In the UAE, ESR refers to the Economic Substance Regulations, a framework established to curb the shifting of profits by multinational corporations to low or no-tax jurisdictions. Implemented in 2019, these regulations require businesses engaged in certain activities to maintain a significant economic presence in the UAE. The aim is to ensure that profits align with the region’s economic activities and substantial presence.
The ESR mandates entities to declare their Relevant Activities annually, demonstrating that they are managed from within the UAE and are not merely profit-shifting arrangements. As businesses navigate these stringent regulations, understanding and adhering to ESR requirements is crucial to maintaining compliance and avoiding the steep penalties associated with non-compliance.
The Economic Substance Regulations (ESR) were introduced in the United Arab Emirates (UAE) in 2019 to combat multinational corporations’ improper practice of profit shifting. These regulations ensure businesses with certain geographically mobile activities maintain a substantial economic presence in the UAE. The ESR’s primary goal is to prevent entities from exploiting the tax system by moving profits to low or no-tax jurisdictions without engaging in significant economic activities in those locations.
Under the ESR, entities in the UAE that engage in specific activities, known as “Relevant Activities,” must submit a detailed annual report to the regulatory authorities. This report is a crucial document that demonstrates the entity’s economic substance in the UAE. The Relevant Activities span a wide range of business operations, including banking, insurance, fund management, lease-finance, headquarters, shipping, holding company, intellectual property, and distribution and service centre businesses.
Suppose you’re running a business that falls within these categories. In that case, you’ll need to conduct your “Core Income Generating Activities” within the UAE. You’ll also have to ensure that the management and direction of the activities are based in the UAE. This can be shown by holding board meetings in the country, having UAE-based managers or directors, and maintaining an adequate level of qualified employees and physical assets relative to the activity undertaken.
The regulations require entities to assess both qualitatively and quantitatively whether their activities fall within the scope of ESR. You’ll need to determine how to meet the substance requirements for each Relevant Activity. This assessment includes various aspects of your business, such as operational, financial, tax, legal, and governance considerations.
Entities exempt from the ESR, like those tax resident outside the UAE or part of a group that files tax returns in another jurisdiction, must still file a Notification and provide evidence of their exempt status. Meanwhile, entities that aren’t exempt must file an annual economic substance report. This report self-assesses their compliance with the substance requirements and includes detailed information about their Relevant Activities.
The first filing season for ESR concluded by the end of 2020, and businesses are now gearing up for subsequent filings. It’s important for entities to stay informed about these regulations and their implications to avoid sanctions. Penalties can range from AED 50,000 to AED 400,000, depending on the nature and frequency of non-compliance. More severe consequences may also be enforced, such as the suspension, revocation, or non-renewal of the entity’s trade licence.
The introduction of ESR in the UAE aligns the country with international efforts to combat tax evasion. It ensures that the UAE remains a reputable business hub. The ESR clearly indicates the UAE’s commitment to global tax standards and the prevention of profit shifting to no or nominal tax jurisdictions. If you’re operating in the UAE, you’ll need to navigate these regulations carefully to maintain your economic substance within the country and comply with the reporting requirements to avoid any potential penalties.
The ESR was enacted by the Cabinet of UAE Ministers through Resolution No. 31 and later amended by Resolution No. 57. These measures were taken to adhere to the directives of the OECD Forum and the EU COCG, focusing on specific business sectors within the UAE.
A “Licensee” refers to any juridical person or unincorporated partnership registered in the UAE, including those in Free Zones and Financial Free Zones, that holds a legal licence or permit to operate. These entities must be involved in one or more of the Relevant Activities.
Exempted Licensees include:
- Investment funds.
- Entities that are tax residents outside the UAE.
- Entities wholly owned by UAE residents that operate exclusively within the UAE.
Branches of foreign entities whose income is subject to tax in another jurisdiction are also exempt. These entities must still submit a notification to confirm their exemption status.
Foreign-owned businesses in the UAE that undertake Relevant Activities must adhere to the ESR. The Federal Tax Authority is responsible for ensuring compliance. To pass the Economic Substance Test, a Licensee must show that it is directed and managed in the UAE, conducts its CIGAs within the country, and has adequate employees, physical assets, and operational expenditures in the UAE.
Holding companies have specific compliance obligations and must have sufficient resources to conduct their activities. High-risk IP businesses have additional requirements to demonstrate control over their intellectual property assets.
Licensees, including exempt ones, must file an annual Notification and an Economic Substance Report through the Ministry of Finance Portal within six months after the end of their financial year. The report should detail their Relevant Activities, income, expenses, assets, and the employees involved.
