A few months ago, the UAE Cabinet released Resolution No. 31 of 2019 to the Cabinet of Ministers requiring all in-scope UAE institutions engaging in a few operations to have apparent economic substance in the UAE as of 30 April 2019. Companies who do not comply with these regulations could face fines and penalties, suspensions, cancellation or non-renewal of licences and notification of their status to other foreign authorities.
The Economic Substances Regulation in the United Arab Emirates (UAE) extends to all licences carrying on the related activities in the Emirates, including the licensee in the Free Zone and the Legal Free Zone. Let us first explain what substance means before we get into the depths?
The term 'economic substance' refers to the obligation for an individual to have a physical-economic existence in the jurisdiction formed to apply for the benefit of a tax treaty. Substances related structure have been the key trend in regulatory tax circles at all levels – domestic, regional and foreign.
While this idea of substance has yet to be expressly adopted in any treaty, it stands behind the interconnected principles of residency and valuable possession and, in effect, it institutes a safeguard instrument of choice for governments seeking to prevent treaty shopping. It is therefore of utmost importance for UAE companies engaged in foreign activities to be aware of the principle of the "economic material" and to deter and tackle the possibility of a possible tax residence challenge.
The UAE’s Economic Substance Definition
The definition of an economic substance comes from the Center on Harmful Tax Practices of the Organisation for Economic Cooperation and Development. This group is the one that sets the international norm that allows businesses in a jurisdiction to have significant operations. The idea is that instead of registering in a country solely for tax purposes, companies perform business operations in their country of jurisdiction.
In a way to ensure that Emirati-based companies operating in a collection of sectors do not serve to artificially attract revenues that are not commensurate with economic activity in the UAE, the UAE adopted its economic substance regulations.
Companies engaged in banking, investment fund administration, lease financing, insurance, holding companies, shipping, headquarters, distribution and service centres, intellectual property and shipping are the business activities subject to this economic substance screening.
The company would have to conduct three tests to satisfy the criteria for economic substances, which are:
- For the defined economic operation, your business should be guided and controlled within the UAE.
- Within the UAE, the organisation must carry out its CIGA activities.
- Your entity should have a sufficient number of trained personnel, annual operating costs and equipment to carry out its activities.
Why has the UAE Issued the Resolution?
In March 2019, the European Union released an amended list of non-cooperative tax jurisdictions involving the UAE for failing to meet its obligation to comply with the EU's reasonable governance requirements. Since then, the UAE has adopted new regulations in line with Cabinet Resolution No. 31 of 2019, which lays out conditions for companies to have an economic substance or presence in the UAE. The resolution released on 19 June 2018, compliance with the criteria has been in effect since 30 April 2019.
Who is Subject to the Laws in the UAE?
The Regulations extend to all UAE mainland and free zone businesses carrying out a 'Related Operation' It needs to be determined if the Regulations would even extend to sole proprietorships and branches. However, we expect companies incorporated under the offshore (free zone) business regulations that carry out the "Related Activity" to come within the framework of the Regulations.
Entities which are directly or indirectly maintained by the UAE government (both federal and local) are expressly omitted from the Regulations. On this basis, may not have been expected UAE sovereign wealth funds and other UAE government-related institutions to fulfil the criteria of the UAE economic substance.
What are the Economic Substance Requirements?
To satisfy the economic substance conditions about a particular operation, the operation must-
- Conduct the effective 'core income-generating operations' in the nations
- Be focused and controlled in the Emirates, and
- Concerning the level of operations carried out in the UAE
- Have a good number of qualified full-time staff in the UAE
- Incur a fair amount of operating cost in the UAE
- Have sufficient physical assets in the UAE
A relevant organisation that only ventures into a holding firm market would be subject to less stringent economic content criteria. Supplementary provisions apply where a Relevant Entity carries out "high-risk IP related operations." If a business entity carries out more than one Relevant Operation, the requirements for each Relevant Activity shall be fulfilled by the Relevant Entity.
