In the earlier part of 201, the Cabinet of Ministers in the UAE announced the release of Resolution No 31 of 2019 (Resolution), which was regarding the Economic Substance Regulations (ESR) that would be applicable with immediate effect.
ESR was introduced to make sure that all the companies that are conducting their business in the UAE, pursuant to the trade license gained from relevant authorities, comply with the Economic Substance Test. The resolution offers useful and important guidelines and parameters to perform any such substance tests.
This particular resolution is also a move to meet the EU’s obligation to remove UAE from the EU black list. EU has had a list of non-co-operative jurisdiction aimed for tax purposes. Consequently, on 10 October 2019, the EU has struck off UAE’s name from its black list.
Where is it applicable?
- ESR is applicable to all UAE companies who have gained a trade license or permit from relevant authorities to perform ‘Relevant Activity,’ which includes the Free Zone and also the Financial Free Zone.
- Nonetheless, this resolution would not be applicable to the companies that are owned by the Government of the state, other Government authority or body, or Emirate of the state directly or indirectly.
Relevant businesses and their core income-generating activity
| Relevant Business or Activity | Core Income-generating Activity |
| Shipping |
|
| Holding Company |
|
| Banking |
|
| Insurance |
|
| Investment Fund Management |
|
| Lease-Finance |
|
| Headquarter |
|
| Intellectual Property or IP (where IP is patent/non-trade intangible) and it is a High-Risk IP Licensee* |
|
| Distribution and Service Centre |
|
* High-Risk IP Licensee is defined as a licensee who:
- Did not create an IP that is held for business and acquired an IP from any related persons, in deliberation for funding any research and development activities carried out by another person located outside of the UAE and licenses such IP to related persons or generates any income
- Does not perform any research and development activity, or any marketing, branding, or distribution activities as part of main income-generating activity
What are the main parameters for the Economic Substance Test?
Licensee should mandatorily satisfy the below-mentioned criteria to be able to meet the Economic Substance Test in relation to the Relevant Activity:
- Perform the core or key income-generating activities in the UAE
- Licensee should be guided and managed in the UAE
- Required frequency of the Board of Directors meetings to be held in the UAE
- Directors should be having the required knowledge and expertise to carry out their duties
- To hire the required number of qualified and trained full-time employees, or satisfactory outsourcing expenditure spent for third party service providers
- To own the required amount of physical assets in the UAE
Requirement from the compliance point of view
- Notifications to be submitted
Licensee has to notify the authority on following every year:
- Whether or not it is performing the Relevant Activity
- If yes, then the gross income for the Relevant Activity depends on the tax outside the UAE
- If the financial year is followed by the licensee
- Reports to be submitted
If the licensee is performing the Relevant Activity, then it is needed to submit a detailed report every year within 12 months from the end of that Financial Year, detailing all the operations-related information, which includes but is not limited to employee details such as their experience, qualifications, type of contract, duration of employment, etc. and also detailed information on intangible details of the licensee.
What are the various offenses and penalties that are prescribed?
The resolution has recommended the following offenses and their penalties as mentioned here:
| Offenses | The related penalty |
|
Failure to comply with the Economic Substance Test | AED 10,000 – AED 50,000 (First Year) |
| AED 50,000 – AED 300,000 (Subsequent Year) | |
| Failure to give the required information or provide inaccurate information | AED 10,000 to AED 50,000 |
However, before a penalty is levied, the relevant authority should issue a notice (that is, giving an opportunity of being heard) to the licensee.
In addition, the authority can neither decide the economic substance test of the licensee nor levy any penalty after 6 years from the end of that financial year (an exception is only if there is deliberate misrepresentation or any fraudulent action done by the licensee or any other individual)
What lies ahead?
- The UAE has announced Country-by-Country-Reporting (CbCR) Regulations recently, which are in line with its commitment for implementing the Base Erosion and Profit Shifting (BEPS) standard for Action Plan 13. After the introduction of ESR, UAE has been able to send a positive signal to the rulers of its trade partners located in the other jurisdictions.
- Additionally, announcement of these regulations have already aided the UAE in striking off their names from the EU blacklist. However, the execution and implementation process of these regulations in the UAE, could pose some challenges as it does not have any taxation related law till date.
- In spite of the regulations offering some very useful guidelines, the licensees will need a lot of judgment professionally to decipher if a particular activity meets the substance test or not.
- The above-mentioned regulations also bring out extra compliance requirements on part of the licensee and all the businesses operating in the UAE who are still struggling with the GST-related issues and compliances in the area.
Multinational companies are recommended to be pro-active and reconsider their current operational activities to alleviate and avoid any probable risk of non-compliance with regards to the above regulations.
