UAE empowers the local business to flourish and acquire new heights while abiding by the laws and regulations. One such law was introduced by the Cabinet of Ministers Resolution no 31 called the Economic Substance Regulation. It was enforced on the 11th of September 2019 following Ministerial Decision No 215. The Economic Substance Regulation (ESR) provides guidance on the “Relevant Activities” and companies “Core Income Generating Activities” CIGA.
What is a relevant activity?
Under the ESR, a relevant activity can be explained as an adequate economic presence of an onshore or free zone company through their appropriate activities.
To define a business’s relevant activity, the “Substance over form” is to be accessed within the financial period. All the appropriate activities mentioned in the Licence of the company must be in line with the actual activities performed by the business during that financial period.
What licenses are considered for the Economic Substance Regulation?
- A limited liability companies
- A public shareholding company
- A private shareholding company
- A joint venture and a partnership company
Understanding the Leased Finance Business
Any company in the UAE is considered a leased financial business if its activities include financing or providing credit for any consideration. In simple terms, if a company offers loans or any other form of credit to a company within UAE or a foreign country is termed as a lease finance company. Such leading includes but is not limited to long term loans, hire and purchase agreements and finance leases.
The returns generated from investing in leased finance activities are interest, processing fees, late payment fees or gains on the loan conversion into a shareholder capital for the debtor.
While understanding the concept of ESR in leased finance companies, we can quickly think of learning institutions such as banks, insurance companies or investment fund management companies. These companies have a major activity in leased finances, and hence they are not to report for the ESR to prevent duplication of reporting. Therefore, they do not separately report their ESR financials with respect to any ancillary of a leased Finance activity.
What is the Core Income generating Activities of a leased Finance Business?
The leased Finance Business must follow the set of regulations mentioned under the CIGA.
Agreeing Funding terms
The funding terms of the agreement under the ESR disclose the activity by agreeing on the type of funding, including equity, shares, loans, etc.). The important terms to be stated are the type of funding, the currency, interest rates payable, covenants and securities.
Identification and acquisition of assets
The next step is identifying and verifying the acquired asset that is to be leased out to the hirer or the lessee for a financial return over a fixed period of time. It includes negotiations during the acquisition and the terms of supply of the asset that is to be leased or rented out.
Terms and Duration of the financial leasing
The licensee holds the authority over the terms of the financial leasing. Hence, they dictate the terms of the duration of the lease, the amount of financing, and similar other relevant terms of the agreements. The licensee holder or the lessor also heads the negotiations.
Monitoring and revision of any agreements
The CIGA regulates that the license holder must obtain data about the lessee or the borrower. They must ensure that the borrower is compliant throughout the leasing period. The borrower may adhere to changes in terms of financing provided. On the same lines, they need to disclose any relevant information of their business activity directly or indirectly related to the financial lease contract. This enables the lender to better their decision-making process and bring about pertinent changes of agreement in the future.
Managing any Risks
Leased assets are not immune from risks. Hence the CIGA expects the license holder to have a setup for debt collection, risk mitigation and risk monitoring. In the process of lending, there is always a risk involved. The CIGA expects lenders to monitor the compliance from both parties and reduce any risk arising from doubtful debts.
You should know: ESR For Holding Company Business In UAE
Under the UAE ESR Law, companies that trade over securities exchange and bonds are exempt from following the ESR. The Economic Substance Regulatory ensures that licensed relevant activity companies comply with ESR filing, ESR Notification filing, and the Economic Substance Test. Companies in Mainland, offshore, and free zone are to be considered for the filing as per the ESR. However, they need to run a self-assessment test to check if they are eligible under the scope covered by ESR Law. If you require professional assistance for ESR Filing, you can call us today!
Farahat & Co are one of the best audit service providers in Dubai and the UAE. They have an expert and experienced team of Chartered Accountants who can assist you with the correct information on ESR Law in the UAE.
Bola Olaoye is a Legal Senior Associate and holds an LLB from Adekunle Ajasin University as well as a Bar Certificate from the Council of Legal Education. With experience spanning 14 years, she knows the ins and outs of UAE’s laws and practices and has helped provide clear and concise guidance to clients on the appropriate law-abiding measures to be taken concerning Economic Substance Regulations (ESR).