What is Economic Substance Regulation and the purpose for enacting them?
The UAE introduced Economic Substance Regulation (ESR) on 30 April 2019 through a Cabinet of Ministers Resolution No. 31 of 2019.
This was done as a part of UAE’s commitment as a member of the OECD Inclusive Framework to implement the action points of OECD base erosion and profit shifting framework for countries across the globe with low or no corporate taxes where harmful tax practices such as tax avoidance and evasion are prevalent. UAE’s move to implement ESR also came in response to an assessment of the UAE’s tax framework by the European Union (EU) Code of Conduct Group on Business Taxation.
The objective of this new regulation is to ensure that all legal entities in UAE have genuine substance in the region and are reporting actual profits generated from activities conducted in the region.
In consultation with the OECD and the EU, the Ministry of Finance (MoF) has made amendments to the Regulations and the revised Regulations were announced through Cabinet of Ministers Resolution No. 57 of 2020 signed on 10 August 2020 and updated Guidance was issued on 19 August 2020 (Ministerial Decision No.100 of 2020).
Where can I find the ESR legislation and guidance?
The amended ESR legislation and guidance are as follows:
Cabinet of Ministers Resolution No. 57 of 2020 revoking the erstwhile ESR regulation
Ministerial Decision No. 100 of 2020 (Guidance) including the Relevant Activities guide
The FAQs are also published by the Ministry of Finance on their website along with the flowchart.
Will the licensees be required to re-assess the applicability of ESR as per the amended legislation?
The amended ESR legislation has brought in certain changes. Some of these which may require the licensee to re-assess are:
Legal type of licensees covered under ESR. Refer Q4 below for details
Treatment of branches. Refer Q9 below
Definition of certain Relevant Activities. Refer Q5 below
Exemptions. Refer Q8 below.
Who does the Economic Substance Regulations apply to?
ESR applies to all judicial persons and unincorporated partnerships licensed with SAIF Zone carrying on one or more “Relevant Activities” in UAE.
The following persons are not covered under the Regulations:
A natural person
A sole proprietorship
Further, ESR is not limited to companies which are a part of foreign multinational group.
If a Licensee does not undertake any Relevant Activity, it does not have comply with the ESR.
What are Relevant Activities under ESR?
The Relevant Activities under the Economic Substance Regulations are:
Investment Fund Management Businesses
Holding Company Businesses
Intellectual Property (IP) Businesses
Distribution and Service Centre Businesses
The MoF has released guide for relevant activities which is attached as an annexure to the Ministerial decision.
It is important to note that there has been changes to the definition of Distribution and Service Centre Business and High Risk IP business.
Distribution and Service Centre Business:
The old definition of a ‘Distribution and Service Centre Business’ required the purchase of goods from a Foreign Connected Person, importing goods into UAE and subsequently reselling them outside UAE. This was amended to exclude the requirement to import and export goods from UAE. The new definition now only requires the purchase and resale of goods.
The definition of a Distribution and Service Centre Business has also been amended to exclude the requirement of the services to be in connection with a business outside UAE. Therefore, licensees providing any services to a Foreign Connected Person will now qualify as service center business.
High Risk IP Business:
The definition of a High Risk IP business has been narrowed. The condition relating to a licensee not carrying out any research and development, or branding, marketing and distribution as part of its core income-generating activity in the UAE has been removed in the new definition.
Are the Relevant Activities same as the activities mentioned on Commercial licenses?
No, substance over form approach should be adopted. The licensee is required to look beyond what is stated on the commercial license for the activities actually undertaken during the financial period.
What if a Licensee does not earn any income from the Relevant activity performed?
The licensee is not required to comply with the ESR tests. However, the licensee is required to submit the notification for ESR.
Who is exempt from ESR?
The following licensees are exempt from ESR under the amended Regulations:
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.
Please note that sufficient evidence must be submitted along with the Notification form to claim any of the above exemptions.
Are branches subject to ESR?
