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ESR - Frequently Asked Questions

General

ESR has been introduced in countries with low or no corporate taxes, in order to comply with international initiatives to combat harmful tax practices including unlawful avoidance or evasion of tax.

As a member of the Organization for Economic Cooperation and Development (OECD) Inclusive Framework, the UAE is committed to ensuring that the UAE’s legal and commercial framework is in line with global standards and is subject to review by the OECD to ensure that these standards are implemented.

A. Regulations

  • UAE Cabinet of Ministers Resolution No. 31 of 2019 Concerning Economic Substance Regulations, issued on 30 April 2019;
  • UAE Cabinet of Ministers Resolution No.58 of 2019 identifying the relevant Regulatory Authorities responsible for supervision and enforcement of the Regulations, issued on 4 September 2019.
  • Cabinet Resolution 7 OF 2020 amending some provisions of the Cabinet Resolution No. 31 of 2019, issued on 19 January 2020.

B. Guidance

  • Ministerial Decision No. 215 for the year 2019 providing guidance on Cabinet Decision No. 31 of 2019, issued on 11 September 2019;
  • Relevant Activities Guide released by the UAE Ministry of Finance in April 2020.
  • Relevant guides issued by different Regulatory Authorities

A “Licensee” under the Regulations is a natural or juridical (legal) person licensed by the competent licensing authority/authorities in the State to carry out a Relevant Activity in the UAE, including a Free Zone (including an off shore free zone) and a Financial Free Zone (e. g DIFC).

Scope of Application

Followings Nine (09) are Relevant Activities under ESR:

1. Banking Business
2. Insurance Business
3. Investment Fund Management Business
4. Lease-Finance Business
5. Headquarter Business
6. Shipping Business
7. Holding Company Business
8. Intellectual Property Business
9. Distribution and Service Centre Business

A Licensee (aside from those carrying out a “Holding Company” Business and those carrying out a “High-Risk IP” Business) need to demonstrate all 3 of the following conditions:

1. Adequate employees, physical assets & expenditure in the UAE
2. Core Income Generating Activities (“CIGAs”) are undertaken in the UAE.
3. Directed and managed in the UAE.

The Regulations impose economic substance requirements on any UAE entity which carries on a Relevant Activity, regardless of whether the UAE entity belongs to a foreign multinational group. However, a UAE based Distribution Business, Service Centre Business, Headquarter Business or High-Risk IP Business would only be within the scope of the Regulations if the UAE entity transacts with foreign group companies. Distribution, Service Centre, Headquarter and High-Risk IP activities where transactions between UAE entities are not subject to economic substance requirements.

No. Whilst the commercial license may indeed state the Relevant Activity, a ‘substance over form’ approach must be used to determine whether a Licensee undertakes a Relevant Activity and is within the scope of the Regulations. This means looking beyond what is stated on the commercial license to the activities actually undertaken by the Licensee during a financial period.

Licensees that are directly or indirectly at least 51% owned by the Federal or an Emirate Government, or a UAE Government body or authority, are exempt from the Regulations.

If a Licensee does not undertake a Relevant Activity during a financial period, it does not need to meet the Economic Substance Test.

A Licensee that undertakes a Relevant Activity but that does not earn income from this activity in a financial period is not required to meet the Economic Substance Test for that period. Whilst the Licensee would still need to submit a notification with its Regulatory Authority, it is not required to file an Economic Substance Return for the relevant financial period.

No, this Licensee is not exempt from the Regulations. Income from a Relevant Activity for which the Licensee needs to demonstrate economic substance in the UAE includes all income, including income that is generated by the Licensee outside of the UAE.

Demonstrating Economic Substance in the UAE

There is no definition of “adequate”
What is adequate and appropriate will depend on
  • The nature and level of activities carried out; and
  • The level of income earned by the Licensee.
The regulations and Guidance, therefore, do not provide a “minimum” standard for what is considered “adequate” or “appropriate”.
The Regulatory Authorities are expected to take a pragmatic approach when assessing whether a licensee has met the Economic Substance Test, recognizing that the type and level of activity of a Licensee may fluctuate during the course of a financial period and from year to year.

No. The Regulations do not allow Licensees that are part of the same group to be aggregated for economic substance purposes. Each Licensee will need to comply with the Regulations, and demonstrate economic substance on an individual basis.

Yes, an adequate number of board meetings should be held in the UAE. What is considered to be an adequate number of board meetings will depend on the nature and extent of the Relevant Activity being undertaken by the Licensee. For each board meeting held in the UAE:
  • a quorum of directors must be physically present in the UAE; and
  • meeting minutes must be maintained and signed in the UAE; and
  • directors attending the board meeting must have the necessary skills and expertise to discharge their fiduciary duties. A Holding Company Business is not required to be directed and managed in the UAE, except where this is a requirement of the relevant licensing authority.

