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ECONOMIC SUBSTANCE REGULATIONS (ESR)

The UAE has enacted Economic Substance Regulations (“ESR”) that applies in all UAE jurisdictions, including financial free zones such as the DIFC.

What is Economic Substance Regulations

The UAE has enacted Economic Substance Regulations (“ESR”) that applies in all UAE jurisdictions, including financial free zones such as the DIFC. In the DIFC, the ESR will be administered by the Registrar of Companies (“Registrar”) for all DIFC entities, including entities that are regulated by the DFSA.
Key points to note about ESR and how to prepare your business for it are set out below:

1. All DIFC entities are required to submit an economic substance notification by 30 June 2020 in the DIFC Client Portal

2. The UAE Ministry of Finance has issued a Relevant Activities Guide which should assist you in determining whether your business conducts a relevant activity and falls within the scope of the ESR.

3. Your business may also be required to file an economic substance return (“ES Return”), within 12 months of your financial year-end, to demonstrate that your business meets the ESR requirements. Information relating to the ES Return will be issued in the second half of 2020.

The relevant UAE Economic Substance Legislation can be found at the Ministry of Finance Website.

Further information on the ESR can be found in the presentation (which can be accessed by clicking on the “Download PDF” button below) and on the Ministry of Finance’s Economic Substance Regulations page.

We can help you!

While it is each our entity’s responsibility to evaluate their obligations under the ESR, determine whether it conducts a Relevant Activity and ensure compliance with the regulations, we will provide support by conducting outreach sessions and general enquiries can be directed to info@vatsol.me or you can call us on +971 052 926 9710. We will not be able to provide specific advice relating to your entity, confirm whether it conducts a relevant activity, or whether it meets the economic substance test.

Economic Substance Regulations FAQs

What are the Economic Substance Regulations (“ESR”) and why did the UAE government enact them?

ESR has been introduced in countries with low or no corporate taxes, in order to comply with international initiatives to combat harmful tax practices including unlawful avoidance or evasion. ESR requires certain legal entities to demonstrate that they carry out substantial economic activities in these jurisdictions, in accordance with the Economic Substance Test.

The UAE introduced the Economic Substance Regulations, applicable in free zones as well as on-shore, to honour its 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 reporting framework by the European Union (EU). The purpose of the Regulations is to ensure that UAE entities undertaking certain activities report actual profits that are commensurate with the economic activity undertaken within the UAE.

When did the ESR come into force?

The UAE Economic Substance Regulations came into force on 30 April 2019, and subsequent guidance on the regulations was issued on 11 September 2019. Regulatory Authorities responsible for administering the ESR were identified in a Ministerial Resolution issued on 4 September 2019. Amendments were made to the ESR in Cabinet Decree No. 7 of 2020, which was issued on 19 January 2020. The Ministry of Finance is working with the OECD to further refine the scope and applicability of the UAE Economic Substance Regulations. Updates will be posted on this website and on the Ministry’s website.

Who does the Economic Substance Regulations apply to?

The Regulations primarily apply to legal entities that carry out a ‘Relevant Activity’.

 

What are the Relevant Activities?

The Relevant Activities under the Economic Substance Regulations are:

  • Banking Businesses
  • Insurance Businesses
  • Investment Fund Management Businesses
  • Lease-Finance Businesses
  • Headquarters Businesses
  • Shipping Businesses
  • Holding Company Businesses
  • Intellectual Property Businesses
  • Distribution and Service Centre Businesses

Please refer to the UAE Economic Substance Relevant Activities Guide issued by the Ministry of Finance for further information and explanation on each of the above Relevant Activities.

What is the Economic Substance Test?

The Economic Substance Test requires a business entity to demonstrate that:

  • the business entity and the Relevant Activity are being directed and managed in the UAE;
  • the relevant Core Income Generating Activities (CIGAs) are being conducted in the UAE; and
  • the business entity has adequate employees, premises and expenditure in the UAE.
Has your Relevant activity complied with Economic Substance Test?
  1. The Economic substance test is required to be met for each relevant activity by conducting the Core-Income Generating Activities (CIGA) in UAE. The list of activities is provided by regulation for CIGA, but it is not exhaustive list. It is clarified that CIGA includes the activities listed in the regulation, but the list is not restricted to those activities. We assume that any incidental or ancillary activities in relation to the main relevant activity will also take the color of relevant activity and fall under the list of CIGA.
  2. It is stated that the business of the licensee should be directed and managed in UAE, which means the board meetings should be held in UAE. Further, the quorum of the meeting, minutes of meeting duly signed by the directors attending the meeting need to be maintained. Physical presence & Expertise of the Directors is mandatory requirement. It is also made clear that atleast one meeting in one Financial Year or as required by the law applicable to the Licensee should be conducted in UAE for discussing the matters of the Company.

In cases where Companies are managed by Manager & CEO, the requirements shall apply to that concerned Manager or CEO. Also, the responsibility lies with the licensee to prove that the Manger or CEO has relevant knowledge and expertise to take decisions and merely acting on the decisions taken outside UAE.

iii. One of ESR test is to have adequate number of qualified employees to conduct licensee activities. Adequate number will depend on the nature and the size of Business of Companies. Again, the responsibility lies on the licensee to prove to the regulatory authority the genuineness of the activities with the available Employees, Operating Expenditure and Assets.

  1. Licensee Company carrying on relevant activity must incur adequate Operating Expenditure, should have adequate Physical Assets and appropriate Premises to conduct business. Again, what is adequate & appropriate will depend on the nature and the size of Business of Companies. It is made very clear that Licensee has to maintain all the records and should be in a position to prove or demonstrate the adequacy & appropriateness of its Expenses & Assets.

These requirements are to be satisfied to prove that the licensee holds substance and the business are genuine.

What are the penalties under the Regulations?
  • Failure to file a Notification – penalty of AED10, 000 – AED50, 000
  • Failure to provide accurate or complete information – penalty of AED10, 000 – AED50, 000
  • Failure to demonstrate sufficient economic substance in the UAE for the relevant Financial Year.

1. penalty for first year:

(a) AED10, 000 – AED50, 000; and

(b) information exchange with foreign competent authority of:

(i) Parent company;

(ii) Ultimate parent company; and

(iii) Ultimate beneficial owner

2. penalty for second consecutive year of failure:

(a) information exchange (see 1(b) above);

(b) penalty of AED100, 000 – AED300, 000; and commercial license could be: suspended, withdrawn or not renewed

Where can I find out more information about Economic Substance?

At the Ministry of Finance’s Economic Substance Regulations page, which includes additional FAQs and other useful background information.