UAE Economic Substance Regulations: A Detailed Guide

In this article, we will explore the UAE Economic Substance Regulations in detail, with a particular focus on their effects on RAK companies. Let’s begin.

Overview of the UAE Economic Substance Regulations

The UAE’s journey with Economic Substance Regulations (ESR) began on April 30, 2019, when the Cabinet of UAE Ministers introduced Resolution No. 31, applying the regulations to specific business sectors.

This step was further strengthened on August 10, 2020, with the issuance of Resolution No. 57, which amended and replaced the previous resolution.

The jurisdiction’s commitment to implementing these regulations aligns with the directives from the Organisation for Economic Cooperation and Development (OECD) Forum and the European Union Code of Conduct Group (EU COCG), aimed at countering harmful tax practices.

Who is subject to UAE Economic Substance Regulations?

Several categories of business entities fall under the purview of the UAE Economic Substance Regulations (ESR), and such classification is the term “Licensee”.

There are two types of Licensees: typical Licensees who must comply with all ESR requirements, and “Exempted Licensees”. Let’s take a closer look at these subjects and the requirements they must meet.

What are common Licensees?

An entity will be classified as a “Licensee” if it is:

• A juridical person (incorporated inside or outside the State) or an Unincorporated Partnership;
• Registered in the UAE, including the Free Zone/ Financial Free Zone;
• Holding a legal license, permit, or other form of approval to conduct business activities; and
• Carrying out Relevant Activities

What regulations must Licensees adhere to?

As per the UAE ES framework, a Licensee shall fulfill the following requirements:

• Maintain accurate records
• Meet the criteria of the Economic Substance Test
• Submit an annual Notification form to the Regulatory Authority

You might also be required to submit an Economic Substance Report within 12 months from the end of the financial year.

What about Exempted Licensees?

An exempted licensee, on the other hand, refers to a licensee exempted from economic substance reporting due to certain reasons.

The ESR defines an Exempted Licensee as a Licensee which is regarded as:

• an Investment Fund;
• a tax resident in a jurisdiction other than the UAE;
• an entity wholly owned by UAE residents, is not part of an MNE Group; with activities only carried out in the UAE;
• a branch of a foreign entity with its relevant income subject to tax in another jurisdiction.

In addition to the mentioned situations, there are several other practical instances. Therefore, businesses should seek guidance from local experts to determine their eligibility for exemption and to stay compliant.

However, note that even if your company falls under one of the exempted categories, you must still submit a notice (or Notification) to the relevant authority to establish the exemption.

Responsible authorities for the ESR implementation

To ensure the effective execution of Economic Substance Regulations, the Cabinet of Ministers has designated particular departments as Regulatory Authorities and the National Assessing Authority.

How do they supervise and enforce the implementation of ESR? It’s time to find out.

Regulatory Authorities

The appointed Regulatory Authorities will be the initial department to receive and review the reporting information from UAE companies. The main responsibilities may encompass:

• Collecting Notifications and Economic Substance Reports;
• Collecting all relevant information as required for the reporting;
• Checking if the details are accurate;
• Reporting all collected information to the National Assessing Authority for final evaluation;
• Carrying out any other functions to implement the provisions of the ESR Regulations.

Once the information is transmitted to the National Assessing Authority, the respective department will begin the review process.

The National Assessing Authority

The UAE Federal Tax Authority, as the National Assessing Authority, is responsible for evaluating whether UAE companies must adhere to the ESR. Furthermore, they are to carry out any other functions related to the implementation of the ESR Regulations.

They also share information with the relevant authority for assessment purposes and enforce penalties on non-compliant companies.

In the upcoming section, we will examine how these regulations are applied to entities falling within the scope, and whether your entity needs to take any specific actions.

Economic Substance Test

In the UAE, the Economic Substance Test is applied to assess the significant objectives of a company. The tests differ for different kinds of businesses.

While holding companies undergo a simplified test, high-risk IP businesses undergo a more stringent examination. In addition, the standard assessment may apply to other Licensees.

Here’s how these tests differ from one another.

General economic substance test

For this test, the Licensee must satisfy the following criteria:

• The Licensee and relevant activities are directed and managed in the UAE;
• The Core Income Generating Activities (CIGAs) are conducted in the UAE. Note that each relevant activity has a different set of GIGAs; and
• The Licensee has enough employees, physical assets, and operating expenditures in the UAE.

To evaluate if your physical assets and operating expenditures are adequate, you must maintain sufficient and accurate records for verification. The National Assessing Authority shall review such records and other supporting documentation to decide.

What does “directed and managed in the UAE” indicate?

This means that the licensee holds a sufficient number of board meetings in the UAE. Additionally, each meeting must have:

• A minimum number of directors physically present in the UAE;
• Meeting minutes maintained in the UAE; and
• Competent attending directors with adequate expertise.

Moreover, regarding the employees’ resident status, employees who perform the CIGAs need to be residents of the UEA. Meanwhile, non-resident employees will be included in a Licensee’s scope of economic substance requirements if:

• The relevant activities are conducted while the employees are physically present in the UAE;
• The Licensee is responsible for the employees’ relevant costs.

What if the Licensee uses an outsourcing provider to perform CIGAs?

