In April 2019, the U.A.E. Ministry of Finance announced Cabinet Resolution No 31 of 2019 (Resolution) on Economic Substance Regulations (ESR). The regulation is an element of Kingdom’s commitment to the OECD inclusive framework.
As per the regulations, the U.A.E. onshore and free zone companies along with other U.A.E. businesses (collectively known as Licensee) that conduct any of the listed ‘Relevant Activities’ to maintain an acceptable economic presence in the country related to the activities.
In continuance to the above, the Finance Ministry of U.A.E. recently published a list of 41 Frequently Asked Questions (FAQs) for addressing the apprehensions of impacted companies in relation to ESR. Along with listing down the FAQs, the Ministry has also offered valuable guidance on what steps a Licensee should take before the end of a specific financial year to be able to meet the compliance requirements related to the regulations. As per the stated guidance, a Licensee should –
- Evaluate what Relevant Activities were being or are likely to be conducted during the financial period while applying a ’substance over form’ approach;
- Evaluate the amount and type of income that is earned from the Relevant Activity in that financial period;
- Organise board meetings with a particular required number of directors’ present in the U.A.E. document the important minutes of these meetings;
- Investigate all the expenses incurred;
- Study and document main U.A.E.-based assets like premises, which is related to the Relevant Activity;
- Maintain relevant documents like agreements or financial records which support the assets and expenses;
- Examine roles and responsibilities of the staff towards the Relevant Activity;
- Analyse applicable outsourcing agreements;
- Any other facets that may help Licensee to prove adequate Economic Substance in the U.A.E. for a relevant financial period.
|Which is the first reportable financial year?||Regulations apply to financial year that starts on or after 1 January 2019. For a U.A.E. company that follows January to December as their financial year, the first assessable period would become 1 January 2019 to 31 December 2019. But for a U.A.E. company that follows April-March financial year, the first assessable period would become 1 April 2019 to 31 March 2020.|
|Will these regulations only apply to entities in U.A.E. that are part of a global multinational group?||No. The regulations enforce Economic Substance obligations on any U.A.E. business which conducts a Relevant Activity, irrespective of whether the U.A.E. business belongs to a global multinational group. But in case of a U.A.E.-based Distribution Business, Headquarter Business, Service Centre Business, or High-Risk IP Business would remain within the scope of the regulations only if the U.A.E. company or firm is doing transactions with any foreign group companies.|
|Will a company that is registered under an ‘offshore’ free zone company regime be subjected to these regulations?||Yes. Regulation would apply to ‘offshore’ company in case it conducts a Relevant Activity.|
|Do the listed activities on the commercial license regulate whether a Licensee undertakes a Relevant Activity or not?||No. Though the commercial license might define the Relevant Activity, a ‘substance over form’ method should be used to decide whether a Licensee conducts a Relevant Activity and is within the scope of these regulations.|
|What happens if a Licensee does not conduct any Relevant Activity during a specific financial period?||The Licensee would not need to inform its Regulatory Authority nor is it required to submit an Economic Substance return for the applicable financial period.|
|What if a Licensee conducts a Relevant Activity, but is not able to earn any income from the same during a financial period?||Then the Licensee would only be required to submit a notification with the Regulatory Authority. Nevertheless, they would not be needed to file an Economic Substance return for the applicable financial period.|
|If the entire income from the Relevant Activity has been earned from outside U.A.E., then does the Licensee get an exemption from the Regulations?||No, this Licensee will not be exempted from the regulations. Any income from a Relevant Activity for which the Licensee needs to show Economic Substance return in the U.A.E. includes all income, inclusive of income generated by the Licensee outside of the U.A.E.|
|How is ‘adequate’ or ’appropriate’ economic substance defined?||The regulations and directive do not give a minimum standard for what is defined as adequate or appropriate. The Regulatory Authorities are supposed to take a realistic approach while assessing if a Licensee complies with the Economic Substance test, understanding that the type and level of activity of any Licensee might vary during the financial period and also from year to year.|
|Is the Economic Substance evaluated on a Licensee by Licensee basis, or can Licensees who are part of the same group chose to be evaluated on a ‘consolidated’ basis?||No. The regulations do not permit the Licensees who are a part of the same group to be combined for Economic Substance purposes. All the Licensees would have to comply with the regulations, and validate Economic Substance on an individual basis.|
|Are conditions for directed and managed applicable to Holding company business?||A Holding Company Business is not needed to be directed and managed in the U.A.E.; only exception is when this is a condition for the relevant licensing authority.|
|Is it necessary for the employees who conduct Core Income Generating Activities (CIGAs) to be the residents in the U.A.E.?||Yes, the employees who conduct the CIGAs of a Licensee would, be needed to be residents in the U.A.E. Any non-resident employees or other individuals would be counted towards the Economic Substance of a Licensee in the U.A.E. only if:
|Is it necessary the directors of the Licensee need to be resident in the U.A.E.?||No. Directors only need to be physically present in the U.A.E. to attend pertinent board meetings of the Licensee.|
|Can CIGAs or any other related activities be outsourced by the Licensee?||A Licensee is allowed to outsource any or all of its CIGAs as long as the outsourced activities are conducted in the U.A.E. However, a Licensee is not permitted to outsource activity of being supervised and managed, as the Licensee itself is needed to show oversight and control of the Relevant Activity in the U.A.E..
Activities that are not defined as CIGAs (like back office functions) could be outsourced to people located outside U.A.E. without negatively affecting the Economic Substance of the Licensee in the U.A.E..
|Are investment funds dependant on the Regulations as a Holding Company Business?||No. An investment fund is not deemed as a Holding Company Business.|
|Is lending to any other group entity deemed a Lease-Finance Business?||Yes, a U.A.E. company that offers a loan or provides some other form of credit to a U.A.E. or any other international group company for deliberation, for example, interest would be deemed as engaged in a Lease-Finance Business.|
|Is doing investment and trading in debt securities deemed as undertaking a Lease-Finance Business?||No, all the U.A.E. company that invest and hold bonds or other debt securities which are traded on a regulated exchange are not deemed as engaged in a Lease-Finance Business.|
|What happens if there is no consideration payable for the credit given?||The Regulations are not applicable to credit and other financing and leasing provisions where there is no anticipation of consideration in the form of fees, interest, rental payments, capital gains or any other such form of payment. The grant of security which is in favour of the lender does not constitute consideration.|