Economic Substance Regulation

Economic Substance Regulation

The Organisation for Economic Co-operation and Development (OECD) has set guidelines to combat tax avoidance through tax base erosion and profit shifting. As a member of the OECD inclusive framework, UAE is committed to ensure that the UAE’s legal and commercial framework is in line with global standards. As a part of this commitment and in response to an assessment of the UAE’s tax framework by the European Union Code of Conduct Group on Business Taxation, the UAE issued Economic Substance Regulations (“ESR”) in April 2019.

These regulations are recently amended by Cabinet of Ministers Resolution No. (57) of 2020 on 10 August 2020, and updated Guidance was issued on 19 August 2020 (Ministerial Decision No. (100) of 2020.

ESR is applicable to all licensees carrying out a ‘Relevant Activity’ in the UAE. This includes licensees in Free Zones, Financial Free Zones and Offshore Free Zones. The regulations apply to financial year commencing from 1 January 2019.

Licensees within the scope of ESR are required to submit notification and report confirming whether they undertake any Relevant Activity and meet the ESR tests.

For more details, please refer our FAQs below:

1. What are Economic Substance Regulation and the purpose for enacting them?
- The UAE introduced Economic Substance Regulation (ESR) on 30 April 2019 through a Cabinet of Ministers Resolution No. 31 of 2019.
  
  This was done as a part of UAE’s commitment as a member of the OECD Inclusive Framework to implement the action points of OECD base erosion and profit shifting framework for countries across the globe with low or no corporate taxes where harmful tax practices such as tax avoidance and evasion are prevalent. UAE’s move to implement ESR also came in response to an assessment of the UAE’s tax framework by the European Union (EU) Code of Conduct Group on Business Taxation
  
  The objective of this new regulation is to ensure that all legal entities in UAE have genuine substance in the region and are reporting actual profits generated from activities conducted in the region.
  
  In consultation with the OECD and the EU, the Ministry of Finance (MoF) has made amendments to the Regulations and the revised Regulations were announced through Cabinet of Ministers Resolution No. 57 of 2020 signed on 10 August 2020 and updated Guidance was issued on 19 August 2020 (Ministerial Decision No.100 of 2020)
2. Where can I find the ESR legislation and guidance?
- The amended ESR legislation and guidance are as follows:
  
  · Cabinet of Ministers Resolution No. 57 of 2020 revoking the erstwhile ESR regulation
  
  KNOW MORE
  
  · Ministerial Decision No. 100 of 2020 (Guidance)including the Relevant Activities guide
  
  KNOW MORE
  
  The FAQs are also published by the Ministry of Finance on their website along with the flowchart .
3. Where I can submit ESR notification and Report?
- The Ministry of Finance has launched ESR portal filing
  
  CLICK HERE
4. Will the licenses be required to re-assess the applicability of ESR as per the amenged legislation?
- The amended ESR legislation has brought in certain changes. Some of these which may require the licensee to re-assess are:
  - Legal type of licensees covered under ESR. Refer Q5 below for details
  - Treatment of branches. Refer Q10 below
  - Definition of certain Relevant Activities. Refer Q6 below
  - Exemptions. Refer Q9 below.
5. To who does the Economic Substance Regulations apply?
- ESR applies to all judicial persons and unincorporated partnerships licensed with SRTIP carrying on one or more “Relevant Activities” in UAE.
  
  The following persons are not covered under the Regulations:
  - A natural person
  - A sole proprietorship
  - A Trust
  - A Foundation
  Further, ESR is not limited to companies which are a part of foreign multinational group.
  
  If a Licensee does not undertake any Relevant Activity, it does not have comply with the ESR.
6. What are Relevant Activities under ESR?
- The Relevant Activities under the Economic Substance Regulations are:
  
  · Banking Businesses
  
  · Insurance Businesses
  
  · Investment Fund Management Businesses
  
  · Lease-Finance Businesses
  
  · Headquarters Businesses
  
  · Shipping Businesses
  
  · Holding Company Businesses
  
  · Intellectual Property (IP) Businesses
  
  · Distribution and Service Centre Businesses
  
  The MoF has released guide for relevant activities which is attached as an annexure to the Ministerial decision.
  
  CLICK HERE
  
  It is important to note that there has been changes to the definition of Distribution and Service Centre Business and High Risk IP business.
  
  Distribution and Service Centre Business :
  
  The old definition of a ‘Distribution and Service Centre Business’ required the purchase of goods from a Foreign Connected Person, importing goods into UAE and subsequently reselling them outside UAE. This was amended to exclude the requirement to import and export goods from UAE. The new definition now only requires the purchase and resale of goods.
  
  The definition of a Distribution and Service Centre Business has also been amended to exclude the requirement of the services to be in connection with a business outside UAE. Therefore, licensees providing any services to a Foreign Connected Person will now qualify as service center business.
  
  High Risk IP Business:
  
  The definition of a High Risk IP business has been narrowed. The condition relating to a licensee not carrying out any research and development, or branding, marketing and distribution as part of its core income-generating activity in the UAE has been removed in the new definition.
7. Are the Relevant Activities same as the activities mentioned on Commercial licenses?
- No, substance over form approach should be adopted. The licensee is required to look beyond what is stated on the commercial license for the activities actually undertaken during the financial period.
8. What if a Licensee does not earn any income from the Relevant activity performed?
- The licensee is not required to comply with the ESR tests. However, the licensee is required to submit the notification for ESR.
9. Who is exempt from ESR?
- The following licensees are exempt from ESR under the amended Regulations:· A Licensee that is tax resident outside the UAE;
  
  · An Investment fund and its underlying SPVs / investment holding entities;
  
  · A wholly UAE resident-owned business that is not part of a multinational group and that only carries on business in the UAE
  
  · A branch of a foreign entity that is subject to tax on all of its Relevant Income in a foreign jurisdiction.Please note that sufficient evidence must be submitted along with the Notification form to claim any of the above exemptions.
10. Are branches subject to ESR?
- There are three types of branches:
  
  1. Local branches of UAE entity
  
  2. UAE branch of foreign company
  
  3. Foreign branch of UAE entity
  
  The matters to be considered for each of these scenarios is listed below:
  
  1. Local branches registered in the UAE are an extension of their parent/head office and do not have separate legal personality. Therefore, the entity with its head office registered in the UAE must file ESR notification and report as a single Licensee, reporting the Relevant Activities of itself and all its branches.
  
  2. A UAE branch of a foreign entity that carries out a Relevant Activity will be within the scope of ESR as if it were a separate legal person, unless the branch is claiming exemption from ESR.
  
  3. The UAE entity is not required to consolidate the activities and income of the foreign branch provided the Relevant Income of the foreign branch is subject to tax in the foreign jurisdiction where the branch is located.
  
  In this context, a branch can include a permanent establishment or any other form of taxable presence for corporate income tax purposes which is not a separate legal entity.