Economic Substance Review Amendments and its Impact on UAE Business
Economic Substance Regulation in Dubai, UAE is a compliance requirement for the business operating in UAE, which needs to be followed and maintained for honoring the UAE commitment as a member of the OECD inclusive framework on Base Erosion and Profit sharing (BEPS). Since UAE has been included on the EU list of non-cooperative jurisdictions for tax purposes (EU Blacklist) after reviewing UAE tax framework which leads to the issuance of the Economic Substance Regulations on 30 April 2019, and the release of Guidance on the application of the Regulations on 11 September 2019 to ensure the removal of UAE from the EU Blacklist on 10 October 2019.
According to regulations, entities conducting business in UAE should not artificially attract profits which are not commensurate with the economic activity undertaken in the UAE. Moreover, regulations require onshore, free zone, and other businesses to carry out Economic Substance Test i.e. to conduct defined relevant activities to maintain and demonstrate an adequate “economic presence” in the UAE relative to the activities they undertake.
Economic Substance Regulation applies to all Licensee & Exempted Licensee carrying on the Relevant Activities in the UAE, including the Free Zone or Financial Free Zone; with effect from the year 2019. Following is the List of Relevant
- Banking Business
- Insurance Business
- Investment Fund Management Business
- Lease-Finance Business
- Shipping Business
- Headquarters Business
- Intellectual Property Business
- Holding Company Business
- Distribution & Service Centre Business
Here it is essential to mention that even Passive Income from any of the activity falling within the definition of relevant activity would require an entity to comply with the regulation. However, going incorrect with the Assessment may lead to the filing of inaccurate information with the Authorities which may result in fine and heavy penalties.
The United Arab Emirates (UAE) Ministry initially enacted the Cabinet Resolution no. 31/2019 with effect from 30th April on Economic Substance Regulation in UAE. This was followed by Ministerial Decision 215 for the year 2019 giving directives for the implementation of the provisions of Cabinet Decision no. 31/2019. In consultation with the OECD and the EU, amendments to the Regulations were made by Cabinet of Ministers Resolution No. (57) of 2020 on 10 August 2020 (the Regulations), and updated Guidance was issued on 10 August 2020 (Ministerial Decision No. (100) for the year 2020 ) which replaced Ministerial Decision 215 for the year 2019.
The Changes in ESR and New Guidance have introduced some key amendments to the scope of the ESR, covered entities, compliance requirements, and governing authorities. Given below is a synopsis of the important changes provided in the New ESR and New Guidance which should be closely reviewed by all UAE businesses.
Definition of Licensee
The amended definition now covers i) juridical persons (incorporated inside and outside the UAE); or ii) unincorporated partnerships; which are registered in the UAE and that conduct a relevant activity (RA). An indication that natural persons, sole proprietors, trusts, and foundations are no longer in the scope of the New ESR.
Treatment of Branches
The treatment of UAE and foreign branches has been clarified. Broadly, branches registered in the UAE are now seen as an extension of their parent or head office and do not have separate legal personality. Branches being subject to corporate income tax at head office level may be exempt from the application of the New ESR.
New exemptions include: i) Investment funds, ii) entities tax resident outside UAE, iii) UAE resident-owned businesses not part of an MNE Group, and with only domestic transactions and iv) branches of foreign companies being subject to tax outside the UAE. The government ownership exemption has been withdrawn.
Definition of Connected/Related Person
Clearer guidance on which transactions would be treated as performed between related persons.
Distribution and Service Centre Business RA
The updated definition of the Distribution and Service Centre Business in the New ESR excludes the reference to ‘import and store the goods in the UAE’. Therefore, if a UAE entity is purchasing and selling goods but the goods do not physically enter/are stored in the UAE, the entity would be considered conducting an RA.
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 New ESR at the MOF Portal once available.
Licensees are now required to provide financial reports as part of the ES Report submission.
Penalties for non-compliance
Penalties for non-compliance have been increased significantly.
Regulatory Authority and Introduction of National Assessing Authority
The Federal Tax Authority (FTA) has become the “National Assessing Authority” to oversee compliance and control with the New ESR. The Regulatory Authorities will remain involved in providing support to the FTA.
Exchange of information
The MoF has expanded the cases where information would be exchanged with foreign competent authorities from being a punitive measure (or related to High-Risk IP) to be a source of information for confirmation of tax residency of UAE entities and branches.
ESR Notification should be filed by all Licensee and Exempted Licensee annually providing the following details:
- Date of commencement and end of Financial Year
- Relevant Activity being carried
- Whether Revenue generated from such Relevant activity during relevant Financial year
- Other information as required by the Regulatory Authority
It is mandatory for Exempted Licensee to also provide all the information and documents for claiming the status of Exempted Licensee. And this Notification must be filed within 6months from the end of its fiscal year of Licensee or exempted licensee.
To be specific, after the recent ESR amendments distribution and service center businesses in UAE need to consider the impact of the amended definition of the Distribution and Service Centre. In addition to that, Business to ensure that the position is correct. Companies that have been excluded from the previous definition as goods have not been imported and stored in the UAE will now be covered under the new ESR. Moreover, Government-owned entities that availed the government exemption from the ESR previously, will now be subject to the New ESR and need to change their notifications.
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