Which are the Relevant Activities?
The following list is considered as "Relevant Activities" under the Regulations:
- Banking
- Insurance
- Fund management
- Lease-finance
- Headquarters
- Shipping
- Holding company
- Intellectual property (IP)
- Distribution and service centre
What are the Reporting Requirements?
They may require a relevant entity to disclose some reports on its Relevant Operations on an annual basis to the appropriate regulatory body (the authority that granted the Trade License to the Relevant Entity). Failure to adhere would result in administrative penalties.
- Existing companies (with a current trade licence in the UAE as of 30 April 2019 as of the date of Regulations)
- Shall comply with the Legislation from 30 April 2019, with the first return expected in 2020.
- Existing agencies (an organisation that receives a business licence on or after the date of entry into force of the Legislation, 30 April 2019)
- Must comply with the Regulations upon receipt of their trade licence, with the first return due in 2020 (or later)
Economic Substance in the UAE
The UAE companies, including those who have already filed ESR notifications, are allowed to file or refile ESR notifications through MoF's dedicated portal. It is mandatory to file an ES report within 12 months of the close of the licensee's financial year.
The UAE Ministry of Finance ( MoF) has released models for alerts and reports. According to the ES notification template, additional details is provided for the following;
- Both divisions of a licensee involved in the related practise.
- Confirm that the licensee follows the criteria of 'restricted licensee' under the current ES Regulations.
- The parent group, the final parent company, and the licensee's top beneficial shareholders
Below are some primary comments on the report;
- Licensees are given a chance to clarify why CIGAs have not been carried out in the UAE (if applicable).
- The same CIGAs are now used in the prototype for all operations but are planned to be corrected later.
- Licensees are expected to make the accounting profit/(loss) along with the 'related profits' received from the operations in question.
- It is mandatory to attach the financial statements along with the survey, but there is little clarification as to whether or not these accounts need to be audited.
- Licensees must establish their primary/primary regulatory authority, which becomes complicated as the licensee carries out several related operations, which are regulated by separate regulatory regimes.
- Detailed information is given concerning all the outsourcing companies.
- Information regarding the holding corporation, the ultimate parent company and the top beneficial owners of the licensee, shall be given.
- Differences in the information contained in the notice, along with the explanations for it, is provided in the report.
- Licenses can also contain any additional paperwork and evidence required to show the substance if they so wish.
Last year, the UAE adopted Economic Substances Regulations. The Laws apply to financial years beginning on or after 1 January 2019. Entities that come under the scope of the Regulations are expected to send an annual notice form to their Regulatory Authority. It must be completed and submit an Economic Substances Report to the same Regulatory Authority within twelve months of the end of their financial year Failure to adhere to the Regulations which result in huge penalties.
There have been several amendments to the rules and regulations on economic substances in the UAE. The UAE Cabinet of Ministers recently released Cabinet Resolution No. 57 of 2020 which contains a collection of revised rules, and all licensees in the UAE are expected to reassess their existing ESR classifications and to conform them accordingly with the new regulations. To know more in detail, click here.
How Can We Help?
The implementation of the Regulations in the UAE brings the country into line with other jurisdictions that have recently adopted laws on economic substances, such as Bermuda, Cayman Islands and Mauritius. It confirms the willingness of the UAE to resolve questions about transferring revenues from certain mobile market operations to 'no or nominal tax jurisdictions' without a local economic counterpart. It can also be seen as optimistic progress by the Emirates towards fulfilling the conditions of the EU to be excluded from the EU list of non-cooperative jurisdictions for tax purposes.
The Regulation would have a small effect on UAE – headquartered companies and international multinationals with some commercial and management activities in the UAE. For companies that conduct related operations in the Emirates but are operated remotely, should reassess the governance system and operational model in the context of the conditions for the economic content of the Emirates, and should make any appropriate changes to ensure compliance with the Regulations.
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