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UAE is on the path of transformation by introduction and implementation of the new tax regime of Excise Tax in the year 2017, VAT in the year 2018 and Economic Substance Regulations (ESR) in the year 2019 to demonstrate the determination to accredit, adapt and execute the enacted taxation and ESR successfully. UAE is considered as a low or no corporate and income tax jurisdiction and it was the major concern of the European Union for the territories such as Cayman Islands, British Virgin Islands, Isle of Man, Bahrain, Bermuda and UAE enjoying the status of low tax or no tax regime and allowing businesses to avail the tax benefits.
UAE introduced Economic Substance Regulations (ESR) to honor the UAE’s commitment as a member of the OECD Inclusive Framework on Base Erosion and Profit Shifting (BEPS), and in response to a review of the UAE tax framework by the EU which resulted in the UAE being included in the EU list of non-cooperative jurisdictions for tax purposes. The UAE joined the BEPS Inclusive Framework on 16th May 2018 and has committed to implementing the four BEPS minimum standards of Harmful tax practices, Prevention of tax treaty abuse, Country by country reporting (CbCR) and Mutual Agreement Procedure.
ESR is introduced to curb international tax planning of certain business activities, which are typically characterized by the fact that they do not require extensive fixed infrastructure in terms of human and technical capital. This allows profits of those businesses to be shifted to no or nominal tax jurisdictions, as opposed to taxing profits in the countries where the company has actually created economic value. The economic substance legislation is specifically targeted at businesses that do not have genuine commercial operations and management in the UAE.
The UAE issued the ESR legislation in April, 2019 under the cabinet resolution no. 31 of April, 2019, followed by cabinet resolution no. 58 of September, 2019 for determining the concerned regulatory authorities as well as cabinet decision no. 215 of 11th September, 2019 guidelines for the implementation of ESR.
As per the ESR, all the Licensees that carry out any Relevant Activity in the UAE via Offshore, Free Zone or a Limited Liability Company will fall under the scope of this legislation and they must ensure compliance with the Economic Substance Test. A Licensee who carries out any of the nine relevant activities, Banking Business, Insurance Business, Investment Fund Management Business, Lease - Finance Business, Headquarters Business, Shipping Business, Holding Company Business, Intellectual Property Business (“IP”), Distribution and Service Centre Business, is covered under the scope of ESR and responsible to meet the ESR compliances.
A Licensee who undertakes a Relevant Activity meets the Economic Substance Test in relation to that particular Relevant Activity if the Licensee conducts State Core Income-Generating Activity in UAE, it is directed and managed in the UAE, if there is an adequate number of qualified full-time employees who are physically present in the UAE even if not employed by the Licensee and includes temporary or outsourced, or adequate level of expenditure on outsourcing to third party service providers in UAE, if there is adequate operating expenditure incurred by a licensee in the UAE, or adequate level of expenditure on outsourcing to third party service providers in the UAE, if there are adequate physical assets in the UAE or adequate level of expenditure on the outsourcing. In case of State Core Income-Generating Activity is outsourced to another entity if it must be monitored and controlled by the licensee.
There are reduced substance requirements for Holding Company businesses. If a Licensee whose activity is restricted to carrying out a Holding Company Business that derives its income from only dividends and capital gains, such Licensee meets the Economic Substance Test if it complies with the requirements of the relevant Regulatory Authority in accordance with the law applicable to the Licensee in the UAE and has adequate employees and premises for holding and managing the Holding Company Business.
Administrative penalty from AED 10,000 to AED 50,000 can be imposed for failure to meet the Economic Substance Test, failure to provide information or for providing inaccurate information. The administrative penalty can go up from AED 50,000 to AED 300,000 in the financial year immediately following the financial year in which penalty notice was issued by the authority.