There are three types of branches:
Local branches of UAE entity
UAE branch of foreign company
Foreign branch of UAE entity
The matters to be considered for each of these scenarios is listed below:
Local branches registered in the UAE are an extension of their parent/head office and do not have separate legal personality. Therefore, the entity with its head office registered in the UAE must file ESR notification and report as a single Licensee, reporting the Relevant Activities of itself and all its branches.
A UAE branch of a foreign entity that carries out a Relevant Activity will be within the scope of ESR as if it were a separate legal person, unless the branch is claiming exemption from ESR.
The UAE entity is not required to consolidate the activities and income of the foreign branch provided the Relevant Income of the foreign branch is subject to tax in the foreign jurisdiction where the branch is located.
In this context, a branch can include a permanent establishment or any other form of taxable presence for corporate income tax purposes which is not a separate legal entity.
What are the tests under ESR?
There are three tests for ESR:
the relevant Core Income Generating Activities (CIGAs) are being conducted in the UAE;
the Relevant Activity is being directed and managed in the UAE;
the entity should have adequate employees, premises and expenditure in the UAE.
Please refer our webinars and MoF website for detailed understanding of each of the above tests.
What is the first reportable period under ESR?
The Reportable Period is the financial period commencing from 01 January 2019.
For example- An entity having financial year starting 1 January 2019 to 31 December 2019, the reportable financial year under ESR will be 1 January 2019 to 31 December 2019.
What are the reporting requirements for licensees under ESR?
All the licensees in SAIF Zone within the scope of ESR and licensees claiming exemption are required to submit an annual notification under ESR within 6 months from the end of its financial year.
Non-exempt licensees who earn income from Relevant Activities during a particular financial year will also be required to file an annual report under ESR within 12 months from the end of its financial year.
If a notification was already submitted on 30 June 2020, would a resubmission be required in light of the updated legislation?
All the licensees in SAIF Zone within the scope of ESR (i.e. performing a Relevant Activity) and licensees claiming exemption are required to resubmit a notification. We will provide an update on the method of this re submission shortly.
Which businesses are required to file ESR Notification by 30th June 2020?
Licensees having financial year commencing on or after 1 January 2019 and ending 31 December 2019 is 30 June 2020.
What if the business has a financial year that ends after 31 December 2019 (e.g. a financial year ending 31 March 2020 or 30 June 2020)?
There is no statutory requirement to file the notification by 30 June 2020. The notification deadline will be announced shortly.
No penalties will apply if a notification for financial years ending after 31 December 2019 is not submitted by 30 June 2020.
What if the business has a long first financial reporting period which started in 2018 and ended during 2019 (e.g. 1 October 2018 to 31 December 2019), is the business required to file a Notification for the period by 30 June 2020?
No, in the above example, the Licensee's first reportable period will be 1 January 2020 to 31 December 2020 and the first Notification would be due in 2021.
What happens if a licensee does not submit the notification or any relevant information or documents?
Non-compliance with the obligation to file an ESR notification or any relevant information within the deadline shall attract a penalty AED 20,000.
What are the consequences of failure to meet ESR test or submit ESR report?
First year of failure
Administrative penalty of AED 50,000; and
Information exchange with foreign competent authority of:
ultimate parent company; and
ultimate beneficial owner
Second consecutive year of failure
Administrative penalty of AED 400,000
Information exchange with foreign competent authorities as above;
Any other administrative action including potential suspension, revocation or non-renewal of the Commercial license.
What happens if incorrect or false information is recorded in the ESR notification/ report?
Providing incorrect, false, or misleading information in the ESR report form shall be subject to a penalty of AED 50,000 under the UAE ESR laws. This can further result in the licensee being treated as having failed the ESR test for the relevant financial year.
Can SAIF Zone advise whether my Company is within the scope of ESR and whether I meet the tests?
ESR is a self-assessing requirement. SAIF Zone is unable to make decisions on behalf of the licensees, as SAIF Zone is required to validate the information submitted in ESR notification and reports by the licensees.
If you require further information or advice, please refer to the MOF website or contact professional advisors.
Click to go through the steps to submit the Economic Substance Requirement Notification online through SAIF Zone website.
For any further queries regarding ESR, feel free to get in touch with us at [email protected]