Employees who perform the CIGAs of a Licensee would in principle need to be residents in the UAE. Non-resident employees or other persons would count towards the economic substance of a Licensee in the UAE only if
(i) the relevant activities are performed while the individual is physically present in the UAE, and under the direction of the Licensee and
(ii) the Licensee bears the relevant costs of the non-resident individuals.

No, directors only need to be physically present in the UAE to attend relevant board meetings of the Licensee.

Yes, directors who in addition to performing their fiduciary duties also perform CIGAs can be counted as employees of the Licensee for the purposes of meeting the Economic Substance Test.

No, whilst obtaining a UAE Tax Residency Certificate requires a certain minimum presence in the UAE, a UAE Tax Residency Certificate in itself is not proof of a Licensee having adequate economic substance in the UAE in relation to is Relevant Activity and the income earned from this activity.

Demonstrating economic substance in the UAE – Outsourcing

A Licensee can outsource any or all of its CIGAs so long as the outsourced activities are performed in the UAE. Effectively, this means that a Licensee can use UAE based
(i) employees and
(ii) physical assets (including premises) of third parties or related entities to satisfy the Economic Substance Test.
A Licensee cannot outsource “directed and managed”, as the Licensee is required to demonstrate oversight and control of its Relevant Activity in the UAE.

A Licensee can outsource, contract or delegate CIGAs to related parties or to third-party service providers, as long as the Licensee monitors and retains the ability to control the outsourced activities.

A Licensee should:
  • Have adequate supervision of the outsourced activity; and
  • Ensure the outsourcing provider has adequate substance in the UAE; and
  • Ensure the outsourced activity is conducted in the UAE; and
  • Ensure there is no double-counting of the outsourcing providers' resources. The above can be evidenced through contractual agreements that govern the relationship and responsibilities of each party.

Activities that are not CIGAs (e.g. back-office functions) can be outsourced to related parties or third-party service providers that are located outside the UAE without adversely impacting the economic substance of the Licensee in the UAE.

Distribution and Service Centre Business

A “Distribution and Service Centre” Business refers to two distinct activities that are covered under one “Relevant Activity” heading. A UAE entity is considered engaged in a Distribution Business if it:
  • Purchases goods from a Foreign Connected Person; and
  • Import those goods into the UAE; and
  • Distributes those goods outside the UAE.
A UAE entity is considered engaged in a Service Centre Business if it:
  • Provides services to a Foreign Connected Person; and
  • Those services are in connection with the Foreign Connected Person’s business outside the UAE.
UAE entities that purchase and sell goods from and to third parties, or that provide services to third parties, are not subject to the Regulations (as a Distribution and Service Centre Business).

Holding Company Business

A UAE entity is considered engaged in a Holding Company Business if it:
  • Only holds equity interest(s) in juridical person(s); and
  • Only earns dividend and capital gains from its equity interest(s) A UAE entity that holds other assets or earns other forms of income will not be considered a Holding Company Business. Where the holding of such other assets or the performance of other commercial activities constitute a different “Relevant Activity” (e.g. a Lease-Finance Business), the UAE entity would be subject to the Regulations in respect of that other Relevant Activity.

No, an investment fund is not considered a Holding Company Business.
Yes, however, a Holding Company Business is subject to reduced substance requirements as follows:
  • Comply with existing reporting/compliance requirements under the regulations applicable to the Licensee; and
  • Have adequate employees and physical assets (e.g. premises)

    A Holding Company Business is not required:
    • to be “directed and managed” in the UAE (unless otherwise provided for under the rules and regulations of any Regulatory Authority’s); or
    • To have/demonstrate adequate expenditure in the UAE

      Yes, however, a Holding Company Business is subject to reduced substance requirements as follows:
      • Comply with existing reporting/compliance requirements under the regulations applicable to the Licensee; and
      • Have adequate employees and physical assets (e.g. premises) A Holding Company Business is not required:
      • to be “directed and managed” in the UAE (unless otherwise provided for under the rules and regulations of any Regulatory Authority’s); or
      • To have/demonstrate adequate expenditure in the UAE

        “High Risk” IP Businesses

        Either Condition A or B as set out below must be met for an IP Business to be considered as “High Risk".

