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 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.
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:
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:
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.
Each Relevant Activity has a specific definition and criteria that determine whether or not a business falls within its scope.
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.
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.
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.
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.
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.
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:
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.
Read More: Impact of UAE Economic Substance Regulations on International Businesses