ESR Audit in UAE
HLB HAMT ESR Team
As part of the UAE’s commitment as a member of the Organization for Economic Co-operation and Development (OECD) inclusive framework, 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.
This established a requirement for companies to conduct specific relevant activities to maintain an adequate “Economic Presence” in the UAE relative to the activities they undertake. The goal is to avoid harmful tax practices and to prevent low-tax jurisdictions from attracting profits from certain mobile activities without adequate corresponding economic activity. The Regulations’ main objective is to guarantee that UAE firms declare actual profits that are adequate for the level of economic activity conducted.
The entities will need to assess whether they perform any relevant activities mentioned in the regulations. Businesses operating in the UAE are required to adopt a “substance over form” position when determining whether they engage in a Relevant Activity and, thus, fall under the coverage of the ESR Regulations. In order to make this decision, the UAE business would need to examine well beyond the information on their commercial licence and at the actions carried out throughout the course of a financial period.
The Federal Tax Authority (FTA) has now begun to conduct ESR audits, clarifications, and assessments starting with the 2019 financial year. FTA is the National Assessing Authority, and they can conduct an audit of any licensee to ensure their compliance with ESR regulations. They intend to examine the substance to analyse whether the licensee demonstrates that:
- The Licensee and the Relevant Activity are being directed and managed in the UAE
- The relevant Core Income Generating Activities (CIGAs) are being conducted in the UAE
- The Licensee has adequate people, premises, and expenditure in the UAE
For this purpose, companies falling under ESR regulations shall maintain appropriate records proving the presence of Economic Substances in the UAE and provide this information to the FTA within five days from the date of the FTA’s request for the same.
Entities are required to maintain relevant documents depicting adequate Economic Substance in the UAE for a period of six years to ensure their readiness to provide the information if asked by the Regulatory Authority or the FTA.
Adequate substance is not mentioned in the regulations, but FTA can still challenge it.
- FTA will inform the client that they are subject to an ESR audit via email and through the MOF ESR portal. In the initial mail itself, they will share the requirement list which needs to be reverted with adequate explanations and documents within five working days.
- The ESR audit is commenced to assess whether the entity meets the substance test. It includes the licensee being directed and managed in UAE, having adequate people, premises and expenditure and also whether they perform adequately the relevant Core Income Generating Activities (CIGAs) in UAE. The below mentions the CIGA for each relevant activity:
- Raising funds, managing risk including credit, currency and interest risk.
- Taking hedging positions.
- Offering credit, loans, or other financial services to consumers.
- Managing capital and preparing reports to investors or any government authority with functions relating to the supervision or regulation of such business.
- Predicting and calculating risk.
- Offering clients with insurance business services and insuring or re-insuring against risk.
- Underwriting insurance and reinsurance.
- Taking decisions on the holding and selling of investments.
- Calculating risk and reserves.
- Making the decisions about interest or currency volatility and hedging holdings.
- Preparing reports to investors or any government authority with functions relating to the supervision or regulation of such business.
- Agreeing funding terms.
- Locating and obtaining the assets that will be leased (in the case of leasing).
- Setting the duration and terms & conditions of any financing or lease.
- Monitoring and revising any agreements.
- Managing any risks.
- Taking relevant management decisions.
- Incurring operating expenditures on behalf of a Group.
- Coordinating Group activities.
- Managing crew (including hiring, paying and overseeing crew members).
- Overhauling and maintaining Ships.
- Overseeing and tracking shipping.
- Determining what goods to order and when to deliver them, organizing and overseeing voyages.
- Where the Intellectual Property Asset is a:
- patent or a similar Intellectual Property Asset; the Core Income Generating Activity shall be research and development.
- marketing intangible or a similar Intellectual Property Asset; the Core Income Generating Activity shall be branding, marketing and distribution.
- In exceptional cases, except in the case where the Licensee is a High-Risk IP Licensee, the Core Income-Generating Activity in respect of an Intellectual Property Business may include any of the following:
- taking strategic decisions and managing as well as bearing the principal risks related to the development and subsequent exploitation of the Intellectual Property Asset generating income;
- taking the strategic decisions and managing as well as bearing the principal risks relating to the acquisition by third parties and subsequent exploitation and protection of the Intellectual Property Asset;
- carrying on the ancillary trading activities through which the Intellectual Property Asset are exploited leading to the generation of income from third parties.
- Transporting and storing component parts, materials, or goods ready for sale.
- Managing inventories.
- Taking orders.
- Providing consulting or other administrative services.
- The following is an inexhaustive list of documents that the regulatory authority may require from a company selected for an ESR audit:
- Board minutes and resolutions
- Evidence that the non-resident directors who formed the quorum were in the UAE for board meetings
- Documents outlining the operations process flow
- Documents of relevance and emails/correspondence to commensurate with CIGA
- Working papers for calculation of relevant income, operating expenditure, and accounting profit/loss
- Working papers for the calculation of FTEs
- Contracts and agreements
- Employee CVs and Timesheets / biometric logs of FTEs
- Details of physical assets
- Outsourcing agreements.
- The ESR auditors can schedule an in-office visit to gain more understanding and seek further documentation and explanations beyond those sought in the requirement list.
- The auditors will issue a report on their observations and findings during the audit, and if the licensee fails to prove adequate substance as mentioned in the submitted ESR report, the licensee will be subjected to a penalty of AED 50,000.
|Investment Fund Management Business|
Holding Company Business Intellectual Property Business
|all activities related to that business|
|Distribution and Service Center Business|
How HLB HAMT can assist you?
- Review the previous ESR submissions to evaluate on the adequacy of the substance demonstrated.
- Compilation of documents as per the audit requirement list from FTA.
- Review of documents to ensure the audit requirements are complied with.
- Draft responses to the audit queries from FTA and assist in the submissions.
- Review and assist in drafting an appeal in the case of a penalty, and support procedures to waive a
- Assist in understanding and formulating responses for communications with FTA.
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Submissions deadlines for Licensee under ESR in UAE- Economic Substance Regulations Deadline 2022
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