Economic Substance Regulation (ESR) Compliance
As a member of Organisation for Economic Development and Cooperation (“OECD”), and in response to an assessment of the UAE’s tax framework by the European Union Code of Conduct Group, the UAE has committed to ensuring standards related to Base Erosion and Profit Shifting (“BEPS”) are implemented.
On 30 April 2019, the UAE enacted the ESR in Resolution No. 31 of 2019.1 Any natural or juridical person licensed by a competent licensing authority in the UAE (licensee) that carries out any relevant activity is subject to the ESR. On 11 September 2019, the United Arab Emirates (UAE) issued Ministerial Decision No. 215 of 2019 containing guidance for businesses on compliance with the Economic Substance Regulations (ESR), enacted in April. Businesses in the UAE should review the ESR and associated guidance to determine whether they are subject to the ESR requirements and the related notification and reporting requirements.
Entities covered under regulation
The Regulations apply to all UAE onshore and free zone companies that carry on a “Relevant Activity”. It is yet to be confirmed whether the Regulations will also apply to sole proprietorships and branches, but we expect entities incorporated under offshore (free zone) companies regulations that carry on a “Relevant Activity” to be within the scope of the Regulations.
Entities that are directly or indirectly owned by the UAE government (both federal and local) are specifically excluded from the Regulations. On this basis, UAE sovereign investment funds and other UAE government related entities would not need to meet the UAE economic substance requirements.
The following are considered as “Relevant Activities” under the Regulations:
- Fund management
- Holding company
- Intellectual property (IP)
- Distribution and service centre
Activities that must be conducted by a licensee in the State shall include:
In respect of Banking Business:
- Raising funds, managing risk including credit, currency and interest risk.
- Taking hedging positions.
- Providing loans, credit or other financial services to customers.
- Managing capital and preparing reports to investors or any government authority with functions relating to the supervision or regulation of such business.
In respect of insurance Business:
- Predicting and calculating risk.
- Insuring or re-insuring against risk and providing Insurance Business services to clients.
- Underwriting insurance and reinsurance.
In respect of Investment Fund Management Business:
- Taking decisions on the holding and selling of investments.
- Calculating risk and reserves.
- Taking decisions on currency or interest fluctuations and hedging positions.
- Preparing reports to investors or any government authority with functions relating to the supervision or regulation of such business.
In respect of Lease-Finance Business:
- Agreeing funding terms.
- Identifying and acquiring assets to be leased (in the case of leasing).
- Setting the terms and duration of any financing or leasing.
- Monitoring and revising any agreements.
- Managing any risks
In respect of Headquarters Business:
- Taking relevant management decisions.
- Incurring operating expenditures on behalf of group entities.
- Coordinating group activities
In respect of Shipping Business:
- Managing crew (including hiring, paying and overseeing crew members).
- Overhauling and maintaining ships.
- Overseeing and tracking shipping.
- Determining what goods to order and when to deliver them, organizing and overseeing voyages.
In respect of Holding Company Business, all activities related to that business; and in respect of Holding Company Business that derives income from other sources other than dividends and capital gains from its equity interest, the state Core Income-Generating Activities shall be those activities associated with the income generated.
In respect of Intellectual Property Business:
(a) where the Intellectual Property Asset is a –
- Patent or an asset that is similar to a patent, research and development.
- Non-trade intangible (including a trademark), branding, marketing and distribution.
(b) If the Relevant Activity is conducted by a Licensee that is regarded as a High Risk IP Licensee, the State Core Income-Generating Activity must include any of the following additional activities:
- Taking strategic decisions and managing (as well as bearing) the principal risks related to development and subsequent exploitation of the intangible asset generating income.
- Taking the strategic decisions and managing (as well as bearing) the principal risks relating to acquisition by third parties and subsequent exploitation and protection of the intangible asset.
- carrying on the ancillary trading activities through which the intangible assets are exploited leading to the generation of income from third parties.
In respect of Distribution and Service Center Business;
- Providing consulting or other administrative services to foreign related parties.
- Procuring goods (raw materials or finished products) from foreign related parties.
Entities exempt from regulation
A Licensee, i.e. any commercial company which is directly or indirectly owned 51% or more by the UAE government is exempt. In this respect, the “UAE Government” includes the UAE Federal Government, as well as governments of any Emirate of the UAE.
What are the economic substance requirements
To satisfy the economic substance requirements in relation to a Relevant Activity, a Relevant Entity must:
- Conduct the relevant “core income generating activities” in the UAE;
- Be “directed and managed” in the UAE; and
- With reference to the level of activities performed in the UAE:
- Have adequate number of qualified full-time employees in the UAE
- Incur an adequate amount of operating expenditure in the UAE
- Have adequate physical assets in the UAE.
A Relevant Entity that only undertakes a Holding Company Business will be subject to less stringent economic substance requirements. Additional requirements apply if a Relevant Entity carries out “high risk IP related activities”. If a Relevant Entity carries out more than one Relevant Activity, the economic substance requirements must be met for each of the Relevant Activities.
What are the reporting requirement under the Regulation
- The company needs to file ESR notification with respective authority under which the company is registered.
- The company needs to file annual return within 12 months of end of financial year or as stipulated by the relevant authority.
Penalties for non-compliance
Failure to comply would result in administrative penalties (not less than AED 10,000 but not exceeding AED 50,000 in the first year, increased to an amount not less than AED 50,000 but not exceeding AED 300,000 in the subsequent year), subject to a six-year limitation period. Additional penalties such as suspending, revoking or not renewing the UAE Relevant Entity’s trade license could also apply.
How can TRC Help
- TRC can support you in assessing the applicability along with the impact of the new legislation on your business by providing a preliminary assessment of your company’s current compliance obligations. We will also help you to define a strategy and implement a bespoke plan of action in order to mitigate any risks that are anticipated.
- Ensuring that your company complies with its administrative and statutory responsibilities.
- TRC will assist you in filing the notifications and the final report.
- Support you to comply with your obligations and to focus on what you do best – manage your operations and grow your business.