ECONOMIC SUBSTANCE REGULATIONS OVERVIEW
Following the Introduction of Value Added Tax in the year 2018, the UAE came up with another update to its Tax regime with the introduction of Economic substance Regulations (the regulations) in the year 2019.
Let us discuss some important aspects of these regulations.
ECONOMIC SUBSTANCE REGULATIONS
The Economic Substance Regulations (the regulations) of the UAE require UAE onshore and free zone companies and certain other business forms that carry out any of the defined “Relevant Activities” to maintain and demonstrate an adequate “economic presence” in the UAE relative to the activities they undertake (“Economic Substance Test”).
INTRODUCTION OF ESR
The Introduction of the Regulations took place in phases, with necessary updates and amendments in the form of Ministerial DEcesions and Guidelines, which were issued from time to time, in the following sequence :
- 30 April 2019 - the UAE issued Economic Substance Regulations (Cabinet of Ministers Resolution No. 31 of 2019), (the “Regulations”).
- 11 September 2019 – A guidance Note on the application of the Regulations was issued, and Cabinet Decision No. 58/2019 on the Determination of Regulatory Competencies lists the Regulatory Authorities tasked with administering and enforcing the Regulations.
- 10 August 2020 - Amendments to the Regulations were made by the Cabinet of Ministers Resolution No. (57) of 2020.
- 19 August 2020 - updated Guidance was issued – (Ministerial Decision No. (100) of 2020)
- First Financial Year – The Regulations apply to financial years commencing on or from 1 January 2019.
NEED OF ESR
Now that we noted when and how the ESR got introduced in the UAE let us also understand what factors led to the introduction of these regulations in the UAE! What is the objective of the UAE Government behind imposing the compliance requirements on the UAE Businesses under these regulations?
Well, The ESR regulations were issued pursuant to the global standard set by the Organization for Economic Development ‘’ÓECD” Forum on Harmful Tax Practices, which requires Entities undertaking geographically mobile business activities to have substantial activities in a jurisdiction
The Cabinet of Ministers enacted the ESR Regulations considering the relevant standards developed by the OECD and the EU COCG. The Objective of this Resolution is to determine the requirements and set out the criteria that confirm that a Licensee is carrying on an activity in the State that has Economic Substance.
So, to prevent Harmful Tax Practices, to adhere to the European Union Code of Conduct on Business Taxation, and as a commitment to OECD Inclusive Framework, UAE Introduced the Economic Substance Regulations
APPLICABILITY OF ESR
IS ESR Applicable to all the businesses registered or operating in the UAE? To answer this question, the regulations have clearly specified that only businesses that carry out Relevant Activities will be regarded as Licensees. Therefore, the ESR regulations are to be complied with by the entities falling under the definition of Licensees defined under the regulation.
Let us look at the definition of “Licensee “ –
Licensee: Means any of the following two entities:
(a) a juridical person (incorporated inside or outside the State); or
(b) an Unincorporated Partnership; registered in the State, including a Free Zone and a Financial Free Zone, and carries on a Relevant Activity.
Therefore, businesses have to evaluate their business activities vis-à-vis the Relevant activities defined under regulations and accordingly determine their compliance requirements
Relevant activities include the following:
- Banking Businesses
- Insurance Businesses
- Investment Fund Management Businesses
- Lease-Finance Businesses
- Headquartered Businesses
- Shipping Businesses
- Holding Company Businesses
- Intellectual Property Businesses
- Distribution and Service Centre Businesses
Cabinet of Ministers resolution no. 57 of 2020 concerning economic substance requirements also specifies the Core Income Generating Activities for each of the relevant activities.
Download the Relevant activity summary table.
EVALUATION OF THE ESR APPLICABILITY
Entities are expected to use a ‘substance over form approach to determine whether or not they undertake a Relevant Activity and, as a result, will be considered Licensees for the purposes of the ESR Regulations, irrespective of whether such Relevant Activity is included in the trade licence or permit of the Entity.
Below are the steps an entity may generally follow for the ESR applicability assessment
- Understand whether the Entity meets the definition of a ‘Licensee’ as per ESR Law, and
- Evaluate and review the business activities to determine if the business activities fall under the scope of one or more ‘Relevant Activity’ mentioned above.
As per the regulations, an entity is not required to meet the Economic Substance Test and file an Economic Substance Report for any financial period in which it has not earned income from a Relevant Activity or if it meets the conditions for being exempt.
So let us see the definition of Exempted Licensee –
Exempted Licensee: means any of the following:
(a) a Licensee that is an Investment Fund;
(b) a Licensee that is a tax resident in a jurisdiction other than the State;
(c) a Licensee that is wholly owned by one or more residents in the State and meets the following two conditions :
- it is not part of an MNE Group; and
- it only carries out business in the State.
(d) a Licensee that is a branch of a foreign entity, the Relevant Income of which is subject to tax in a jurisdiction other than the State; and
(e) any other Licensee as determined pursuant to a decision of the Minister of Finance
Depending on the Review of the Business Activities of an entity for the given reporting financial year, it can determine :
- Whether it has carried on a Relevant activity during the year;
- Whether it meets the definition of Licensee and
- Whether it is an exempted Licensee or not
Based on this assessment, a Licensee or an exempted Licensee has to meet the compliance requirements as set out in the regulations
TIMELINES FOR FILLING ESR NOTIFICATION AND REPORT
Entities that are within the scope of the Regulations are required to submit an annual Notification form to their Regulatory Authority and complete and submit to the same Regulatory Authority an Economic Substance Report as per the below-mentioned timeline –
- A Licensee or an exempted Licensee shall file the Notifications within six months from the end of the relevant financial period in which the Relevant Activity was carried out; and
- A Licensee shall file Economic Substance Reports within 12 months from the end of the relevant financial period in which the Relevant Activity was carried out.
FAME ADVISORY’s ESR SERVICES
We offer the following services concerning ESR regulations implementation:
1. Impact Assessment:
We help business entities assess Business Activities based on Relevant Activities defined under the Economic Substance regulations.
2. Gap and remediation investigation
We provide support in determining whether the Entity under review meets the criteria of the Economic Substance Test and advising the correct measures to be taken in case there are any gaps with regard to Expenses, premises, employees and the decision-making process.
3. Compliance / Reporting
We also offer services for the following:
- Timely submissions of ESR Notifications for Licensees and Exempted Licensees
- Timely submission of ESR Reports for Licensees
- Filing of ESR Appeals against administrative penalties levied
- Assistance in addressing the ESR Audits conducted by National Assessing Authority.’
HOW CAN FAME ADVISORY ASSIST YOU FOR ESR
Our expert ESR panel can help you perform Impact assessment, gap, and remediation investigation and assist in filling ESR notifications, ESR reports, and appeals against administrative penalties. We have so far filled 250+ ESR Notifications, 135+ ESR reports and 10+ ESR Appeals with a 100% success rate.