The UAE Economic Substance Rules (ESR) in the UAE – Does it impact you?
From 01/01/2020 onwards, entities within the scope of the rules are required to give in their economic substance declarations to their pertinent regulatory authority, and may be needed to meet an Economic Substance Test. In this article, you’ll explore the UAE Economic Substance Rules (ESR). And does it impact you?
The Regulations apply to UAE onshore and Free Zone companies, branches, partnerships, and other UAE business forms that run any of the following businesses
- Investment fund management
- Holding company
- Intellectual property
- Distribution and service center
A “substance over form” approach is to regulate whether a Licensee commences a pertinent activity and is in the scope of the laws. This means looking outside what is stated on its commercial license to the activities that are undertaken by the Licensee.
It is important to note that Free Zone companies are not exempted from the Regulations. However, licensees that are directly or indirectly at least 51% possessed by the Federal or an Emirate’s Government, or a UAE Government body or authority, are exempted.
The Regulations apply to financial years beginning on or from January 1, 2019.
Declarations must be given within 12 months from the relevant financial year’s ending. For Licensees with a financial year ending on 31/12/2019, a declaration must be made by 31/12/2020.
The Regulations apply regardless of whether the licensee is from a foreign multinational group. If one earns an income from a relevant activity outside of the UAE, they aren’t exempt from the regulations either. Income from a relevant activity for which the Licensee needs to validate economic substance in the UAE comprises all income, with income that is generated by the Licensee outside of the UAE.
Businesses vary in size and nature, and what is adequate and appropriate will depend on the nature and level of activities, and the level of income earned by the Licensee.
The Regulations and guidance provided to date do not provide a “minimum” standard for what is considered acceptable. The regulatory authorities are likely to take a realistic approach when assessing whether a Licensee has met the Economic Substance Test, recognizing that the type and level of activity of a Licensee, as it may differ during the tenure of a financial period and from year to year.
However, there are new exemption categories as mentioned below
- Investment funds
- Entities that are wholly owned by UAE residents and which are not part of a multinational enterprise group and which only carry out their activities in the UAE
- Entities that are a tax resident outside of the UAE
- Branches of foreign parent companies where the relevant income is subject to tax outside the UAE.
Most government-owned entities are no longer excused, unless they come within one of the updated exemptions of the New ESR.
If you are a Licensee and wish to apply for the exemption you are required to provide evidence that your entity is suitable for that exemption.
Below are a few things you need to be mindful of before filing.
Separate notifications need not be filed by UAE companies
The New ESR identifies UAE branches of a UAE company that don’t have separate legal personalities from their parent or head office. Therefore, if you are a branch of a UAE parent entity and are registered in the UAE, you no longer need to file distinct notifications. All that’s required is a single notification concerning the Relevant Activities of your UAE parent company together with all your UAE branches.
Modified reporting requirements for UAE companies with non-UAE branches
If you are a UAE company that conducts a relevant activity only through a branch registered outside the UAE, your UAE company doesn’t need to report and validate economic substance in situations where the income made through the branch is taxed in the overseas jurisdiction where the branch is listed.
Hassle-free reporting requirements for foreign companies with UAE branches
If you are a foreign company with a branch office registered in the UAE, then you are not required to demonstrate economic substance under the New ESR, provided that the income earned by your branch’s activities, that would theoretically fall into a relevant activity category, is subject to tax in your overseas jurisdiction.
Increase of Penalties
The penalties under the New ESR have been amplified, including the administrative penalties for non-compliance, which are now between AED 20,000 and AED 50,000. Failure to meet the economic substance test of your business results in a penalty of AED 50,000. Suspension or non-renewal of your license are other penalties you may face.
What happens next?
It’s important to note that all Licensees (including exempted Licensees) are needed to file notifications on the new online portal once it’s available, regardless of whether they have already submitted notifications for the 2019 financial year under the old legislation.
Your next steps
If you have a UAE business – including entities registered in Free Zones and offshore entities – we recommend you re-assess whether you qualify as a Licensee or an exempted Licensee as soon as possible. Together with this, urgently reconsider if you’re carrying out an appropriate activity under the New ESR and new guidance. Doing so will allow you to make the appropriate compliance filings when the new filing portal becomes available.
Given that the end of the 12-month period following a Licensee’s 2019 financial year is forthcoming for many entities, we also recommend that you look beyond the first stage notification filing. If your UAE entity qualifies as a Licensee, has conducted a relevant activity, and derived income from the same in the reporting period, it would be practical to start preparation of the documents and information required to demonstrate how the economic substance test is met.
If any gaps are identified, it’s crucial for you to plan and implement a mitigation strategy to safeguard compliance and avoid severe consequences in the future.