Economic Substance Regulations
The UAE enacted Economic Substance Regulations (Cabinet of MinistersResolution No. 31 of 2019) on 30 April 2019 and released Guidance (Ministerial Decision 215 of 2019) on the application of the Regulations on 11 September 2019. The Regulations and guidance applies in all UAE jurisdictions, including financial free zones such as the DIFC.
In consultation with the OECD and the EU, amendments to the ESR were made by Cabinet of Ministers Resolution No.57 of 2020 (“Amended ESR”) issued on 10 August 2020, along with an updated Guidance (Ministerial Decision No. 100 of 2020, “Amended Guidance”, which contains an updated Relevant Activities Guide at Schedule 1). The Amended ESR appoints the Federal Tax Authority as National Assessing Authority that will determine whether an entity meets the Economic Substance Test and issues penalties for contraventions of the Amended ESR.
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”):
- Investment Fund management
- Lease – Finance
- Holding Company
- Intellectual property
- Distribution and Service Centre
The Regulations apply to financial years commencing on or from 1 January 2019. 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 within 12 months from the end of their financial year (e.g. 31 December 2020 for entities with a financial year ending 31 December 2019). 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. A Notification form will need to be submitted regardless. Failure to comply with the Regulations can result in penalties, spontaneous exchange of information with the Foreign Competent Authority (as defined in Article 1 of the Regulations), as well as other administrative sanctions such as the suspension, revocation or non-renewal of the entity’s trade license or permit.
View the Guides:
- Economic Substance UAE Economic Substance Flowchart
- Relevant Activities Summary
- Notice of COVID-19
- Notice regarding ESR Filing Requirements and Deadlines
- Economic Substance – Report Template
- Economic Substance – Notifications Template
- Economic Substance – Economic Substance Report Guidance
- Economic Substance – Notification Guidance
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FAQS on ESR
Ever since the introduction of Economic Substance regulations in the UAE in April 2019, people have been wanting to clarify a lot of queries pertaining to the compliance norm. We have jotted a set of answers on queries regarding ESR in UAE.
Why as Economic Substance Regulations (ESR) introduced in the UAE?
The UAE was added to the European Union (EU) list of non-cooperative tax jurisdictions by the European Commission and this was the reason behind the introduction of Economic Substance Regulations in UAE on 30 April ,2019. In late 2019, the EU removed the UAE from the blacklist.
The norm is similar to the economic substance requirements that were recently implemented in jurisdictions of the Cayman Islands and Jersey. The regulation ensures that business entities that undertake certain activities does not artificially attract profits.
What is the first reportable Financial Year?
The Regulations apply to financial years starting on or after 1 January 2019. For a UAE entity with 1 January 2019 – 31 December 2019 financial year, the first assessable period would be the same time period and for an entity with 1 April 2019 – 31 March 2020 financial year, the first assessable period would be 1 April 2019 – 31 March 2020.
What are the requirements to meet the economic substance test?
For each financial period in which a Licensee earns income from a Relevant Activity, it will need to meet an Economic Substance Test in relation to that activity. The Economic Substance Test requires a Licensee to demonstrate that:
- The Licensee and Relevant Activity are being directed and managed in the UAE
- The relevant Core Income Generating Activities (“CIGAs”) are being conducted in the UAE
- The Licensee has adequate employees, premises and expenditure in the UAE
Licensees that undertake and earn income from a Relevant Activity are also required to file an economic substance return within 12 months from the end of the relevant financial period.
It should be noted that 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. Further specific detail on certain of the Relevant Activities is available on the MoF website.
The MoF has provided the following non-exhaustive list of matters a Licensee should consider (and action, where relevant) before the end of a financial period:
- Assess what Relevant Activities it has performed during the financial period (applying a “substance over form” approach)
- Assess the amount and type of income earned from the Relevant Activity during the financial period
- Hold board meetings with a quorum of directors physically present in the UAE
- Ensure board meeting minutes are signed and maintained in the UAE
- Identify the amount and type of expenses and UAE based assets (including premises) in respect of the Relevant Activity, and ensure access to assets (including premises) can be demonstrated (through agreements and financial records)
- Identify the number of UAE based full-time employees or other personnel (and their qualifications) responsible for carrying on the Licensee’s Relevant Activity
Additional actions may be required to ensure a Licensee can demonstrate sufficient economic substance in the UAE for a relevant financial period, and the considerations above may differ where a Licensee has either a Holding Company or a “High Risk” Intellectual Property Business (as defined in the Regulations).
