Economic Substance Regulations in The UAE: An Overview with The Latest Updates
The United Arab Emirates (UAE) has been a lucrative market for international companies to expand their businesses. With preferential policies for domestic and global businesses, many entrepreneurs and companies are interested in developing business in the UAE.
Like other jurisdictions, the UAE implements legal regulations that introduce Economic Substance requirements for established and new companies in the UAE. This overview outlines key aspects of the legislation and latest updates on the deadline for the annual Economic Substance notification filings.
Here at Shanda Consult, we specialize in UAE compliance. We work actively in the UAE, and can help your company with any compliance issues it may have. Let’s take a look at the kinds of businesses that are subject to the Economic Substance Regulations (“ESR”) in the UAE, and what is new for 2022.
Legislation
On the 30th of April 2019, the regulations regarding economic substance came into force in the UAE. The Economic Substance Regulations have been issued in accordance with Resolution No. 31 of the Cabinet of Ministers, which was passed in 2019, and was later updated by Cabinet Decision No. 57 and Ministerial Decision No. 100 of 2020.
The ES Regulations are intended to demonstrate that the economic activity of UAE-incorporated business licenses takes place in the UAE, and that incorporation is not solely motivated by taxation.
Relevant Entities
The ES Regulations apply to all UAE Free Zone and Mainland enterprises that are considered tax residents in the UAE and yield income from one or more relevant activities.
The UAE may not include a company in its Economic Substance Report when a UAE entity carries on a Relevant Activity through an establishment or branch that is not subject to tax in the country’s jurisdiction.
Those include:
- Number of employees of the branch of establishment
- Assets
- Expenditure
- Relevant income
Important Exemptions:
Furthermore, a UAE company is exempted from maintaining Economic Substance Report if the shareholder(s) of a company are tax residents of the UAE. However, those companies still have to do their annual ES notification filings not later than 30 June each year, for the prospective previous year.
Relevant Activities
According to the Substance Regulations, there are specific types of income-generating activities that bring a UAE tax resident company into compliance with the rules, and these activities are as follows:
- Banking – refers to a business that accepts deposits in accordance with the Banking Supervision (Bailiwick of Guernsey) Law, 1994 and is performed by an institution that has been granted permission in accordance with that Law.
- Investment funds management – refers to the provision of discretionary investment management services in connection with domestic or foreign “Investment Funds” or investment-underlying assets, except for UAE businesses that offer services such as fund administration, custodianship, investment advising, and other services connected to investment funds.
- Insurance – refers to a business that effects or carries out insurance contracts, Free Zone or Mainland, in both life and non-life sectors. This includes reinsurance and captive insurance within the meaning of the UAE Securities & Commodities Authority (for an onshore Licensee), the DFSA (for a DIFC Licensee), or the FSRA (for a Licensee established in ADGM).
- Financing and leasing – offers credit of any kind in exchange for money, unless this is part of banking, fund management, or insurance.
- Distribution and service centre – refers to company that purchases raw materials, or goods from non-UAE resident groups and distribute those materials, or goods to end-users, except where such activities fall within another category of relevant activity.
- Headquartering – delivers services to overseas group enterprises. These services can include senior management, the assumption or control of substantial risk for foreign group firms, and substantive advice regarding the assumption or control of such risks, unless such activities come under other categories of relevant activities.
- Holding company – is a model of parent company that owns enough shares to hold voting rights in another company. Income is only generated from earning dividends and capital gains from its equitable interests.
- Intellectual property – is defined to be an intellectual property company that earns income from intellectual property assets (either directly or in its function as a shareholder or partner of a partnership or limited liability partnership, or indirectly).
- Shipping – operates ships in international traffic to convey passengers or cargo for income. This definition encompasses chartering, ticket sales, the use, maintenance, or rental of containers (including trailers and other transport equipment), and crew management when tied to ship operations.
The ES Regulations explicitly exempt UAE businesses owned directly or indirectly by the UAE Government or a UAE Government Body or Authority. In addition to entities established in the UAE, licensed businesses with branches and representative offices, and standalone subsidiaries are required to meet economic substance requirements.