Entities that fail to meet the ESR can incur penalties from AED 20,000 for late notifications up to AED 400,000 for repeated violations. All entities, including those in RAK and other emirates, must submit the required reports to their respective Regulatory Authorities.
Entities must adhere to specific timelines for submitting their economic substance notification and report. The notification must be filed within six months following the end of the entity’s financial year, while the economic substance report is due within 12 months from the financial year-end.
Entities must demonstrate that they are performing their CIGAs in the UAE to pass the Economic Substance Test. This involves maintaining an appropriate number of qualified employees, assets, and expenditures in the country. Decision-making processes must also occur within the UAE.
Entities that did not engage in a Relevant Activity or did not earn income from such activities during the reportable period are not subject to the Economic Substance Test for that period. Exemptions may apply to certain entities, such as those owned by UAE nationals and not part of a multinational group, although they must still file a notification.
Entities are required to keep detailed records to prove compliance with the ESR. These records must be available for inspection by the authorities.
Penalties for non-compliance include financial sanctions and, for persistent violations, more severe actions such as suspension or revocation of the entity’s trade licence. It is crucial for entities to prepare and maintain all necessary documentation to support their compliance and avoid these penalties.
Entities must ascertain their involvement in Relevant Activities and the generation of income from these activities to determine the necessity of filing a Notification. This submission is mandatory even for entities that qualify for exemptions from the full reporting process.
The Notification must be submitted to the Ministry of Finance within the prescribed time frame, confirming the engagement in Relevant Activities and income generation during the reportable period. Ensuring that strategic decisions are made locally and that there is a sufficient economic presence is also essential. Adherence to submission deadlines is critical to prevent the imposition of fines.
Entities often incur penalties due to oversights, such as missing the submission deadline or providing incomplete documentation. To prevent such errors, entities should prepare in advance, ensuring the accuracy and completeness of all required information and evidence. Deliberate submission of false information can result in severe sanctions.
Guidance is available, such as the manual published by Deloitte, which consolidates the pertinent regulations and provides a comprehensive overview of the assessment and submission process for Notifications and Reports. This resource includes insights from experts in the field.
Updates to the ESR have altered the Notification process, necessitating entities to remain informed about the latest legislative changes. For example, subsequent to the initial Cabinet Resolution, further directives have been issued, such as Ministerial Decision No. 100 of 2020, which have refined the criteria for economic substance.
Entities must monitor legislative developments to ensure their compliance procedures remain current. A proactive stance in this regard will aid in circumventing penalties and maintaining the integrity of their UAE operations in line with the ESR.
The implementation of the ESR has been pivotal in reinforcing the UAE’s commitment to economic integrity. The regulations have bolstered the nation’s alignment with international norms by mandating entities to substantiate their economic presence.
Entities are required to make strategic management decisions domestically and satisfy the Economic Substance Test, tailored to the specific Relevant Activities they conduct. The emphasis on transparency and substance has solidified the UAE’s global standing and promoted a more collaborative environment with international economic partners.
The regulations have introduced additional layers of complexity for companies. They must ensure compliance by accurately documenting their governance structures and the scale of their operations concerning their Relevant Activities.
The necessity for a tangible economic presence has prompted companies to evaluate and adjust their business models. The stringent penalties underscore the critical nature of adherence to the ESR. Companies must diligently assess their applicability under the ESR and submit the required filings punctually to circumvent sanctions.
The UAE is expected to continue updating its ESR framework to remain responsive to the evolving global economic environment and feedback from international bodies. The ESR’s flexibility is essential for maintaining its effectiveness while fostering economic development.
Businesses must remain vigilant and adaptable to modifications in the ESR that could impact their operations and reporting obligations. Diligent preparation of supporting documentation for Notifications and Reports is imperative for demonstrating compliance and mitigating non-compliance risks. As the UAE persists in its dedication to economic substance, the ESR will likely persist as a significant factor in its economic strategy and corporate operations.
The ESR framework is a steadfast component of the UAE’s regulatory landscape, emphasising accountability and economic presence within its vibrant market. Entities are expected to proactively manage their compliance duties, balancing both the strategic management and operational nuance associated with ESR. The commitment to demonstrate a robust economic substance is more than a statutory obligation; it reflects a business’s dedication to sustainable practices and alignment with international economic standards.
As the UAE continues refining its policies, entities must keep abreast of legislative updates and adapt their activities accordingly. Proactive compliance fosters trust with regulatory bodies, mitigates the risk of punitive measures, and upholds the reputation of businesses operating in the UAE. For entities navigating the complexities of ESR, attention to detail and an informed approach are not merely options but necessities for thriving in the UAE’s progressive economic environment.