        Condition A - all of the following need to be met
          1. The Licensee did not create the IP asset which it holds for the purposes of its business;
            1. The Licensee acquired the IP asset either from:
            • a Connected Person, or
            • in consideration for funding research and development by another person situated in a country other than the UAE;

          Condition B
          The Licensee does not carry out research and development, or branding, marketing, and distribution as part of its UAE Core Income-Generating Activity

          Investment Fund Management Business

          A UAE entity that provides discretionary investment management services to Collective Investment Vehicles located in the UAE or in a different jurisdiction. An Investment Fund Management Business includes making discretionary investment, divestment and risk related decisions on behalf of an investment fund. UAE entities providing other types of investment fund related services such as fund administration, investment advisory and custodian services are not considered engaged in an Investment Fund Management Business.

          Lease-Finance Business

          A UAE entity is considered engaged in a Lease-Finance Business if it provides credit or rents assets, equipment or any other good to another person for consideration. Providing credit includes making loans and entering into other financing arrangements such as hire purchase agreements and finance leases. Licensees engaged in Banking, Insurance, and Fund Management Business may also perform lease or financing activities as a normal part of their business operations. To prevent duplicate reporting, such Licensees are not also considered engaged in a Lease-Finance Business and will not need to separately demonstrate economic substance in respect of any ancillary Lease-Finance activities.

          Yes, a UAE entity that makes a loan or provides any other form of credit to a UAE or foreign group company for consideration (e.g. interest) will be considered engaged in a Lease-Finance Business.

          No, UAE entities that invest and hold bonds and other debt securities that are traded on a regulated exchange are not considered engaged in a Lease-Finance Business.

          The Regulations do not apply to credit and other financing and leasing arrangements where there is no expectation of consideration in the form of interest, fees, rental payments, capital gains or any other form of compensation. The grant of security in favor of the lender would not constitute consideration.

          Headquarter Business

          A UAE entity that provides services to other foreign group entities, and through the provision of such services:
          • has taken on the responsibility for the overall success of the group; or
          • is responsible for an important aspect of the group’s performance.

            No, a group’s corporate structure is not relevant in determining whether a UAE entity within the group is engaged in a Headquarter Business. Whether an entity is engaged in a Headquarter Business is entirely dependent on the nature of the services provided to foreign group companies.

            Possibly, if the Relevant Activities from two or more distinct business activities. However, if an activity that might otherwise fall within the definition of a Headquarters Business forms part of another main Relevant Activity of the Licensee, the Licensee would not be considered to also be engaged in a Headquarters Business. For Example, a UAE subsidiary of a captive insurance group will not be considered to carry on a “Headquarter Business” simply because it assumes the material risk on behalf of the group.

            Administration

            A Licensees that undertakes a Relevant Activity (irrespective of whether the Licensee qualifies for an exemption under the Regulations or has earned income from the Relevant Activity during the relevant financial period) need to submit a simple notification with its Regulatory Authority. Notification for the financial period 2019 can be filed on or after 1st January 2020.

            Only Licensees that earn income from a Relevant Activity during the relevant financial period and that are not exempt from the Regulations are required to demonstrate economic substance in the UAE and file an economic substance return. Economic Substance returns must be filed within 12 months from the end of the relevant financial period.

            Failure to Notify: AED 10k to 50k Failure to provide accurate or complete Information:
            • A penalty of AED 10k to 50k; and
            • Deemed failure to demonstrate economic substance in the UAE Failure to demonstrate sufficient economic substance in the UAE for the relevant Financial Year: First Failure
            • Penalty of AED 10k to 50k; and
            • Information exchange with the foreign competent authority of: (1) parent company, (2) ultimate parent company, and (3) ultimate beneficial owner; and
            • Penalty of AED 100k to 300k; and
            • Trade / commercial license could be: suspended, withdrawn or not renewed.

              DIFC and DFSA – FAQs

              DIFC entities that are in the process of liquidation (under dissolution) are required to comply with the Economic Substance Notification requirement in respect of Reportable Periods ending on or before the completion of the liquidation process.

              Entities that have been dissolved, struck- off or liquidated prior to deadline for the submission of ESR notification are exempt to file ESR notification.

              No, each DIFC entity must file a Notification on a stand-alone basis, irrespective of whether the entity is part of a consolidated group, for accounting purposes.

              The reportable period commenced on or after 1st January 2019 to which the ESR Notification relates and will end at the end of it.

              Example 1:
              The entity whose financial year corresponds to the calendar year would have the following Reportable Period:
              Start date: 1st January 2019
              End Date: 31st December 2019
              ESR Notification date: 30th June 2020
              ESR Report: on or before 31st December 2020

              Example 2:
              An entity incorporated on 1st July 2019 with a 31st March 2020 financial year-end, would have the following Reportable Period:
              Start date: 1st July 2019
              End Date: 31st March 2020
              ESR Notification date: 30th June 2020
              ESR Report: on or before 31st March 2021

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