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Stay Compliant with Economic Substance Regulation

On April 30, 2019, the United Arab Emirates (UAE) issued the Cabinet of Ministers Resolution No. 31 of 2019 concerning economic substance regulations in the UAE (“New Law”). The introduction of the new law follows the decision of the European Union (EU) to include UAE on a list of non- cooperative jurisdictions for tax purposes. This new rule is a milestone for the UAE’s tax policy and an important step towards its alignment with the global Organization for Economic Co-operation and Development’s (OECD) Base Erosion and Profit Shifting (BEPS) directives.

Purpose of the law

The purpose of the Economic Substance Regulation (ESR) is to bring specific requirements for businesses to demonstrate the actual economic activity in the country and to serve as the basis of support that the incorporation in the UAE was not driven solely to benefit from the privileged tax regime.

Companies that can comply with ESR

Companies include those that are incorporated in the UAE mainland or Free Zones (the “licensees” or the “companies”), to demonstrate that they have effective substance in the country by satisfying an “economic substance” test in relation to any income-generating “relevant activity.” Starting from 2020, every licensee will have to notify the Regulatory Authority of the following:

Whether or not it carries out a relevant activity
Whether or not all or any part of thecompany’s gross income in relation to a relevant activity is subject to tax in a jurisdiction outside the UAE
The date of the end of its financial year

The New Law contains specific requirements on how a company has to be “directed and managed” in the UAE. They are the following:

Number of board meetings being held and attended in the country
Composition and competence of the board of directors
Record of the minutes of all board meetings
An adequate number of qualified full-time employees in relation to the relative activity who are physically present in the UAE
Have premises and an adequate level of expenditure in the UAE
Conduct core income-generating activities (or “CIGA”) in the country

Existing entities must comply with the New Law from April 30, 2019, with the first return due in 2020. New entities must comply with the New Law upon receiving its license, with the first return due in 2020 or later.

Companies in which the Federal Government or Government of any Emirate of UAE or any governmental authority or body of any of them holding at least 51% of direct or indirect ownership in its shareholding, will fall out of the purview of Economic Substance Regulations in the UAE.

What are the relevant activities?

The Forum of Harmful Tax Practices (FHTP) has identified the type of activities within the scope of Economic Substance Regulations in the UAE. The following are the activities:

Headquartered Business
Banking Business
Insurance Business
Shipping Business
Lease-finance Business
Intellectual Property Asset
Investment Fund Management
Distribution & Service Centre
Holding Company

A licensee is not required to pass the economic substance test if it does not generate income in relation to a relevant activity that it carries.

Penalties

Fines ranging from AED 10,000 to AED 50,000 may be imposed on UAE companies for failure to comply with the New Law, including not providing the Regulatory Authority with the information specified under Article 8 in the first year. Subsequent breaches entail greater penalties ranging from AED 50,000 to AED 300,000.

Recommendation:

Companies not deploying a “relevant activity” are implementing proper corporate governance mechanisms in order to avoid any risk of failing the economic substance test. If you own a business in the UAE, we highly recommend you take an active role in auditing your corporate arrangements with the view of bringing in the necessary level of corporate substance.

How can we help?

If your business falls under the entities with the above-mentioned activities in the UAE, then you may need assistance to determine if the Economic Substance Regulations are relevant for you and understand the implication of these new regulations in the UAE.