Update on UAE Economic Substance Regulations – the changes and what these mean for your organisation
The UAE Economic Substance Regulations (ESR) introduced on 30 April 2019 under Ministerial Resolution No. 31 of 2019 has been repealed and replaced by Cabinet of Ministers formally adopting Resolution No. 57/2020 on 10 August 2020.
Ministry of Finance (MoF) Decision No. 215 of 2019 has also been repealed and superseded by MoF Decision No. 100/2020 which was adopted on 19 August 2020.
Both the Resolution and the Decision, were made available to the public on 2 Sept 2020.
There has been no change to the overall list of Relevant Activities (RA) which fall within the scope of ESR, with companies who carry out one of the below RA required to file an ESR Notification, and potentially demonstrate Economic Substance if they fulfil certain other criteria.
The list of RA remain as follows:
- Banking business
- Insurance business
- Investment fund management business
- Lease-finance business
- Headquarter business
- Shipping business
- Holding company business
- Intellectual Property business
- Distribution and Service Centre business
However it is important to note that there have been changes to the definitions of the following RA, which may impact upon whether a company falls in scope.
Amendments to “Relevant Activities”
- Distribution and Service Centre Business – the scope of the “Distribution and Service Centre Business” has been expanded- There is no longer a requirement for the goods to be imported and stored in the UAE for an entity to be considered a Distribution and Service Centre Business.- There is no longer a requirement for services to be provided “in connection with a business outside the State”, as result of which the any service provided to a foreign related party is now a Relevant Activity.
- High Risk Intellectual Property Licensees – the definition of a High Risk Intellectual Property Licensee limited to an intellectual property business that satisfies all of the following:- The business did not create the intellectual property asset.
– The business acquired the intellectual property asset from either:(a) a Connected Person, or
(b) in consideration for funding research and development by another person situated in a foreign jurisdiction; and that
– The business licenses or has sold the intellectual property asset to a Connected Person, or earns separately identifiable income from a Foreign Connected Person in respect of the use or exploitation of the intellectual property asset.
Amendments to definition of “Connected Person” and introduction of “Group”
Connected Person = an entity that is a part of the same Group as the Licensee or the Exempted Licensee.
Group = two or more entities related through ownership or control such that they are required to prepare consolidated financial statements for financial reporting purposes under the accounting standards applicable thereto.
Important changes to note:
“Licensee” has been redefined
The amended ESR only applies to:
(i) juridical persons (persons with separate legal personality) and
(ii) unincorporated partnerships that carry on a relevant activity in the UAE.
Natural persons, sole proprietors, trusts and foundations are no longer in scope and therefore do not need to file a notification or meet the Economic Substance Test.
Branches fall outside the definition of “Licensees”, however, according to the updated guidance, branches and their “parent” or “head office” are required to comply with the amended ESR as follows:
- UAE branch of a UAE business: The UAE business must file a single notification and (if applicable) an Economic Substance Report to report the relevant activities of itself and all its UAE branches.
- UAE branches of a foreign business: The UAE branch is not subject to the amended ESR if its relevant income is reported in the tax return of the foreign parent / head office (see Exemptions below).
- Foreign branch of a UAE business: The UAE business does not need to report (and demonstrate economic substance in the UAE related to the relevant activities of its foreign branch, provided that the foreign branch is subject to tax on its relevant income in the foreign jurisdiction (see Exemptions below).
The amended ESR provides for the following exemptions:
- Entities that are tax resident outside the UAE
The UAE entity must submit a tax residence certificate or other documentation issued by the tax authority in the foreign jurisdiction in which it claims to be a tax resident to prove that it is treated as a local tax resident entity in that foreign jurisdiction, in support of its ESR notification claiming exemption.
- Investment Funds
The exemption applies to the Investment Fund as well as any UAE entities used by the Investment Fund to make or hold investments, but does not extend to the entity or entities in which the Investment Fund ultimately invests.
- Entities that are wholly owned by UAE residents and that (i) are not part of a multinational group, and (ii) only carry out business activities in the UAE
The term UAE residents refers to either (i) UAE citizens or (ii) individuals holding a UAE residency visa who reside in the UAE.
- UAE branches of a foreign head office / parent whose relevant income is subject to tax in the jurisdiction of the foreign head office / parent.
Subject to further guidance, it is expected that the “subject to tax” test is met where the income of the UAE branch is included in the taxable income of the foreign head office / parent, irrespective of whether the foreign head office / parent can claim a branch profit exemption under a double tax treaty with the UAE or under the domestic tax law of the jurisdiction of the foreign head office / parent.
The exemption for UAE government owned entities (directly or indirectly owned at least 51%) has been removed but these entities can benefit from the exemptions introduced in the amended ESR and set out above.
Exempt entities must (i) file a notification and (ii) provide sufficient documentary evidence to substantiate and benefit from their exempt status.
Exchange of information
The amended ESR provide that the MoF will exchange information with Foreign Competent Authorities on Licensees that claim to be exempt from the ESR based on:
– being tax resident outside the UAE; or
– being a UAE branch of a foreign entity whose income is subject to tax outside of the UAE.
Administration & Penalties
The UAE Federal Tax Authority (FTA) has been appointed to:
(i) assess whether Licensees have met the Economic Substance Tests;
(ii) impose administrative penalties for non-compliance; and
(iii) hear and decide on appeals filed by Licensees, among others.
Decision 100/2020 now clarifies that the UAE Ministry of Finance (MoF) will launch a portal to facilitate the electronic filing of the notifications, reports and other relevant information.
The Regulatory Authorities’ primary responsibility is the collection and verification of information regarding their Licensees, and assisting the FTA in carrying out its role as National Assessing Authority.
The administrative penalties for non-compliance have increased as follows
- AED 20,000 for failing to complete ESR Notification
- AED 50,000 for failing to complete ES Report (and automatic deemed failure to demonstrate substance)
- AED 50,000 for failure to demonstrate substance 1st Year
- AED 400,000 for failure to demonstrate substance 2nd Year & potential to lose Trade License.
What this means for businesses in the UAE
Businesses that do not carry out a RA – no action required
Businesses that carry out a RA but have not earned income from that RA in the reporting period – required to file ESR Notification via the MoF portal (once available)
Businesses that carry out a RA but who are classified as exempt as per the Regulations – required to file ESR Notification and provide proof of exempt status via the MoF portal (once available)
Businesses that carry out a RA, have earned an income from that activity in the reporting period and do not fall into an exemption category – required to file ESR notification and submit ES Report demonstrating compliance with the Regulations by 31 December 2020.
Businesses need to reassess their activities in light of the changes under the amended ESR and be prepared to submit their filings ahead of the deadline, if applicable.
Should you be interested in learning more and understanding what your business needs to do to ensure compliance, please get in touch with us on firstname.lastname@example.org or +971 (0) 4 446 3900.
Disclaimer: All information provided in this article was correct at time of publishing. Not all Regulatory Authorities had released information on the filing deadline of the notification, at time of publishing.