The Licensee can still satisfy the ES test even when it outsources business activities as long as:

• The third party conducts activities in the UAE;
• The third party has adequate employees, expenditure, and physical assets in the UAE;
• The licensee is directed and managed in the UAE
• The licensee proves its control over the outsourced activities;
• The licensee makes sure the third party’s resources are not counted multiple times when carrying out a CIGA for another licensee.

ES test for holding company business

Under the ES regulations, holding company business is defined as a business which:

• Only holds equity in other companies or entities; and
• Only earns dividends and capital gains as income.

An entity that holds other kinds of assets or earns other kinds of income is not considered a holding company business under ES regulations.

The ES test for holding companies states that the business shall:

• Comply with all the existing compliance requirements to submit any documents, records, or information to the Regulatory Authority under the applicable regulations to such Licensee
• Have adequate employees and physical assets to perform the activity

ES test for high-risk IP business

When an intellectual property (IP) business is considered high-risk, it is subject to a stricter test. A Licensee is a high-risk IP business when:

• It does not create its intellectual property
• It acquires an IP asset in consideration for funding research and development by another party located in another foreign country or gets it from a connected party
• It licenses the asset to at least one connected party or gains income from its intellectual property asset as a result of activities conducted by connected foreign parties

A high-risk IP business must first satisfy the general test requirements at first.

Following that, it must prove to have high control over the development, exploitation, maintenance, protection, and enhancement of the IP Asset by submitting the necessary documents.

Economic Substance Notification

The Ministry of Finance mandates an annual filing of a Notification by both Licensees and Exempted Licensees. This Notification serves to verify whether the Licensee conducted and generated income from such activities during the assessment year.

The Notification should be submitted annually, within six months from the end of the licensee’s financial year, through the Ministry of Finance’s (MoF) online ESR portal.

The Exempted Licensee is required to provide documentation that verifies their exempted status. If compliance is not maintained, the entity will forfeit its current status and be subject to the ESR as a standard Licensee.

Do note that if a UAE entity has multiple UAE branches, only one consolidated notification needs to be submitted.

Economic Substance Reporting Obligations

Once your company has qualified for the ES test and filed the necessary notifications, what should you do next? We’re now ready to examine the reporting requirements.

Particularly, the UAE Economic Substance Regulations require business entities to submit Notifications and Economic Substance Reports to their Regulatory Authorities.

Licensees can submit these reports electronically on the UAE Ministry of Finance Portal. Even if you’ve already submitted the paper documents to local authorities, you would still need to resubmit these reports on the portal.

What to include in the reports

Overall, in an ES report, a Licensee will need to include the following information:

• The relevant activity
• The amount and type of earned income concerning the relevant activity
• The amount and type of expenses in relation to the relevant activity
• The UAE-based assets used for the relevant activity
• The number of full-time local employees with sufficient qualifications who carry out the relevant activity
• Other requested details by the law.

For high-risk IP businesses, there are more information required:

• The qualifications, experience, and contracts of full-time employees who permanently reside and perform relevant activities in the UAE;
• A business plan showing the reasons for holding IP assets there; and
• Evidence of business decisions made in the UAE.

Moreover, these businesses must provide sufficient information to demonstrate that the Licensee exercises and historically has exercised a high degree of control over the intellectual property assets’ development, exploitation, maintenance, protection, and enhancement.

Timeframes for UAE Economic Substance Reporting

Since the UAE published the Economic Substance Regulations in 2019, all UAE companies starting their businesses on or after January 1st, 2019, are bound by the ES.

Under the ESR, Licensees are required to submit an ES report within 12 months after the financial year ends. Keep in mind that ensuring compliance with the regulations set out is imperative, as failure to do so can result in severe penalties.

Penalties for non-compliance with the ESR

Failure to comply with the Economic Substance Regulations (ESR) in the UAE can result in various penalties. For instance, an AED 20,000 penalty will be imposed on Licensees if they fail to submit a notification on time.

Meanwhile, a fine of AED 50,000 must be submitted if the Licensees commit any of the following violations:

• Not submitting the ES report with any relevant documentation required per the Resolution; and/ or
• Failing to meet the ES test of each relevant financial year.

Notably, if the Licensee continuously commits the same violation in the following financial year, a penalty of AED 400,000 shall then be applied.

In this case, the National Assessing Authority will issue a notification to the Licensee of the essential information regarding the penalty, specified in Article 14, Cabinet Resolution No.57 of 2020.

By enforcing these regulations, the UAE demonstrates its commitment to economic activity and transparency.

What companies registered in the RAK should keep in mind

Being a member state of the UAE, Ras Al Khaimah (RAK) adheres to the UAE Economic Substance Regulations, from the filing process to the application of penalties. However, there are some notable differences.

RAK has appointed its own Regulatory Authorities for the collection and examination of reporting information from relevant business entities.

Furthermore, businesses operating in RAK are obliged to provide Notifications and Economic Substance Reports to the emirate’s Relevant Authorities. The Notifications must also be resubmitted online through the Portal platform of the UAE Ministry of Finance if already submitted physically.

Note that RAK’s Economic Substance regulatory bodies may request further documentation, depending on the licensees’ business activities and scope.

Conclusion

Companies registered in the UAE, including RAK companies, are obligated to comply with UAE Economic Substance Regulations.

While staying compliant with these regulations might seem complex, this process contributes to creating a reputable image for your UAE business. With our intensive guide in hand, we hope you can now navigate this challenge confidently.

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