The Economic Substance Regulations (ESR) in the UAE
On 10 August, 2020, the UAE Government has issued Cabinet Resolution No. 57 of 2020 (“Amended Regulations”) along with updated Guidance clarifying the amended ESR through Ministerial Decision 100 of 2020 dated 19 August 2020 (“Amended Guidance), which update and replaces the original ES Regulation (Ministerial Decision No. 215 of 2019 and Cabinet Decision No. 31 of 2019).
The New Guidance has brought many changes and provided several clarifications on the ESR requirements for entities in the UAE and the following summarizes a few of these changes:
- The New Guidance has been applicable retrospectively from the effective date of the original regulations on financial years commence on the 01st January 2019.
- The Ministry of Finance has reopened the ESR notification online portal, and the Notification and re-notification requirements to be submitted electronically to MOF:
Notification is required to be given within six months after the end of the respective financial calendar year-end (e.g. 31st December – Notification by 30th June), or/and Re-notification in respect of previously filed notifications.
- New exempted entities have been defined, and the requirement of 51% government ownership exemption criteria has been removed. Exempted licensees now have been introduced as a new category of the licensee under the ESR and include, among others: (i) investment funds, (ii) licensees which are tax resident in another jurisdiction, and (iii) branches of foreign entities which (relevant) income is subject to tax in a jurisdiction outside the UAE. In order to enjoy their exempt status for ESR purposes, exempted licensees need to file a notification and provide documentary evidence demonstrating such a position.
- Clarification on the status of a branch of UAE local company and branch of foreign company.
- Removal of Investment Funds as part of the Investment Fund Management business unless it is a self-managed fund.
- Some minor changes to what the ESR considers relevant activities and what licensees performing such activities must demonstrate in terms of sufficient economic substance in the UAE. This includes, among others, further clarifications relating to the relevant activities of a distribution and services business and high-risk IP business. As such, licensees that submitted the ESR Notification in June and are now preparing for the ESR Report filing before the end of this year would need to consider the relevant changes.
- Federal Tax Authority (FTA) shall be responsible for assessing and determining the economic substance in the UAE. Regulatory Authorities shall be responsible for collecting and reviewing the accuracy of notifications and reports. The FTA has now been appointed as the authority to (i) assess whether licensees have met the economic substance tests; (ii) impose administrative penalties for non-compliance; and (iii) hear and decide on appeals filed by licensees, among others. Most of these powers were previously in the hands of the regulatory authorities of each licensee, which include the relevant UAE Free Zone Authorities and the Ministry of Economy, among others.
- The requirement to have qualified full-time employees has been modified and considers the employees who are physically present in the UAE.
- The updated regulations now clarify that the UAE MOF will launch a portal to facilitate the electronic filing of the notifications, reports, and other relevant information, unlike before where the notifications, reports, and related documentation had to be submitted by licensees with their respective regulatory authority. The Decision does not state when this portal will be accessible.
- The updated ESR Regulation provides a revised list of penalties and sanctions which are almost doubled, for example; failure to provide ESR Notification is now AED 20,000 from AED 10,000. Others are:
- Provide ESR Report – AED 50,000
- Provide accurate or complete information – AED 10,000 to AED 50,000
- Demonstrate Economic Substance – First Failure – AED 50,000, Second Failure – AED 400,000 and information exchanged with Foreign Competent Authority of (i) Parent Company, (ii) Ultimate Parent Company, and (iii) Ultimate Beneficial Owner.
Effective 01st January 2019, all UAE entities conducting “relevant activities “will be obliged to meet certain legal requirements. The application of the ESR is expected to be on almost most of the businesses within the following sectors and activities, regardless of the legal framework of being a mainland entity or a free zone, with the exception of entities owned by UAE Federal or Emirates government of 51% or more.
- Banking Business
- Insurance Business
- Investment Fund Management Business
- Lease-Finance Business
- Headquarters Business
- Shipping Business
- Holding Company Business
- Intellectual Property Business
- Distribution & Service Centre Business
Why these new regulations?
The Economic Substance Regulations have been passed to implement the commitments to improve the tax policy framework and compliance. The implementation of such measures is necessary to prove that the UAE is a compliant, cooperative and reputable jurisdiction in the international landscape.
Requirements to meet Economic Substance Test
In order to meet the requirements, the entity must assess that it satisfies all of the following criteria:
- The company conducts the State Core Income-Generating Activities (relevant activities associated with the income generated) in the UAE
- Management and decision making in relation to that activity situated in the UAE
- An adequate number of qualified full-time employees who are physically present in the UAE/adequate level of expenditure on outsourcing present in the UAE
- Adequate operating expenses incurred within the UAE
- Adequate physical assets within the UAE
- Control over the relevant activities outsourced
It worth noting that entities undertaking intellectual property activities and those companies that outsource their activities might be subject to increased scrutiny.
The companies undertaking relevant activities are required to notify the Regulatory Authority of:
- Whether the company is carrying out the relevant activity or not
- All or any party of gross income from the relevant activity is subject to tax in other jurisdiction
- The date of financial year-end.
Moreover, entities must submit annual reports to the Regulatory Authority. These reports must be provided within 12 months of the end of each financial year and contain information on the type of activities, income, operating expenses and assets, place of business, personnel. Companies conducting “high-risk” intellectual property business will be subject to additional requirements.
Penalties and potential sanctions in case of non-compliance
Obviously, failure to meet the requirements will lead to unpleasant consequences. The following fines are envisaged for non-compliance:
- Failure to meet the Economic Substance Test (first time) – AED 10,000 to AED 50,000
- Failure to meet the Economic Substance Test (subsequent time) – AED 50,000 to AED 300,000
- Failure to provide information or providing inaccurate information – AED 10,000 to AED 50,000
Non-compliance may also result in other penalties such as revocation, suspension or non-renewal of a license. Besides, the UAE authorities may exchange information about non-compliant companies. Such information may be shared with the tax authorities and the states where ultimate beneficial owners or parent companies reside. Ultimately, it is up to the Regulatory Authority to decide on penalties imposed on a company.
Jurisdiction and regulatory authorities
All assessment, reporting and filing requirements fall under the remit of the relevant Regulatory and licensing Authority, and as such it is the Regulatory Authorities that set the requirements, deadlines and format for notification filing as they believe is appropriate and which may vary.
The following needs to be performed by entities considered within the scope of the regulations:
- Assess the applicability of the regulations into the business of the entity for the financial period of 2019, and provide notification and relevant reporting to the regulatory body which licensed the entity’s activities;
And, where the entity is within the application and scope of the ESRs;
- Report its annual ESR return.
If you need help or support on the ESR compliance assessment and reporting, do not hesitate to contact us.
Economic Substance (ESR) filing reporting deadline
Reporting deadlines as per the latest guidelines issued by the Ministry of Finance, companies conducting Relevant Activities must submit a Notification within 6 months and an Economic Substance Report within 12 months of their Financial Year (FY) -end. Failure to complete and submit the Notification may result in penalties as per ESR laws.
The schedule of deadlines for various financial years end dates are as follows: