In adherence to the Inclusive Framework of the Organization for Economic Cooperation and Development (OECD) and the European Union Code of Conduct Group on Business Taxation, the United Arab Emirates (UAE) enacted the Economic Substance Regulations (ESR) through Cabinet of Ministers Resolution No. 31 of 2019 on April 30, 2019. This resolution was subsequently amended and replaced on August 10, 2020, by Cabinet of Ministers Resolution No. 57 of 2020 (ESR Regulations). The introduction of the Economic Substance Regulations in the UAE is aimed at ensuring that the country maintains a duly represented economic presence corresponding to the economic activities conducted within the region.
Economic substance regulations in UAE
Economic substance regulations in UAE focus on preventing harmful tax practices by enforcing the local companies operating in the country as well as in the free zones to follow UAE’s laws on business taxation.
The regulations apply to an entity based on its specified ‘relevant activities’. These cooperate entities are required to inform the regulatory authorities regarding their activities in the form of economic substance notifications which is later followed by an economic substance report. Failure to comply to The Economic Substance Regulations in UAE will result in penalties and the companies can even end up having their commercial or trade license revoked.
Entities are required to follow The Economic Substance Regulations (ESR) In UAE
Any cooperate entity or a partnership that earns a significant amount of income by performing any of the relevant activities in UAE must adhere to the ESR regulations. An exempted Licensee however may be excluded to fulfilling certain requirements of ESR such as a substance test.
According to Article (1) of the ESR Regulations a Licensee can be defined as:
- A juridical person (incorporated inside or outside the State)
- An Unincorporated Partnership
that carries on a Relevant Activity in the state, including a Free Zone and a Financial Free Zone
Certain companies are excluded by the ESR Regulations to meet the requirements of economic substance test. The registered entities that carry out a certain relevant activity may be:
- An Investment Fund
- An entity that is tax resident in a jurisdiction other than the UAE
- An entity wholly owned by UAE residents
- A Licensee that is a branch of a foreign entity the Relevant Income of which is subject to tax in a jurisdiction other than the State
All onshore, free zone, and other commercial entities that engage in one or more of the following “Relevant Activities” are subject to the Economic substance regulations in UAE.
- 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.
Each Relevant Activity has a specific definition and criteria that determine whether or not a business falls within its scope.
ESR compliance obligations enforced by regulatory authorities
Any cooperate entity carrying out “Relevant activities” is required to comply to ESR regulations, which are enforced by the regulatory authorities. Failure in complying to the regulations can result in a penalty or license suspension.
- Economic substance notification
If a company has carried out a relevant activity and earned a certain amount of income from it, it is required to submit an annual notification form to the Regulatory Authority in UAE. This applies to all of the companies even if they are exempted from ESR regulations.
- Economic substance test
The Economic Substance Test is the key indicator showcasing whether a cooperate entity has an appropriate economic presence in UAE compared to the Relevant Activity it performs.
- Economic substance report
In order to exhibit that the cooperating entity has met the criteria of the Economic Substance Test for each of the relevant activities that they have undertaken, they must submit an annual Economic Substance Report unless they are exempted from ESR regulations.
- Document retention requirement
The cooperating entity is required to retain the records and documentation of all the relevant information that is required by a Licensee to fulfill the criteria of obligations according to the ESR Regulations. The documentation should be retained from the end of the company’s financial year up to at least six years.
Penalties enforced by the regulatory authorities for Non-compliance
If an entity fails to comply with the obligations imposed upon it according to the Economic Substance regulations in UAE, it will lead to the following consequences:
- AED 10,000 – 300,000 as a penalty
- An administrative penalty
- Withdrawal or suspension of commercial or trade license
This includes the first failure in exhibiting the appropriate economic substance in UAE of a financial year and the second failure in providing information to foreign competent authorities of a parent company which is the ultimate beneficial owner or parent company.
To sum up, the Economic Substance Regulations (ESR) in the UAE, instated in accordance with the Inclusive Framework of the Organization for Economic Cooperation and Development (OECD) and the European Union Code of Conduct Group on Business Taxation, are actively enforced. Regulatory authorities are tasked with overseeing the implementation of these regulations, establishing specific benchmarks and criteria that companies must meet. Non-compliance may result in penalties, license suspension, or revocation.