Economic Substance Regulations (ESR) in UAE

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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the Cabinet of Ministers issued Cabinet of Ministers Resolution No. 57 of 2020 (ESR Regulations), which amended and repealed Cabinet of Ministers Resolution No. 31 of 2019, issued in 2019.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 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

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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.

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Economic Substance Notification

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:

  1. the type of Relevant Activity they perform;
  2. whether they earn Relevant Income;
  3. the end date of their Financial Year; 
  4. 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. 

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ESR Reporting

ESR Reporting

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

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:

  1. 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.
  2. 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: 

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File an Economic Substance Report

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”

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Why Choose Us

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.

Detailed reports

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


Tailored guidance and legal expertise

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


Accessibility

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.


Help in fully complying with regulations

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.


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Risks for non-compliance to ESR

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.

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