The Economic Substance Regulations in the United Arab Emirates (UAE) applies to all licenses carrying the relevant activities in the Emirates, including the licensee in the free zone and economic free zone. Before getting into the depth, let us first understand what does substance mean?
The term' economic substance' refers to the requirement of an entity to have a physical-economic presence in the jurisdiction it is established to qualify for the benefits of a tax treaty. Substance attached to structures has become the main theme in regulatory tax circles at all levels – domestic (anti-avoidance provisions), regional (EU's belligerent tax planning and harmful tax competition) and global (OECD's base erosion and profit shifting, or BEPS). While the idea of substance has yet to be officially executed in any treaty, it stands behind connected concepts of residence and beneficial ownership, and in practice institutes the safeguard instrument of choice of governments wishing to avert treaty shopping. It is therefore paramount for UAE businesses involved in international operations to be aware of the notion of "economic substance", to prevent and counter the risk of a potential challenge over tax residency.
Who is Subject to the Regulations in the UAE?
The Regulations apply to all the UAE mainland and free zone companies that carry on a "Relevant Activity". It is yet to be long-established whether the Regulations will also apply to sole proprietorships and branches. Still, we expect entities incorporated under offshore (free zone) company's regulations that carry on a "Relevant Activity" to be within the possibility of the Regulations.
Entities that are directly or indirectly maintained by the UAE government (both federal and local) are expressly omitted from the Regulations. On this basis, the UAE sovereign investment funds and other UAE government-related entities would not need to meet the UAE economic substance requirements.
What are the Economic Substance Requirements?
To satisfy the economic substance requirements concerning a Relevant Activity, a Relevant Entity must:
- Conduct the relevant "core income-generating activities" in the UAE
- Be "directed and managed" in the UAE; and
- Regarding the level of activities performed in the UAE:
- Have a satisfactory number of qualified full-time employees in the UAE
- Incur a satisfactory amount of operating expenditure in the UAE
- Have satisfactory physical assets in the UAE
A Relevant Entity that only commences a Holding Company Business will be subject to less severe economic substance requirements. Supplementary requirements apply if a Relevant Entity carries out "high-risk IP related activities". If a Relevant Entity carries out more than one Relevant Activity, the economic substance requirements must be met for each of the Relevant Activities.
Which are the Relevant Activities?
The subsequent list is considered as "Relevant Activities" under the Regulations:
- Fund management
- Holding company
- Intellectual property (IP)
- Distribution and service centre
What are the Reporting Requirements?
A Relevant Entity will be obligatory to report certain information on its Relevant Activities on a yearly basis to the relevant regulatory authority (being the authority that issued the trade license to the Relevant Entity). Failure to fulfil would result in administrative penalties
Existing entities (with an existing trade license in the UAE on the effective date of the Regulations, being 30 April 2019)
Must conform with the Regulations from 30 April 2019, with the first return due in 2020
New entities (an entity that receives a trade license on or after the effective date of the Regulations, being 30 April 2019)
Must conform with the Regulations upon receiving its trade license, with the first return due in 2020 (or later)
The introduction of this substance requirement regulations comes into the picture after countries like Bermuda, Cayman Islands, Mauritius issued similar regulations. The introduction confirms the UAE's commitment to addressing distresses around the shifting of profits derived from certain mobile business activities to "no or nominal tax jurisdictions" without conforming local economic activities.
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Does freezone businesses have to file Economic Substance Regulation?
Yes. Freezones, UAE Onshore, branches, partnerships etc have to apply ESR.
Who has to file Substance ESR?
Organisations dealing with the following need to file ESR
When Economic Substance Regulations needs to be declared?
Declarations must be made by the end of the relevant financial year.
How is adequate or appropriate economic substance determined?
It depends on the scale of the business, activity and income.
Does the regulation apply to foreign multinational groups?