Do the Regulations only apply to UAE entities that are part of a foreign multinational group, or that are owned by a foreign shareholder?
No. The Regulations impose economic substance requirements on any UAE entity which carries on a Relevant Activity, regardless of whether the UAE entity belongs to a foreign multinational group. In the case of a UAE based Distribution Business, Service Centre Business, Headquarter Business or High-Risk IP Business, the regulations will be imposed if the entity transacts with foreign group companies.
Are offshore companies subject to economic substance Regulations?
No, offshore companies are subject to the Economic Substance Regulations in the same way as regular free zone companies or as a company established in mainland UAE.
Who is exempt from the Regulations?
The following Exempted Licensees are exempt from filing an Economic Substance Report and the requirement to demonstrate substance in the UAE:
- A Licensee that is tax resident outside the UAE
- An Investment fund and its underlying SPVs/investment holding entities
- A wholly UAE resident-owned business that is not part of a multinational group and that only carries on business in the UAE
- A branch of a foreign entity that is subject to tax on all of its Relevant Income in a foreign jurisdiction
Note: Sufficient evidence must be submitted along with the Notification form to claim any of the above exemptions
What if a Licensee does not undertake a Relevant Activity during a financial period?
Licensees that do not involve in a relevant activity during a financial period do not have to meet the economic substance test and will be exempted from the process of notifying the regulatory authority and submitting an economic substance return.
What if a Licensee undertakes a Relevant Activity, but does not earn any income from that activity during a financial period?
In this case, the Licensee is not required to file an economic substance return for the relevant financial period. However, the Licensee would still need to submit a Notification on the Ministry of Finance filing portal.
If all income from the Relevant Activity is earned from outside the UAE, is the Licensee exempt from the Regulations?
No. Income from a Relevant Activity for which the Licensee needs to demonstrate economic substance in the UAE includes all income, including income that is generated by the Licensee outside of the UAE.
Will economic substance be assessed on a Licensee-by-Licensee basis, or can Licensees that are part of the same group elect to be assessed on a ‘consolidated’ basis?
No. The Regulations do not allow Licensees that are part of the same group to be aggregated for economic substance purposes. Each Licensee will need to comply with the Regulations and demonstrate economic substance on an individual basis. Relevant economic substance (staff, functions, assets) maintained in the UAE by other group companies can be considered if that economic substance is made available to the Licensee under a service / outsourcing type arrangement.
What is the last date to file ESR notification for mainland companies?
The deadline is 30th June.
Are there penalties for non-compliance?
Non-compliance with ESR (including providing inaccurate or incomplete information) would result in a fine between AED 10,000 – 50,000 in the fiscal year. The fines increase to between AED 50,000 and AED 300,000 for the subsequent fiscal year.
Are entities in liquidation required to file ESR notification?
All licensees in liquidation should file a notification.
Organizations operating in the free zone that has been dissolved or liquidated before the deadline for submission of the Notification need not file ESR notification.
Who are the “Regulatory Authorities”?
The Regulatory Authorities are responsible for monitoring compliance with the Notification and reporting obligations under the Regulations, identifying possible Licensees, validating information submitted, determining whether a relevant entity meets the requirements to be treated as exempt, and sharing information with the UAE Federal Tax Authority and the UAE Ministry of Finance.
The Regulations are administered by the Regulatory Authorities listed in Article 4 of the Regulations, and set out below:
|Federal Entities||Free Zones||Other Emirates|
Ministry of Economy
Security and Commodities Authority
Abu Dhabi Global Market
Media Zone Authority Dhabi
Abu Dhabi Airports Free Zone
Abu Dhabi Ports
Dubai Airport Free Zone
Dubai Healthcare City Authority
Dubai International Financial Center
Dubai South / Dubai Aviation City
Jebel Ali Free Zone Authority/ DP World
Dubai World Trade Center
International Humanitarian City
Dubai Development Authority
Dubai Silicon Oasis
Dubai Maritime City
Dubai Multi Commodities Centre
Sharjah Airport International Free Zone Authority
Hamriyah Free Zone Authority
Sharjah Media City (Shams)
Sharjah Publishing City
Sharjah Research Technology and Innovation Park
Sharjah Healthcare City
Ajman Free Zone Authority
Ajman Media Free Zone Authority
RAK International Corporate Centre
Ras Al Khaimah Economic Zone
RAK Maritime City
UAQ Free Trade Zone
Fujairah Free Zone
International Free Zone Authority
Fujairah Creative City