The government of United Arab Emirates introduced Economic Substance Regulations on 30 April 2019 to prevent businesses from taking advantage of favorable tax environment of the UAE without conducting meaningful business operations within the jurisdiction. These regulations are implemented as part of the UAE’s commitment as a member of the Organization for Economic Co-operation and Development (OECD), and in response to an assessment of the UAE’s tax framework by the EU Code of Conduct Group on Business Taxation.
Understanding Economic Substance Regulations
The purpose of introducing Economic Substance Regulations in UAE was to ensure that businesses operating in the UAE that carry out any of the defined “Relevant Activities” as specified under Article 3 of the Cabinet Of Ministers Resolution No. 57 of 2020 have substantial operations and genuine economic activity within the country. Moreover, UAE took the initiative of ESR to ensure their dedication to OECD Inclusive Framework by designing such regulations that prevent global concerns about base erosion and profit shifting (BEPS). BEPS are strategies used by multinational companies to minimize the overall tax liability by allocating low tax revenue for high-tax countries and potentially create an uneven playing field for the dynamic business market. ESR play an important role in this regard by promoting fair taxation and preventing tax evasion on a global scale.
Implications for UAE Businesses
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Demonstration of Adequate Economic Presence in the UAE:
Under the Economic Substance Regulations, businesses engaged in Relevant Activities are required to fulfill the necessary requirements and satisfy the set criteria to meet the Economic Substance Test, in order to confirm that the business that is carrying on an activity in the UAE has economic substance in the State. This means that businesses must conduct the necessary Core Income-Generating Activities in the UAE, should be directed and managed in the UAE, have an adequate number of qualified full-time employees, adequate operating expenditure, and adequate physical assets in the UAE to support their relevant activities.
2. Review of Corporate Structures:
Many businesses in the UAE adopted corporate structures that aimed to minimize tax liabilities. With the introduction of Economic Substance Regulations, businesses now require to meet the new requirements and demonstrate genuine economic activity within the UAE. In order to avoid legal penalties it is crucial for businesses to ensure compliance with ESR, Therefore, implications of ESR may need companies to make adjustments to their regulatory and corporate structures.
3. Impact on Holding Companies:
Holding company businesses which are typically involved in managing investments are required to satisfy the criteria set under Economic Substance Regulations in order to meet the Economic Substance Test. Due to this fact such businesses need to have adequate employees and premises for holding and managing the Holding Company Business. Moreover, holding companies are required to ensure compliance with economic substance requirements and submit the ESR report of their Core Income-Generating Activities to the relevant regulatory authority.
4. Increased Compliance Burden:
The most challenging implication of ESR on UAE Businesses is compliance with ESR requirements, therefore, businesses need to be careful and give accurate and relevant information about the relevant activity carried out by the company at the right time. Failure to comply with Economic Substance Regulations could result in imposition of administrative penalties, therefore, businesses will need to invest on reputable outsourcing firms in order to seek guidance in the process of compliance.
5. Greater Transparency and Accountability:
In order to ensure transparency in tax practices and to promote sustainable business environment, Economic Substance Regulations require businesses to demonstrate adequate economic presence in the UAE. By doing so the companies ensure that they are genuinely contributing to the local economy in relation with the Relevant Activities carried out by them in the UAE .
6. Potential for Economic Diversification:
The Economic Substance Regulations has a beneficial impact on UAE business market as it contributes to economic diversification. By strengthening the non-oil sectors in UAE, investors may explore new industrial sectors within the UAE,ultimately benefiting the UAE economy as a whole.
Main Requirement of Economic Substance Regulations
In accordance with Article 6 of the Cabinet Of Ministers Resolution No. 57 of 2020, the businesses carrying out the relevant activities are required to satisfy the following criteria in order to meet Economic Substance Test:
- The business should conduct the necessary Core Income-Generating Activity in the UAE.
- The business should direct and manage their respective Relevant Activity in the UAE.
- The company is require to employ adequate number of qualified full-time employees who are physically present in the UAE.
- The business should incur adequate operating expenditure in the UAE.
- The business should have adequate physical assets in the UAE.
It is imperative for businesses to avail professional advice of expert ESR consultants in UAE to effectively navigate the process of compliance with the Economic Substance Regulations to maximize their business potential in the UAE.
