The UAE’s economic substance regulations were introduced in 2019 as part of the country’s commitment to international standards on tax transparency and Base Erosion and Profit Shifting (BEPS). The regulations apply to all UAE onshore and free zone companies that engage in certain “relevant activities,” including banking, insurance, investment fund management, lease-finance, headquarters, shipping, holding company, intellectual property, and distribution and service center businesses. Under the regulations, companies must demonstrate that they have adequate substance in the UAE by meeting certain criteria, such as having a physical presence in the country, employing qualified staff, and incurring expenses. Companies that fail to meet these criteria may be subject to penalties, including fines and the revocation of their license.
Free zones and financial free zones are a crucial part of the UAE’s economic landscape, offering a range of benefits to companies, including foreign ownership, tax exemptions, and streamlined business processes. However, the economic substance regulations have raised concerns about the continued attractiveness of these zones for businesses.
One of the key requirements of the ESR is that companies must have adequate substance in the UAE. This means that companies must have a physical presence in the country, including offices, staff, and equipment. Companies must also demonstrate that they are carrying out core income-generating activities in the UAE and that these activities are directed and managed from within the country.
For companies operating in free zones and financial free zones, meeting these requirements can be a challenge. Many of these companies have been established specifically to take advantage of the tax and regulatory incentives offered in these areas, and may not have a significant physical presence in the UAE. As a result, they may need to restructure their operations to ensure that they meet the substance requirements.
There are several measures that companies operating in free zones and financial free zones can take to ensure that they meet the substance requirements of the ESR. These include:
To address the concerns raised by the economic substance regulations, many free zones and financial free zones in the UAE have taken steps to support their businesses. For example, some zones have introduced new services and incentives to help companies meet the substance requirements, such as:
UAE Licensees located in free zones must assess their economic substance and adopt a “substance over form” approach. They must consider the CIGAs carried out in the free zone and provide documentary evidence supporting the CIGAs. The Licensee should be directed and managed in the UAE, and the directors should have the necessary knowledge and expertise to discharge their duties.
Companies in free zones and financial free zones must also comply with transfer pricing requirements, prepare audited financial statements, and meet other conditions prescribed by the UAE Minister. Failure to comply with the Regulations can result in penalties and a spontaneous exchange of information with the Foreign Competent Authority.
The ESR has also had an impact on investment in the UAE. While the regulations are intended to ensure that companies have real economic substance in the country, they may also deter some investors from establishing operations in free zones and financial free zones. This is because the substance requirements may increase the cost and complexity of doing business in the UAE.
However, it is important to note that the ESR is not intended to discourage foreign investment. Rather, they are intended to ensure that the UAE remains an attractive destination for legitimate business activity. By implementing the ESR, the UAE is demonstrating its commitment to international standards of tax transparency and fairness.
The economic substance regulations in the UAE have significantly impacted companies in free zones and financial free zones. Compliance with these regulations is necessary to maintain the benefits of operating in these zones, such as zero tax on profits and duty exemptions. While there are concerns about increased costs and complexity, free zones can support businesses by offering guidance and affordable solutions to navigate the regulations. Compliance involves assessing economic substance, providing documentary evidence, adhering to transfer pricing requirements, and meeting other conditions set by the UAE Minister.
Read More: Requirements for businesses to comply with Economic Substance Regulations