Economic Substance Regulations Notification in UAE

Jay Krishan, Partner

27 June, 2020

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Key facts on UAE Economic Substance Regulations Relevant activities

Investment Fund Management Business:

The definition of an Investment Fund Management Business encompasses Licensees that provide discretionary investment management services in relation to domestic or foreign “Investment Funds”.

Discretionary Investment Fund Management services include making investment, divestment, and risk-related decisions on behalf of an Investment Fund. UAE businesses providing fund administration, custodian, investment advisory, and other Investment Fund related services are not considered engaged in an Investment Fund Management Business.

The Investment Fund itself is not considered an Investment Fund Management Business unless it is a self-managed fund (the Investment Manager and the Investment Fund are part of the same entity).

Where an Investment Fund is structured as a partnership and has both a corporate General Partner and an Investment Fund Manager, only the Investment Fund Manager would be subject to the Regulations if the General Partner does not undertake business activities separate from its role as General Partner of the Investment Fund.

Some key highlights:

  •   Should be self-managed fund
  •   Should conduct discretionary investment management services
  •   Investment fund management under fiduciary capacity, ie, pooled funds from third parties

Lease Finance Business:

The definition of a Lease-Finance Business encompasses Licensees that offer credit or financing for any kind of consideration and includes intra-group financing.

Offering credit or financing includes making loans to related or unrelated parties, entering into finance leases in relation to assets other than land, and providing credit in the form of hire purchase agreements, long term credit plans, and other types of financing arrangements.

Some key highlights:( Leasing Business )

  • Only finance lease arrangements will be falling under this
  • No operating lease
  • The general definition of a finance lease needs to follow and interpret
  • Should have the relevant clauses in the lease agreement to qualify as a finance lease
  • Normal building lease for rental for a shorter period is not covered under this
  • Should have been licensed by the relevant authority
  • Lease of land is not included

Some key highlights:( Finance Business )

  • Related party or non-related party doesn’t matter
  • Lending with consideration
  • The investment in bonds or similar securities or debt instruments that are traded on a the regulated exchange  would also not be considered a Lease-Finance Business.
  • Any lending in the normal course of activity with the intention of consideration, even if such lending is ancillary to main business, would qualify for the finance business unless these are not essential to maintain the main business.
  • Should have been permitted by the Relevant Authorities

Licensees engaged in Banking, Insurance, and Investment 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.

Headquarters Business:

A Licensee is regarded as carrying on a Headquarters Business if the Licensee provides services to foreign group companies, and through the provision of such services:

  • The Licensee takes on the responsibility for the overall success of the group; or
  • The Licensee is responsible for an important aspect of the overall group’s performance.

In order for a UAE business to be seen as having “taken on the responsibility for the overall or an important aspect of the overall group’s success or performance”, the services provided by the entity must involve:

  • The provision of senior management;
  • The assumption of control of material risk for activities carried out by foreign group companies; or
  • Substantive advice in relation to the assumption of control of such risks.

A Licensee’s position in a group’s corporate structure is not relevant for determining whether it is engaged in a Headquarters Business. The Licensee does not need to be the direct or ultimate parent of a group company for it to be considered a Headquarters Business; whether an entity carries on a Headquarters Business is entirely dependent on the nature of the services it provides to foreign group companies.

Some key highlights:

  • Headquarters services provided to foreign group Entities only
  • The entity is responsible for the overall performance and or success of the group
  • Group corporate structure is not relevant for this purpose and the actual service provided under the headquarter services needs to consider

Shipping Business:

To undertake a Shipping Business, a Licensee must operate one or more ships in international traffic, for the transport of either passenger, cargo, or both.

Further, the following activities will be considered a Shipping Business only where they are undertaken by a Licensee in connection with the business of operating a ship, or ships, in international traffic:

  • The rental on a charter basis of ships
  • The sale of tickets or similar documents
  • The use, maintenance or rental of containers
  • The management of the crew of ships.

The chartering of ships on a bareboat basis does not fall within the scope of a Shipping Business because the entity in which charters the ship does not operate the ship. This activity may, however, fall within the scope of a Lease-Finance Business (depending on the terms of the bareboat charter arrangement.

Key highlights:

  • Ships and vessels used in international traffic for goods or passengers or both
  • Should be engaged in chartering and operating ships
  • Ships on the rental basis used for chartering will be considered as a shipping business
  • Travel agencies and international ship agents/brokers will not be falling under these regulations
  • Should operate themselves the ship or vessel

Holding Company Business:

Holding Company Business is defined under Article 1 of the Regulations as a business that:

  • Is a Holding Company in accordance with the law applicable to the Licensee carrying out such activity
  • has as its primary function the acquisition and holding of shares or equitable interests in other companies
  • does not carry on any other commercial activity

Equity interests include shares in a company and interests in an incorporated partnership, as well as any other instrument which gives the Licensee a beneficial ownership interest in a company.

