Economic Substance Regulations

Why you should know about ESR?

ESR is a annual compliance requirement to determine that the UAE licensees engaged in one or more of nine (9) ‘relevant activities’ have adequate ‘economic substance’ present in the UAE.

A delay or a failure to submit relevant information could attract penal consequences ranging from AED 20,000 to AED 50,000. Absence of adequate ‘economic substance’ in the UAE could attract penal consequences ranging from AED 50,000 to AED 400,000. In case of continuing non-compliance, the commercial/trade license could also be suspended or cancelled.

What is ESR?

While not a tax, ESR aims to determine that UAE entities have adequate ‘economic substance’ present in the UAE. ESR requires that the licensee is:

1. i) directed & supervised in the UAE;
2. ii) has adequate assets, resources and qualified people in the UAE to undertake the ‘relevant activities’; and

iii) conducting the relevant core income generating activities (CIGAs) in the UAE

Is ESR applicable on you?

ESR is applicable on all licensees undertaking ‘relevant activities’ including free zone companies, offshore companies, mainland/local companies, unincorporated  partnerships and other UAE business forms.

The nine (9) relevant activities covered under ESR are: (1) Distribution & Service Centre Business; (2) Intellectual Property Business; (3) Holding Company Business; (4) Headquarters Business; (5) Lease Finance Business; (6) Investment Fund Management Business; (7) Shipping Business; (8) Insurance Business; and (9) Banking Business;

A ‘substance over form’ approach is required to determine the applicability of ESR. Therefore, it is not enough to review the trade license and but actual determination of conducting relevant activities is necessary.

Certain licensees including natural persons, sole proprietorships, trusts, foundations, are eligible to claim exemption from ESR compliance. Investment funds, a licensee that is tax resident in a foreign jurisdiction, and a UAE branch of a foreign entity could seek exemption under ESR.

Entities which are wholly-owned by UAE residents or UAE nationals and are not part of a multinational group could also seek exemption if the entity carries out its business in UAE.

Why ESR has been implemented in the UAE?

As per OECD, Base erosion and profit shifting (BEPS) refers to tax planning strategies, used by multinational enterprises, to artificially shift profits to jurisdictions with no/low tax rates & economic activity. OCED estimates that BEPS results in an annual loss of about 4-10 per cent of global corporate tax revenue aggregating to $100-240 billion. In year 2015, a detailed 15 action points were determined to counter BEPS and improve transparency.

ESR demonstrates the UAE’s commitment to OECD inclusive framework on BEPS and international cooperation.

What has been the evolution of ESR in the UAE?

ESR is applicable in respect of any financial year starting on or after 01 Jan 2019.

ESR was first implemented in the UAE vide Cabinet Resolution 31/2019 and 58/2019. Significant changes were made through Cabinet Resolution 57/2020 and Ministerial decision 100/2020.

The Federal Tax Authority (FTA) has been appointed as the ‘National Assessing Authority’. In addition to VAT and excise tax, the FTA will undertake assessments to determine compliance with economic substance tests by the entities. The FTA will also be responsible for administrative penalties, appeal process and other prescribed functions.

What if ESR is applicable on you?

Applicability of ESR on your business is not a bad news. ESR does not involve any additional tax payment. If ESR is applicable on a licensee then the licensee needs to demonstrate that adequate ‘economic substance’ is present in the UAE.

ESR compliance does not require an externally certified report. It is essentially a self-declaration and reporting to the regulatory authorities. ESR compliance involves following two steps:

1. Submission of ESR notification; and
2. Submission of a detailed ESR Report, if applicable

You must arrange for a comprehensive review of business activities, proactively ensure the presence of ‘economic substance’ in the UAE and undertake ESR compliance, wherever applicable. It is important to maintain all necessary documentary evidence to demonstrate presence of ‘economic substance’ for a review by the regulatory/assessing authorities in the future.

How AskPankaj Tax Advisors can help?

Considering the complex interpretations of legal provisions of the ESR in line with the global principles & jurisprudence, we could assist you to:

1. Determine if you are undertaking ‘relevant activities’;
2. Review whether the licensee is directed and managed in the UAE;
3. Review whether the core income-generating activities (CIGA) are performed in the UAE;
4. Review whether the licensee has adequate assets, resources, premises and human resources in the UAE;
5. If CIGA is outsourced to a group company/third party, review if the licensee has full control and supervision on the activities and whether such activities are adequate;
6. Prepare ESR report and submission to the regulatory authorities