The Economic Substance Regulations (ESR) require UAE companies to establish a substantial “economic presence” within the country, aligning with global standards outlined by the OECD and guidance from the European Union Code of Conduct Group on Business Taxation. The primary aim of the ESR is to address unfavorable tax practices within the UAE. This article will delve into a comprehensive analysis of the ESR and its criteria for businesses operating in the UAE.
Who is subject to UAE Economic Substance Regulations?
The UAE economic substance rules apply to both UAE business organizations and international corporations having a permanent base in the UAE, provided they engage in any of the specified “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
Requirements for Economic Substance Regulations
The ESR outlines the subsequent criteria that a corporation must fulfill to exhibit economic substance in the UAE:
1. Meet the Economic Substance Test
The economic substance test comprises a set of requirements that enterprises in the UAE must fulfill to prove their adequate economic substance. The test necessitates businesses to demonstrate the following criteria:
- Carried out essential core income-generating tasks in the UAE
- Worked under the supervision and management of UAE-based individuals
- Maintained a sufficient number of competent full-time workers in the UAE
Had sufficient operational spending in the UAE - Possessed sufficient physical assets in the UAE
2. Core Income-Generating Activities (CIGA)
The CIGAs refer to the key activities that are crucial for a firm to generate money from its core operations. The CIGAs differ based on the specific activity and are outlined in the ESR. For instance, the critical activities for a banking enterprise encompass the acquisition of money, risk management, loan provision, and capital management. Intellectual property businesses engage in CIGAs such as R&D, marketing, branding, and sales.
3. Directed and Managed in the UAE
To establish economic substance, a firm must be directed and managed in the UAE. Consequently, the firm is required to establish a board of directors that convenes in the United Arab Emirates (UAE) regularly and ensures that there is a sufficient number of directors who are physically present in the UAE to constitute a quorum. Written minutes of the board meetings must be documented and signed by the attending directors. The minutes of the board meetings should document the formulation of strategic choices related to the relevant activity discussed at the board meeting. The directors of the organization must possess the appropriate expertise and abilities to fulfill their responsibilities.
4. Adequate Number of Qualified Full-Time Employees
To establish economic substance, a firm in the UAE must employ a sufficient number of competent full-time staff members. How many workers are needed will depend on what the job is and how big the company is. To perform the CIGA, the staff members must be qualified and experienced. Companies or third-party service providers can hire staff.
5. Adequate Operating Expenditure
In order to establish economic substance, a corporation must have sufficient operational expenditure that is generated within the United Arab Emirates. The operational expenses must be spent inside the borders of the United Arab Emirates in connection with the corresponding activity. The relevant activity’s scope and the organization’s scale will determine the necessary investment.
6. Adequate Physical Assets
When it comes to demonstrating economic substance, an organization must have sufficient physical assets in the UAE. The physical assets may comprise office facilities, factory infrastructure, machinery, and equipment. It is necessary to use the assets in the UAE for the right purpose.
7. Exemptions from ESR
There are certain businesses that are not required to comply with the ESR, which include:
- Businesses having tax residence outside the United Arab Emirates
2. Investment funds together with the companies that support them
3. Foreign businesses’ branches operating in the UAE that are tax residents outside the country but engage in pertinent business there
4. Businesses that operate in the UAE and are not a part of a multinational conglomerate
5. Businesses that are fully owned by citizens of the UAE and engage in pertinent activities there
6. Businesses that simply own shares in other firms and act as holding companies
8. Notification and Reporting Requirements
Entities that fall under the scope of the Economic Substance Regulations (ESR) are required to inform the appropriate regulatory body about their category and provide an annual report on their economic substance. The report should encompass details on the company’s operations, revenue, costs, resources, and personnel. The report must be submitted within a 12-month timeframe following the conclusion of the company’s fiscal year.
9. Penalties for Non-Compliance
Noncompliant companies may be subject to penalties such as fines, license suspension or revocation, and notification to the foreign competent authorities of the ultimate parent business and ultimate beneficial owner of the firm.
Conclusion
For ESR purposes, businesses operating within the UAE are mandated to demonstrate their economic presence in the country under the Economic Substance Regulations (ESR). Comprehending the reporting obligations, economic substance assessment, and pertinent operations is imperative for companies to adhere to the ESR. Engaging consultants specializing in economic substance regulations can aid companies in maintaining compliance. These professionals offer guidance on requisite actions, aid in devising robust policies and procedures, and ensure all documentation meets regulatory standards.
Read More: What are ESR notification and reporting requirements?