Key highlights:

  • The primary function is to acquire the equity interest in other entities
  • Doesn’t carry any other commercial activity
  • The Entity should own beneficial equity ownership interest in a company
  • The general definition “beneficial ownership” should follow for this purpose
  • Percentage of shares or equities doesn’t matter
  • Reduced compliance requirements

Intellectual property Business:

A UAE business is regarded as carrying on an Intellectual Property Business if it holds, exploits, or receives gross income from “Intellectual Property Assets”.

An Intellectual Property Asset is defined as any intellectual property right in intangible assets, such as copyrights, patents, trademarks, brands, and technical know-how, from which the Licensee earns separately identifiable income in the form of royalties, license fees, franchise fees, capital gains and any other income from the sale or exploitation of the Intellectual Property Asset.

Most UAE businesses will own some form of Intellectual Property Asset (e.g. their trademark, technical know-how relating to their processes, copyright in their works, etc.), but not earn separately identifiable income from such assets. Instead, the Intellectual Property Assets contribute to or protect the value of, the goods or services these UAE businesses provide. The ownership of such Intellectual Property Assets would not be considered as carrying on an Intellectual Property Business as the Intellectual Property Asset is merely auxiliary to the main business of the UAE business.

Key highlights:

  • The entity should own any intellectual property right
  • The entity should generate separately identifiable revenue from such intellectual property right
  • Should be able to identify the revenue from Intellectual property
  • Should follow normal substance regulations for the compliance purpose

High-Risk IP Licensee

Where a Licensee is carrying on an Intellectual Property Business, it will also have to consider if it is a High-Risk IP Licensee. A High-Risk IP Licensee is defined under Article 1 of the Economic Substance Regulations as a Licensee which carries on an Intellectual Property Business, and under condition (a) of the definition meets all of the following three requirements:

  1. The Licensee did not create the Intellectual Property Asset which it holds for the purpose of its business, and
  2. The Licensee acquired the IP Asset from either;
    • A group company, or
    • In consideration of funding research and development by another person situated in foreign jurisdiction, and
  3. 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, license fees) from a foreign group company in respect of the use or exploitation of the IP asset.

Any High-Risk IP Licensee is, by default, deemed to have failed the economic substance test, resulting in the Competent Authority exchanging information on the High-Risk IP Licensee with the relevant Foreign Competent Authorities (where the Parent Company, Ultimate Parent Company and the Ultimate Beneficial Owner of the High-Risk IP Licensee are resident.

The Licensee is required to have an adequate number of full-time employees, with the necessary qualifications, who permanently reside and perform their activities in the UAE, and would need to provide the following information:

  • A business plan showing the reasons for holding the ownership in the Intellectual Property Asset in the UAE;
  • Employee information, including;
    1. level of experience;
    2. type of contracts;
    3. qualifications; and
    4. duration of employment of the Licensee;
  • The above information would have to prove that in the UAE there is more than local staff passively holding intangible assets whose creation and exploitation is a function of decisions made and activities performed outside of the jurisdiction. As such, the business would need to evidence that decision making is taking place in the UAE (note: periodic decisions made by non-resident directors or board of members would not be sufficient

Key highlights:

  • By default, high-risk IP business is considered as failed on economic substance test
  • Automatic reporting of information to a foreign competent authority
  • Should demonstrate a high level of a substance in UAE, as defined in the regulations

Distribution & Service Centre Business:

A Licensee is considered engaged in a “Distribution Business” if the Licensee purchases raw materials or finished products from a foreign group company, and distributes those raw materials or finished goods.

Key highlights:

  • An entity buying from a company which is not under the Group will not be considered
  • An entity buying from local group companies are also not to be considered
  • Raw materials or finished products
  • Importing raw materials from foreign group companies, manufacture or alter the raw materials and re-export to another entity will be falling under the distribution license category.

A Licensee is considered engaged in a “Service Centre Business” if it provides consulting, administrative or other services to a foreign group company, and those services are in connection with the foreign group company’s business outside the UAE

Key highlights:

  •  Any services (administrative or consulting etc) to foreign group company
  • Those services are in connection with the foreign group company’s business outside the UAE
  • Service provided to nonconnected or nongroup entities are not to be considered for this purpose
  • Special care on “group company’s business outside UAE” is to be taken and according to the circumstances, needs to decide whether this falls in the regulations or not.

An entity that undertakes a transaction that falls within the scope of a “Distribution and Service Centre Business” would not be required to demonstrate economic substance in the UAE if it can evidence that the transaction was not in the ordinary course of its business (e.g. a one-off transaction) and the transaction is recharged to the relevant foreign group company at cost or less.

 

 

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