Economic Substance Regulation
The United Arab Emirates Cabinet recently issued the Cabinet of Ministers Resolution No.31 of 2019, which requires all in-scope UAE entities to maintain an economic substance.
The UAE was added to the European Union list of non-cooperative tax jurisdictions by the European Commission and this was the reason behind the issuance of the economic substance regulations. Economic Substance regulations UAE are similar to the economic substance requirements that were recently implemented in jurisdictions that include the Cayman Islands and Jersey.
Economic substance regulations UAE will be applicable to onshore and free zone companies that engage in any of the below mentioned “Relevant Activities”
- Banking Businesses as licensed in the State, including Banking Businesses licensed in a Free Zone or a Financial Free
- Insurance Businesses as licensed in the State, including Insurance Businesses licensed in a Free Zone or a Financial Free
- Investment Fund Management Businesses as licensed in the State, including Investment Fund Management Businesses licensed in a Free Zone or a Financial Free
- Lease-Finance Businesses as licensed in the State, including Lease-Finance Businesses licensed in a Free Zone or a Financial Free
- Headquarters Businesses as licensed in the State, including Headquarters Businesses licensed in a Free Zone or a Financial Free
- Shipping Businesses as licensed in the State, including Shipping Businesses licensed in a Free Zone or a Financial Free
- Holding Company Businesses as licensed in the State, including Holding Businesses licensed in a Free Zone or a Financial Free
- Intellectual Property Businesses as licensed in the State, including Intellectual Property Businesses licensed in a Free Zone or a Financial Free
- Distribution and Service Centers Businesses as licensed in the State, including Distribution and Service Centres Businesses licensed in a Free Zone or a Free Zone.
Activities that must be conducted by a licensee in the State shall include:
In respect of Banking Business:
- Raising funds, managing risk including credit, currency, and interest
- Taking hedging
- Providing loans, credit, or other financial services to
- Managing capital and preparing reports to investors or any government authority with functions relating to the supervision or regulation of such business.
In respect of insurance Business:
- Predicting and calculating
- Insuring or re-insuring against risk and providing Insurance Business services to
- Underwriting insurance and
In respect of Investment Fund Management Business:
- Taking decisions on the holding and selling of
- Calculating risk and
- Taking decisions on currency or interest fluctuations and hedging positions.
- Preparing reports to investors or any government authority with functions relating to the supervision or regulation of such
In respect of Lease-Finance Business:
- Agreeing funding
- Identifying and acquiring assets to be leased (in the case of leasing).
- Setting the terms and duration of any financing or
- Monitoring and revising any
- Managing any risks
In respect of Headquarters Business:
- Taking relevant management
- Incurring operating expenditures on behalf of the group
- Coordinating group activities
In respect of Shipping Business:
- Managing crew (including hiring, paying, and overseeing crew members).
- Overhauling and maintaining
- Overseeing and tracking
- Determining what goods to order and when to deliver them, organizing and overseeing
In respect of Holding Company Business, all activities related to that business; and in respect of Holding Company Business that derives income from other sources other than dividends and capital gains from its equity interest, the state Core Income- Generating Activities shall be those activities associated with the income generated.
In respect of Intellectual Property Business:
- where the Intellectual Property Asset is a:
1. Patent or an asset that is similar to a patent, research and
2. Non-trade intangible (including a trademark), branding, marketing, and distribution.
- If the Relevant Activity is conducted by a Licensee that is regarded as a High-Risk IP Licensee, the State Core Income-Generating Activity must include any of the following additional activities:
1. Taking strategic decisions and managing (as well as bearing) the principal risks related to the development and subsequent exploitation of the intangible asset generating
2. Taking the strategic decisions and managing (as well as bearing) the principal risks relating to the acquisition by third parties and subsequent exploitation and protection of the intangible
3. carrying on the ancillary trading activities through which the intangible assets are exploited leading to the generation of income from third
In respect of Distribution and Service Center Business:
- Transporting and storing component parts, materials, or goods ready for sale.
- Managing
- Taking
- Providing consulting or other administrative
Requirements to meet Economic Substance Test in UAE
A Licensee meets the Economic Substance Test in relation to a Relevant Activity in the following cases:
- If the Licensee conducts State Core Income-Generating Activity in the State.
- If the Licensee is directed and managed in the State in relation to that activity, provided the Licensee’s board of directors meets in the State at an adequate frequency having regard to the amount of decision-making required at that level.
- Having regard to the level of Relevant Activity, if there is an adequate number of qualified full-time employees in relation to that activity who are physically present in the State (whether or not employed by the Licensee or by another entity and whether on temporary or long-term contracts), or adequate level of expenditure on outsourcing to third-party service providers, whose activities, employees, expenditure, and premises are in the State; and these activities, employees, expenditures, and premises are adequate for carrying out the Relevant Activity being
- If there is adequate operating expenditure incurred by it in the State, or adequate level of expenditure on outsourcing to third-party service providers whose activities, employees, expenditure and premises are in the State; and these activities, employees, expenditures, and premises are adequate for carrying out the Relevant Activity being
- If there are adequate physical assets in the State or adequate level of expenditure on outsourcing to third-party service providers in the State, for the activities of the Licensee;
- In the case of State Core, Income-Generating Activity carried out for the relevant Licensee by another entity, if it is able to monitor and control the carrying out of that activity by the other
In relation to a Licensee whose activity is restricted to carrying out a Holding Company Business that derives its income from dividends and capital gains only, such Licensee meets the Economic Substance Test if it meets the following conditions:
- Complies with the requirement to submit any documents, records, or information to the relevant Regulatory Authority in accordance with the law applicable to the Licensee in the
- Has adequate employees and premises for holding and managing the Holding Company
The rule won’t be applicable to companies that come under the ownership of the government, directly or indirectly. As such, UAE sovereign investment funds and other UAE government-related entities are exempted. There is still no confirmation regarding sole proprietorship and branches.
A relevant entity must report certain information regarding its relevant activities to the regulatory authority concerned (the one that issued the trade license to the entity), annually. Existing companies should have complied with the regulations by now, since the starting date was 30th April 2019. In the case of new entities, regulations must be complied with upon receiving its trade license.
If an entity fails to meet the requirements or if inaccurate information is given to the regulatory authority, annual administrative penalties of AED 10,000 to AED 300,000 will apply. If they fail to meet the requirements for consecutive years, the penalties will increase and might force the authorities to suspend, revoke, or deny the renewal of an entity’s license.
What Standard Auditing offer?
- Consulting on Economic Substance Regulation (ESR)
- Identify the qualifying entities for Economic Substance Regulation(ESR) compliance
- Identify the qualifying business segments for Economic Substance Regulation(ESR) compliance
- Report and advise on overall Economic Substance Regulation(ESR) readiness by the Entity
- Ongoing Economic Substance Regulation(ESR) compliance
- Secretarial services in connection with Economic Substance Regulation(ESR) record maintenance
- Economic Substance Regulation(ESR) filing with the authorities in the proper
