The United Arab Emirates implemented Economic Substance Regulations to ensure that the business operating in the country contributes to the local economy and promotes a sustainable business environment in the UAE. The Economic Substance Regulations mandate that Businesses carrying out any relevant activity, as identified in Article 3 of Cabinet of Ministers Resolution No. 57 of 2020, in the UAE and deriving Relevant Income during a Financial Year are required to demonstrate sufficient economic substance in the UAE.
In accordance with Ministerial Decision No. 100 for the Year 2020, a Lease-Finance Business is such a business in which Licensees are involved in credit or financing in exchange for some form of consideration and includes financing to Connected Persons (e.g., subsidiaries within the same corporate group).
Consideration for the purpose of a Lease-Finance Business includes interest, origination and processing fees, gains upon conversion and late payment penalties. However, if the debtor provides some form of asset or guarantee to secure the loan will not count as consideration under Economic Substance Regulations.
UAE Economic Substance Regulations on Lease-Finance Business
To ensure compliance with the Economic Substance Regulations, a Licensee carrying out Lease-Finance Business shall meet the Economic Substance Test which requires the Licensee to conduct the necessary Core Income-Generating Activity within the UAE. By doing so, the Licensee ensures that the Lease-Finance Business maintains a substantial economic presence and conducts sustainable business operations in UAE, rather than merely being registered there for tax purposes.
As per Article 3 of Cabinet of Ministers Resolution No. 57 of 2020, Licensee carrying out Lease-Finance Business is related to the following Core Income-Generating Activities:
Agreeing Funding Terms
The Licensee carrying out this Core Income-Generating Activity is involved in making critical decisions in regard to arranging and finalize the financial agreements under which the Licensee will secure its own funding. Therefore, the licensee is required to determine a specific form of financing or funding such as ownership shares, a type of equity with certain preferences, loans or bonds or any other form of funding, which the licensee will adopt. Additionally, the Licensee is required to specify the amount of funding that it will require to support its Lease-Finance Business and the currency in which the Licensee wants to obtain the funds. If the funding involves debt, then the Licensee is required to keep in view the interest rates, security or any other conditions or promises with the lenders.
Identifying and Acquiring Assets to be Leased
This Core Income-Generating Activity requires the Licensee to identify specific types of assets. Once the potential assets are identified, the Licensee must verify the assets to be leased by discussing the price, terms of sale, delivery arrangements, and any other relevant conditions with the sellers. This Core Income-Generating Activity ensures that the Licensee has suitable assets available for leasing, which forms the foundation for generating the gross income through Lease-Finance Business.
Setting the Terms and Duration of any Financing or Leasing
The Licensee under this Core Income-Generating Activity should have power and autonomy to discuss the terms of a lease, propose the amount of financing or leasing, and reach agreements with potential clients or lessees. This Core Income-Generating Activity is essential for bringing out the best financial solutions to meet the desired needs of clients or lessees by complying with legal and regulatory requirements of the Economic Substance Regulations.
Monitoring and Revising any Agreements
In order to reach a financial agreement with the borrower or lessee the Licensee carrying out Lease-Finance Business should collect and analyze the financial situation of the borrower or lessee. For this purpose, the Licensee is required to monitor audited financial statements, performance metrics, and other relevant information to make informed decisions about the financing arrangement. This Core Income-Generating Activity helps ensure that the lease provided is in compliance with the needs of the borrower or lessee, moreover, it enables the Licensee to revise the terms of the financing agreement in order to meet the changing financial conditions or business situation.
Managing Any Risks
This Core Income Generating Activity requires the use of a holistic approach by the Licensee to decide whether they should take a hedging position in response to interest rates, currency fluctuations, or other financial variables to mitigate any risks. For this purpose, the Licensee should manage the process of collecting payments and ensure that the assets leased remain in good condition and are used in compliance with the terms of the lease agreement. Moreover, the Economic Substance Regulations requires the licensee to take into account all relevant risks applicable to the Core Income Generating Activities in relation to the Lease-Finance Business implementing measures to make use of advanced risk management technique which includes identifying, evaluating, and mitigating the risks that the Lease-Finance business may face.
Syed Hassan Ali carries with him an experience of 13 years in providing legal guidance and consultancy. He is a holder of two degrees, one in Business Management and the other in Economics for Engineers and Scientists. He carries an in-depth knowledge of the UAE market and continues to be an asset to businesses, providing clarity regarding applicability of the ESR regulations as well as guide them in making informed decisions.