economic Substance Regulations
You can have an assessment scheduled for your business today simply by contacting our team. In the consultation and assessment, you will only be required to provide a relatively short amount of your time to help us classify your business.
after assessments that are undertaken by our experts, our team will also help you submit the reports and other documents which are mandated for businesses that are affected by the legislation. We can help with the notification filing to relevant licensing authorities and provide you with expert guidance in the annual reporting which is necessary to avoid penalties. Additionally, we can provide updates on deadlines that are applicable to your business on report filing and all other changes to the legislation so you are kept informed and up-to-date on legal matters that affect your business operations in the UAE.
Take note: as per the Cabinet Resolution introduced on the 30th of April 2019 related to Economic Substance, a business has to meet a test for economic substance in relation to relevant activities for every financial period in which the business has earned an income. The test for economic substance requires a business to demonstrate the following:
- All relevant (CIGAs) core income-generating activities of the business are carried out in UAE
- Licensee has a sufficient number of employees, sufficient expenditure, and premises in the UAE
- The licensee is carrying out relevant activities which are managed and directed in UAE
FAQ
ESR stands for Economic Substance Regulations. The Economic Substance Regulations were introduced in the United Arab Emirates in 2019 and apply to UAE entities carrying out certain specified activities referred to as “Relevant Activities”. The objective of the regulations is to ensure that such entities conducting relevant activities have real economic substance and conduct core income generating activities in the UAE.
The ESR in UAE has imposed strict penalties in order to ensure compliance with international standards, some of which includes:
| REF | Non-Compliance | Penalty Amount |
|---|---|---|
| 1 | Failure to submit Notification within 6 months of financial year end | AED 20,000 |
| 2 | Failure to submit Report within 12 months of financial year end or submitting an incomplete report | AED 50,000 |
| 3 | Repeated non-compliance with reporting requirements in the following financial year | AED 400,000 plus potential license suspension |
| 4 | Providing inaccurate information in filings knowingly or without due notification | AED 50,000 |
According to the Cabinet Resolution No. 57 of 2020 concerning Economic Substance Requirements, relevant income refers to:
“All gross income from a Relevant Activity that is recorded in the books and records of the Licensee or the Exempted Licensee under the accounting standards applicable thereto.”
Some key points about relevant income:
- It includes all income generated from activities covered under the Economic Substance Regulations (ESR). These ‘Relevant Activities’ include banking, insurance, fund management etc.
- The income must be recorded in the company’s books of accounts as per applicable accounting standards.
- It refers to the gross income before any deductions.
- Relevant income is important for the ESR as it forms the basis for the Economic Substance Test – the company needs to demonstrate adequate core income generating activities, expenditures etc. in the UAE in proportion to the relevant income.
- Accurate reporting of relevant income is necessary for ESR compliance assessment by regulatory authorities.
The filing of ESR in the UAE involves the annual reporting and submission of documents of all expenditures and activities from companies that engage in relevant economic substances in the country. To do that, they have to complete an Economic Substance Notification form which includes such details as activities, income, a financial year that corresponds to the company. They must also complete and file an Economic Substance Report within 12 months of the financial year end.
Report contains details on how the company meets the Economic Substance Test through:
- Core income generating activities in the UAE
- Level of local expenditures
- Number of qualified employees
- Assets in the UAE
Timely submission of both the notification and report to the company’s regulatory authority is mandatory as part of ESR compliance in the UAE.
The following entities are exempted from the ESR requirements in the UAE:
- Investment funds such as private equity funds, real estate funds, etc.
- Companies that are tax resident in another jurisdiction.
- Companies fully owned by UAE residents that do not belong to a multinational enterprise (MNE) group.
- Pure holding companies that only hold assets and receive dividends/capital gains.
- Branches of foreign companies that are already subject to tax in their home jurisdiction.
- Entities wholly owned by the UAE Government.
- Companies with irrelevant/nil income from activities covered under ESR such as holdings pre-operational phase.
- Companies owned by listed investment exchanges like Dubai Financial Market.
- Any other entities exempted by the Ministry of Finance in the UAE through special exemption orders on a case-to-case basis.
The deadline for ESR filing in UAE are:
| Filing | Deadline |
|---|---|
| Economic Substance Notification | Within a maximum of 6 months from the end of the fiscal/financial year |
| Economic Substance Report | Within a maximum of 12 months from the end of the fiscal/financial year |
Our Clients
What are the penalties or risks for non-compliance to ESR?
Failure in complying to the legislation results in AED 10,000 – 300,000 as a penalty. This includes the first failure to demonstrate appropriate economic substance in UAE for a relevant financial year and the second consecutive failure in providing information with foreign competent authorities of a parent company, ultimate beneficial owner or ultimate parent company.
An administrative penalty may also come with the withdrawal or suspension of a company’s commercial or trade license. The license may also not be allowed to get renewed in UAE.
If you want to know more regarding our Economic Substance Regulations services in UAE and how our solutions can help make sure your business minimizes risk and ensures substance compliance, kindly reach out to us today by calling our office at the numbers listed below!
Alternatively, you can also send us an email should you have inquiries regarding substance legislation and any related service.
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