The United Arab Emirate Ministry of Finance (UAE MoF) has published the revised legislation on Economic Substance Regulations (ESR). The ESR were introduced in 2019, with 2019 being the first reportable year for all UAE based entities (companies, branches and commercial license holders). This revised legislation addresses specific aspects of the ESR.
The main amendments introduced by the revised ESR are summarized below.
Definition of a licensee
A licensee is defined as "an entity that is (i) a juridical person incorporated inside or outside the UAE or (ii)an unincorporated partnership registered in the UAE, including a free zone and a financial free zone and carries on a Relevant Activity."
Branches of a foreign entity registered in the UAE (which can include a permanent establishment or any other form of taxable presence for corporate income tax purposes which are not a separate legal entity) that carries out a relevant activity, are required to comply with the ESR, unless the Relevant Income of such a branch is subject to tax in a jurisdiction outside the UAE.
Similarly, where a UAE entity carries on a relevant activity through a branch registered outside the UAE, the UAE entity is not required to consolidate the activities and income of the branch for purposes of the ESR. This is provided the relevant income of the branch is subject to tax in the foreign jurisdiction where the branch is located.
The following entities are exempted from the ESR:
- an investment fund;
- an entity that is tax resident in a jurisdiction other than the UAE; and
- an entity wholly owned by UAE residents and meets the following conditions:
- the entity is not part of a multinational enterprise group; and
- all of the entity's activities are only carried out in the UAE;
- a licensee that is a branch of a foreign entity the relevant income of which is subject to tax in a jurisdiction other than the UAE.
It should be noted that the exemption provided to companies in which the UAE government, or the government of any emirate of the UAE, has at least 51% as direct or indirect ownership in its share capital has been withdrawn.
Exempted licensees remain subject to the obligation to submit a notification to the relevant authority along with sufficient evidence substantiating their status as an exempted licensee for each financial year in which it claims to be an exempted licensee.
However, a tax resident in a foreign jurisdiction claiming to be an exempted licensee is required to submit one of the following documents along with its notification in respect of each relevant financial year:
- letter or certificate issued by the competent authority of the foreign jurisdiction in which the entity claims to be a tax resident stating that the entity is considered to be resident for corporate income tax purposes in that jurisdiction; or
- an assessment to corporate income tax on the entity, a corporate income tax demand, evidence of payment of corporate income tax, or any other document, issued by the competent authority of the foreign jurisdiction in which the entity claims to be a tax resident.
First reportable financial
The licensees including those exempted are subject to the ESR Regulations from the earlier of:
- their financial year commencing on 1 January 2019, or
- the date on which they commence carrying out a relevant activity (for a financial year commencing after 1 January 2019).
The ESR provides that any licensee carrying out any of the following relevant activities should comply with the economic substance requirements:
- banking business;
- insurance business;
- investment fund management business;
- shipping business;
- lease-finance business;
- distribution & service centre business;
- headquarters business;
- intellectual property business; and
- holding company business.
It should be noted that the new ESR has expanded the scope of the "distribution and service centre business" to include:
- the purchase of spare parts, raw materials and finished goods notwithstanding the fact that these goods will be stored in the UAE; and
- services providers to all related parties notwithstanding where they are established (previously only services providers to foreign related parties were included in the scope of the relevant activity).
It should also be noted that the revised ESR has limited the definition of high-risk intellectual property licensees as follows:
- the licensee did not create the intellectual property asset which it holds for the purpose of its business;
- the licensee acquired the IP asset from either:
- a Connected Person; or
- in consideration for funding research and development by another person situated in a foreign jurisdiction;
- the licensee licenses or has sold the IP asset to one or more group companies, or otherwise earns separately identifiable gross income (e.g. royalties, licence fees) from a foreign group company in respect of the use or exploitation of the IP asset.
The condition that the licensee does not carry out research and development, or branding, marketing and distribution as part of its state core income-generating activity has been withdrawn.
The revised ESR clarified that every licensee and exempted licensee is required to submit a notification to their respective regulatory authorities. The notification shall set out the following for each relevant financial year:
- the nature of the relevant activity being carried out;
- whether it generates relevant income;
- the date of the end of its financial year; and
- any other information as may be requested by the regulatory authority.
The Notification must be submitted electronically on the Ministry of Finance portal within 6 months from the end of the Licensee or Exempted Licensee's financial year.
It should be noted that licensees that have already submitted a notification directly to their regulatory authorities are required to re-submit a notification in accordance with the provisions of the revised ESR on the Ministry of Finance portal once available.
National assessing authority under ESR
In addition to the regulatory authorities of which the main functions are inter alia to collect, review and report the economic substance regulation notification and all the relevant information required to be submitted by the Licensees and exempted Licensees, the revised ESR has appointed the federal tax authority (FTA) as the national assessing authority which should undertake the following functions:
- undertake assessments to determine whether a licensee has met the economic substance test;
- impose administrative penalties, applicable;
- hear and decide on appeals;
- exchange information to the competent authority pursuant to article 10 of the revised ESR; and
- carry out any other functions for the purposes of implementing the provisions of the revised ESR.
The UAE MoF will launch a portal to facilitate the electronic filing of notifications, economic substance reports and all other relevant documents and information.
The revised ESR have increased the penalties imposed for non-compliance by the licensee or the exempted licensee with the requirements as follow:
- An AED 20,000 penalty if the licensee or the exempted licensee do not submit the revised ESR notification; and
- An AED 50,000 penalty (increased to AED 400,000 for the second year) if the licensee or the exempted licensee:
- fails to provide the ESR report; or
- fails to satisfy the ESR requirement.
The UAE MoF also published a new relevant activities guide (schedule 1 of the ESR) and updated the frequently asked question on its website.
Cabinet Decision No 57 of 2020 on the revised ESR was published by the UAE MoF on 1 September 2020, as well as the Ministerial Resolution No 100 of 2020 (The Resolution) dated 19 August 2020 on the issuance of directives for the implementation of the ESR. These regulations repeal and replace respectively Cabinet Decision No 31 of 2019 and Ministerial Decision No 215 of 2019.