Economic Substance Regulations in UAE
The United Arab Emirates Cabinet recently issued the Cabinet of Ministers Resolution No.31 of 2019, that requires all in-scope UAE entities to maintain an economic substance.
The UAE was added to the European Union list of non-cooperative tax jurisdictions by the European Commission and this was the reason behind the issuance of the economic substance regulations. Economic Substance regulations are similar to the economic substance requirements that were recently implemented in jurisdictions that include Cayman Islands and Jersey.
Economic substance regulation will be applicable to onshore and free zone companies that engage in any of the below mentioned “Relevant Activities”;
- Banking Businesses as licensed in the State, including Banking Businesses licensed in a Free Zone or a Financial Free Zone.
- Insurance Businesses as licensed in the State, including Insurance Businesses licensed in a Free Zone or a Financial Free Zone.
- Investment Fund Management Businesses as licensed in the State, including Investment Fund Management Businesses licensed in a Free Zone or a Financial Free Zone.
- Lease-Finance Businesses as licensed in the State, including Lease-Finance Businesses licensed in a Free Zone or a Financial Free Zone.
- Headquarters Businesses as licensed in the State, including Headquarters Businesses licensed in a Free Zone or a Financial Free Zone.
- Shipping Businesses as licensed in the State, including Shipping Businesses licensed in a Free Zone or a Financial Free Zone.
- Holding Company Businesses as licensed in the State, including Holding Businesses licensed in a Free Zone or a Financial Free Zone.
- Intellectual Property Businesses as licensed in the State, including Intellectual Property Businesses licensed in a Free Zone or a Financial Free Zone.
- Distribution and Service Centers Businesses as licensed in the State, including Distribution and Service Centres Businesses licensed in a Free Zone or a Free Zone.
Activities that must be conducted by a licensee in the State shall include:
In respect of Banking Business:
- Raising funds, managing risk including credit, currency and interest risk.
- Taking hedging positions.
- Providing loans, credit or other financial services to customers.
- Managing capital and preparing reports to investors or any government authority with functions relating to the supervision or regulation of such business.
In respect of insurance Business:
- Predicting and calculating risk.
- Insuring or re-insuring against risk and providing Insurance Business services to clients.
- Underwriting insurance and reinsurance.
In respect of Investment Fund Management Business:
- Taking decisions on the holding and selling of investments.
- Calculating risk and reserves.
- Taking decisions on currency or interest fluctuations and hedging positions.
- Preparing reports to investors or any government authority with functions relating to the supervision or regulation of such business.
In respect of Lease-Finance Business:
- Agreeing funding terms.
- Identifying and acquiring assets to be leased (in the case of leasing).
- Setting the terms and duration of any financing or leasing.
- Monitoring and revising any agreements.
- Managing any risks
In respect of Headquarters Business:
- Taking relevant management decisions.
- Incurring operating expenditures on behalf of group entities.
- Coordinating group activities
In respect of Shipping Business:
- 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.
In respect of Holding Company Business, all activities related to that business; and in respect of Holding Company Business that derives income from other sources other than dividends and capital gains from its equity interest, the state Core Income-Generating Activities shall be those activities associated with the income generated.
In respect of Intellectual Property Business:
(a) where the Intellectual Property Asset is a –
- Patent or an asset that is similar to a patent, research and development.
- Non-trade intangible (including a trademark), branding, marketing and distribution.
(b) If the Relevant Activity is conducted by a Licensee that is regarded as a High Risk IP Licensee, the State Core Income-Generating Activity must include any of the following additional activities:
- Taking strategic decisions and managing (as well as bearing) the principal risks related to development and subsequent exploitation of the intangible asset generating income.
- Taking the strategic decisions and managing (as well as bearing) the principal risks relating to acquisition by third parties and subsequent exploitation and protection of the intangible asset.
- carrying on the ancillary trading activities through which the intangible assets are exploited leading to the generation of income from third parties.
In respect of Distribution and Service Center Business;
- Transporting and storing component parts, materials or goods ready for sale.
- Managing inventories.
- Taking orders.
- Providing consulting or other administrative services.
Requirements to meet Economic Substance Test
A Licensee meets the Economic Substance Test in relation to a Relevant Activity in the following cases:
- If the Licensee conducts State Core Income-Generating Activity in the State.
- If the Licensee is directed and managed in the State in relation to that activity, provided the Licensee’s board of directors meets in the State at an adequate frequency having regard to the amount of decision-making required at that level.
- Having regard to the level of Relevant Activity, if there is an adequate number of qualified full-time employees in relation to that activity who are physically present in the State (whether or not employed by the Licensee or by another entity and whether on temporary or long-term contracts), or adequate level of expenditure on outsourcing to third party service providers, whose activities, employees, expenditure, and premises are in the State; and these activities, employees, expenditures and premises are adequate for carrying out the Relevant Activity being outsourced.
- If there is adequate operating expenditure incurred by it in the State, or adequate level of expenditure on outsourcing to third party service providers whose activities, employees, expenditure and premises are in the State; and these activities, employees, expenditures and premises are adequate for carrying out the Relevant Activity being outsourced.
- If there are adequate physical assets in the State or adequate level of expenditure on outsourcing to third party service providers in the State, for the activities of the Licensee;
- In the case of State Core Income-Generating Activity carried out for the relevant Licensee by another entity, if it is able to monitor and control the carrying out of that activity by the other entity.
In relation to a Licensee whose activity is restricted to carrying out a Holding Company Business that derives its income from dividends and capital gains only, such Licensee meets the Economic Substance Test if it meets the following conditions:
- Complies with the requirement to submit any documents, records or information to the relevant Regulatory Authority in accordance with the law applicable to the Licensee in the State.
- Has adequate employees and premises for holding and managing the Holding Company Business.
The rule won’t be applicable to companies that come under the ownership of the government, directly or indirectly. As such, UAE sovereign investment funds and other UAE government related entities are exempted. There is still no confirmation regarding sole proprietorship and branches.
A relevant entity must report certain information regarding its relevant activities to the regulatory authority concerned (the one that issued the trade license to the entity), annually. Existing companies should have complied with the regulations by now, since the starting date was 30th April 2019. In the case of new entities, regulations must be complied with upon receiving its trade license.
If an entity fails to meet the requirements or if inaccurate information is given to the regulatory authority, annual administrative penalties of AED 10,000 to AED 300,000 will apply. If they fail to meet the requirements for consecutive years, the penalties will increase and might force the authorities to suspend, revoke or deny renewal of an entity’s license.
What HLB HAMT offers?
- Consulting on ESR
- Identify the qualifying entities for ESR compliances
- Identify the qualifying business segments for ESR compliances
- Report and advise on overall ESR readiness by the Entity
- Ongoing ESR compliance
- Secretarial services in connection with ESR record maintenance
- ESR filing with the authorities in the proper /prescribed format
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