Businesses in the United Arab Emirates (UAE) that are subject to the ESR have to show economic presence commensurate with the volume and variety of major economic activity they engage in. The respective firm has to pass the ESR Test to conserve its economic existence. To do this, the company must generate income from its CIGAs (Core Income Generating Activities), be supervised and governed in the UAE, have enough workers and space, and incur expenses. Whatever the activities businesses execute, they should always focus on adequate substance.
But right now, the great uncertainty is what will ensue if a licensee or exempted licensee does not pass the ESR test. The ESR test is used as a yardstick by businesses to show that their aims are sincere and that, they are not engaging in unfair tax techniques. The National Assessing Authority ( e.g. FTA) will take action and impose ESR penalties if the economic substance test is failed and non-compliant with economic substance regulations.
Fundamental Conditions to Pass the Economic Substance Test
National Assessing Authority decides about the compliance of economic substance regulation to meet up ESR test by analyzing the company’s performance in the following key requirements:
- Regarding the relevant activities that businesses carry out in the United Arab Emirates, the enterprises must undertake Core Income Generating Activities. The Economic Substance Regulations identify the following activities as relevant: insurance, banking investment, budget administration, shipping, lease-finance, intellectual equity firm, holding firm business, etc.
- The businesses are evaluated in the 2nd test to see if they have convened and participated in an acceptable number of board conferences in the United Arab Emirates. Each participant must sign the written minutes of the meeting, which the corporations must keep on file. All participants must be present physically for the meeting to be quorate. Eventually, the administrators must possess the necessary skills and proficiency to carry out their responsibilities.
- Maintenance of sufficient full-time staff that is proficient enough to govern Core income-generating activities is required to pass the Economic Substance Test. They have to present in the UAE physically while doing different activities there.
- While conducting the Core Income Generating Activities, the businesses should have incurred sufficient costs. If the tasks are being outsourced, the 3rd party’s expenses must be sufficient to pass the ESR test.
- To conduct the Relevant activities in UAE, the Licensees must have sufficient physical assets. The property that the Licensee utilized to carry out the relevant activity in the United Arab Emirates may be considered one of the assets.
What will happen if you don’t meet the Economic Substance Test?
If the company fails to meet the fundamental requirements mentioned above, it will ultimately languish in the Economic Substance Test too. In that scenario, you will receive a notification from the Federal Tax Authority via ESR penalty email containing the following details:
- In the relevant Financial Year, the enterprise failed to pass the ESR Test.
- The grounds upon which the FTA found that the enterprise failed the test.
- The amount of the fine levied against the corporation for failing the Economic Substance Test.
- The deadline for paying the fine.
- The steps businesses must take to pass the test.
A corporation that fails the ESR test in a relevant financial year will be fined ranging from 10,000 dirhams to 50,000 dirhams by the regulating body. Companies that fail the exam in the following year will be subject to fines ranging from 50,000 dirhams to 300,000 dirhams. The actual amount of the sanction will be specified in a notice issued by the National Assessing Authority, and it must be paid within thirty days of the notification’s issuance. It’s important to know that you also have the right to file an appeal against the imposed penalty upon the fact the supposed penalty is not liable. You can also question the amount of sanction.
You may also like: How to Submit Economic Substance Regulations Appeal Request?
Furthermore, it is not a good impression that a business is failing ESR regulation tests and is receiving penalties. This can affect the reputation of the business in the market and the eyes of its customers. Hence, businesses should always do their best to comply with business regulations in the UAE such as ESR regulations.
Choose the Best ESR Consultants
Economic Substance Regulations in UAE is introduced to stop unfair tax practices and meet international standards of the economy. To pass the economic substance test companies have to make sure that, they are pursuing relevant activities. Failure in that attempt results in penalties that may cause a great loss for your business. To avoid these penalties, firms need the service of professional ESR consultants. This is why we are here. We assess whether you are fulfilling all requirements to clear the ESR test or not. We also bestow strategic suggestions to deal with the failure in the Economic Substance test.
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.