The licensee needs to designate whether the licensee has engaged into any outsourcing arrangements with regard to its Relevant Activities. An Outsourcing Provider may be a third party or an entity (or entities) that are part of the same group as the Licensee or are otherwise associated with the Licensee, such as through common ownership or control.
Economic Substance Requirements
A resident entity is required to meet the economic substance requirements for performing relevant activities. The law stipulates that a resident corporation satisfies the economic substance requirements for a relevant activity if:
- Relevant activities must be directed and managed in the UAE;
- The entity carries on core income-generating activities (“CIGA”) in the UAE in accordance with Relevant Activities;
- The entity’s activities must have substantial economic substance in the UAE, which includes:
– Adequate level of full-time qualified employees
– Adequate level of operational expenditure in UAE
– Adequate level of physical presence (including, without limitation, offices and/or premises, albeit that these may be provided by a third party) in UAE.
Holding companies, whose major role is limited to owning shares or other assets, have reduced economic substance requirements. This is because holding firms do not engage in any other activities. Any entity which claims to be an Exempted Licensee is still required to file the ES Notification.
In the case of Outsourcing Provider, there will be the following required outsourcing information:
- The number of Outsourcing Provider(s): This figure should match with all CIGAs that have been outsourced to the providers;
- The name of the Outsourcing Provider(s): This should be the same with the one mentioned on the trade license, permit, or commercial license of the Outsourcing Provider(s);
- The address of the Outsourcing Provider(s): This should match the address mentioned on the trade license, permit, or commercial license of the Outsourcing Provider(s);
- UAE VAT Tax Registration Number: This unique 15-digit number can be found after VAT registration on invoices from the Outsourcing Provider(s);
- Expenditure incurred for the Reportable Period: The Outsourcing Provider will receive this amount from the Licensee for the relevant services;
- The number of full-time relevant employees (FTE): The Outsourcing Provider will provide a list of employees during the Reportable Period. The employee number will be calculated based on a 40-hour standard working week;
- Licensee’s registered address: This address must be equivalent to the relevant Outsourcing Provider;
- The Licensee’s ability to supervise the CIGAs as they are being executed by the Outsourcing Provider.
Note: The CIGAs carried out by the Outsourcing Provide must take place in UAE only. (For example: Employees and other tangible assets must be present in the country physically).
What Shall Be Managed and Directed from the UAE?
- The number of board meetings in all countries are to be reported: These will be held during a Reportable Period by the Licensees to discuss the Relevant Activities.
- The number of board meetings in UAE only: The Licensee will hold these meetings in UAE physically, in relation to the Relevant Activities taking place in a Reportable Period.
- The board members should come to the UAE when attending board meetings and making crucial decisions although they are not required to be the country’s residents.
- Strategic decisions related to Relevant Activities should be made by directors (or equivalent members) that present physically in the country.
- All strategic decisions must be recorded and signed by directors (or equivalent members) that are in the country physically.
- The directors (or equivalent members) are required to have relevant knowledge and expertise to discharge their duties. Also, they should not give effect to decisions that take place outside the UAE.
Reporting Requirements and Penalties
UAE entities that partake in Relevant Activities are required to submit the Economic Substance Notification within 12 months from the end of the relevant fiscal year. Entities that fail to do so may face penalties that are in-line with the current regulations.
The deadline for the annual ES notification filings for financial year 31 December 2021, is no later than 30 June 2022.
The entities that carry on and generate income from Relevant Activity are required to file an ES Report within 12 months from the end of the financial year substantiating their economic substance. This report must include the following information in order to be considered compliant:
- Type of CIGA undertaken;
- Quantity and nature of the income derived from the CIGA;
- Quantity and categorization of operating expenditures incurred in the operation of the CIGA;
- Location of the site of business and type of physical assets that are involved;
- Number of full-time employees in charge of implementation of the CIGA;
- A statement affirming that the economic substance test has been successfully passed in accordance with the Regulations.
It is important to note that financial penalties may apply to entities for failure to meet the deadlines prescribed or for inaccurate information. The penalty for an utility that does not submit the ESR notification is AED 20,000. The penalty for an utility that does not submit the Economic Substance Report is AED 50,000.