According to the Cabinet of Ministers Resolution (no. 31, 2019), on the 30th of April, United Arab Emirates enforced Economic Substance Regulations (Resolution no. 31) for being an active member of the Organization for Economic Cooperation and Development (OECD), and for enhancing the tax framework of the UAE. These ESR regulations were only amended once in August 2020 (Cabinet of Ministers Resolution, no. 57, 2020). These regulations have been enacted by the government of the UAE in accordance with the standards introduced by the EU COCG (European Union Code of Conduct Group) and OECD. The purpose of these regulations is to make the free zone, onshore and some other businesses in the UAE validate their economic presence and actively perform their relevant activities in the UAE. In addition to this, these regulations aim to control illegal tax practices.
Terms to Know
To understand Economic Substance Regulations better, there are some terms that one needs to know. The Ministerial Decision no. 100 of 2020 explains the valid definitions of the following terms;
Licensee: A licensee is defined as a body that is a juridical entity incorporated outside or inside the UAE or a partnership that is unincorporated. A licensee is always registered in the UAE financial free zone or free zone and performs one more than one of the relevant activities. Unincorporated partnerships are those entities that perform a relevant activity in the UAE but do not have a separate legal identity. Similarly, branches are also not considered as separate legal identities and are considered as extensions of the main head office.
Exempted Licensee: ESR in UAE excludes some licensees from the condition to meet the ESR test. These entities are termed as exempted licensees. Exempted licensees execute relevant activities under the registration of the UAE. Following are some examples;
- An exempted licensee can be an investment fund.
- It can be an entity that is a taxpayer in any jurisdiction besides the United Arab Emirates.
- An entity that is completely owned by the residents of UAE can be an exempted licensee if and only if it does not work with any MNE Group and executes its relevant activities within the UAE.
- A branch in UAE whose parent office is in another country can be an exempted licensee only if it pays tax in a jurisdiction of the country where the head office is present.
According to ESR UAE, exempted licensees are required to submit the evidence for being exempt with the notification to the regulatory authority otherwise it will not be considered as an exempted licensee by the authority. An entity that considers itself exempted needs to submit one of the following for every financial year;
- Certificate or letter from the authority of the jurisdiction of whom the entity is a tax resident which should state that the particular entity is the tax resident of a particular jurisdiction.
- Any evidence of income tax payment or demand or any document given by the jurisdiction besides UAE.
First Financial Year: All licensees in the UAE whether exempted or not are required to report for their first financial year either (a) starting from 1 January 2019, or (b) the date of commencement of business if they started executing a relevant activity after 2019.
Relevant Activity: Relevant Activities are the set of activities introduced by Ministerial Decision no. 100. Any entity that performs one or more than one of the relevant activities will need to comply with the Economic Substance Regulations UAE. The ESR expects the entities to utilize a ‘substance over form’ principle to find if they fall under the scope of ESR regulations. According to this, if an entity performs a relevant activity then it will be subject to ESR no matter if it is not included in the permit or trade license of the business. If an entity executes more than one relevant activity in a single financial year then the demonstration of the economic substance of each activity separately is required. Moreover, it is not important to generate maximum active income from a relevant activity within a single financial year. Generating any passive income from relevant activities will subject the business to ESR regulations. Following are these relevant activities;
- IP or Intellectual Property Business
- Shipping Business
- Headquarters Business
- Investment Fund Management Business
- Banking Business
- Service Centre Business
- Holding Company Business
- Lease/Finance Business
- Insurance Business
Relevant Income: According to ESR, relevant income is defined as the total of the gross income of the entity generated by a relevant activity as kept in the accounting records with respect to the standards of bookkeeping and accounting. This income is irrespective of whether it was generated outside or inside the UAE and whether it brought loss or profit to the business. The income generated by all the Core Income Generating Activities of a business is included in relevant income.
Economic Substance Test
The licensees that perform relevant activities and generate active or passive income from that activity are subjected to the economic substance test. The economic substance test aims to demonstrate the adequate economic substance of a licensee in the UAE within a relevant financial year. However, if an entity has not earned any relevant income in a financial year then it does not need to meet the ESR test.
Economic Substance Notification
Any entity that falls under the scope of ESR needs to file the notification to the regulatory authorities. The regulatory authorities are different for different relevant activities. All the licensees file the notification whether they are exempted or not. The regulatory authorities acquire important pieces of information such as the nature of the activity being executed and whether it generates any income or not.
You Should Know: How to file ESR Notification in UAE?
Economic Substance Report
The licensees who meet the ESR test submit the economic substance report which includes all the documentation and other information as required by the ESR regulations. The report needs to be submitted 12 months before the year-end date of a financial year.
See more about : Economic Substance Reporting in UAE
Choose the Best Service
If you want to learn more about the ESR in UAE, let our experts guide you at hand. If your business wants to meet the ESR test, submit the ESR notification or report, consult our expert service providers to help you throughout the procedure. The procedures of ESR can be challenging and difficult, let our experts at Economic Substance Regulations make it easy for you.
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.