Economic Substance Regulations, ESR
As part of the UAE's commitment as a member of the OECD Inclusive Framework, and in response to an assessment of the UAE's tax framework by the European Union Code of Conduct Group on Business Taxation, the UAE issued Economic Substance Regulations (Cabinet of Ministers Resolution No. 31 of 2019), (the "Regulations") on 30 April 2019. Guidance on the application of the Regulations was issued on 11 September 2019 (Ministerial Decision No. 215 of 2019), and Cabinet Decision No. 58/2019 on the Determination of Regulatory Competencies lists the Regulatory Authorities tasked with the administration and enforcement of the Regulations. Amendments to the Regulations were made by Cabinet of Ministers Resolution No. (57) of 2020 on 10 August 2020, and updated Guidance was issued on 19 August 2020 (Ministerial Decision No. (100) of 2020 The Regulations require UAE onshore and free zone companies and certain other business forms that carry out any of the defined "Relevant Activities" listed below to maintain and demonstrate an adequate "economic presence" in the UAE relative to the activities they undertake ("Economic Substance Test").
The companies in UAE are required to demonstrate the
economic substance in the relevant activities they carry out within the UAE. Below are the 5 requirements the companies need to have to
undergo the UAE Economic Substance
Test:1. Conduct Core Income-Generating Activities Within the UAE
The UAE ESR guidelines have listed specific tasks associated
with each relevant activity called the core income-generating activities
(CIGA). For example, the CIGA of the companies carrying out the relevant
activity of the banking business is Raising funds, managing risk including credit, currency and
interest risk
Taking hedging positions
Providing loans, credit or other financial services
Managing capital and preparing reports to investors or
government authority
To demonstrate the UAE Economic Substance Test, the employees
of the company need to conduct the CIGA. However, it is important to note that
the CIGAs of the company should be performed by the employees who are UAE
residents.
2. Direct and Manage Business From Within the UAE
The Economic Substance Test assesses whether the companies
are directed and managed from within the UAE to ensure that they conduct an
adequate number of board meetings in the UAE. For each board meeting held in
the UAE: a quorum of directors must be physically present in the UAE
meeting minutes must be maintained and signed in the UAE
directors attending the board meeting must have the necessary
skills and expertise to discharge their fiduciary duties.
However, a Holding Company Business is not required to be
directed and managed in the UAE, except where this is a requirement of the
relevant licensing authority.
3. Employ Full-time Staff in the UAE
To demonstrate the Economic Substance Test in Dubai, the companies need to employ an adequate number of qualified full-time staff who need to be physically present in the UAE and must be performing the CIGA. The ESR has the option to count the directors as employees for the purpose of the Economic Substance Test if they carry out the CIGAs in addition to their fiduciary duties. However, the regulations mandate that the directors need to be physically present in the UAE and must attend the relevant board meetings of the company.
4. Incur Operating Expenditure in the UAE
To satisfy the UAE Economic Substance Test, the companies are required to ensure that adequate operating expenditure is incurred within the UAE on the Relevant Activity. However, the Ministry of Finance has clarified that the ESR doesn't intend to force the companies to incur expenses beyond their needs provided they carry out genuine business activity and carry out CIGA in the UAE.
5. Retain Adequate Physical Assets in the UAE
According to the ESR guidelines, the companies should either
have adequate levels of physical assets in the UAE used for conducting the
CIGA, or it needs to have an adequate level of expenditure on outsourcing for
the Relevant Activity. The Ministry of Finance clarifies that the definition of
"adequate" is depends upon the nature and level of the Relevant Activity being
undertaken. List of Relevant Activities for the UAE Economic Substance
Test
The ensure ESR compliance, the companies operating in the UAE are required to demonstrate economic substance in the Relevant Activities they carry out in the UAE. The businesses need to look beyond the activities stated in the trade license and consider the actual activity they conduct in the UAE to determine the Relevant Activity. The following is a list of relevant activities for the onshore and free zone companies as per the UAE ESR Guidelines:
Banking
Insurance
Investment fund management
Leasing and finance
Headquarter Business
Shipping
Intellectual property Business
Holding company business
Distribution and service centre