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Amended Economic Substance Regulations in the UAE

On 10th of August 2020, the UAE Cabinet of Ministers issued Cabinet Resolution No. 57, along with the updated guidance through Ministerial Decision No. 100 of 2020 dated 19th of August 2020, (the “Amended ESR”), which repeals and supersedes the Cabinet of Ministers Resolution No. 31 of 2019 (“Original ESR”).

The Ministry of Finance (“MoF”) has also updated the information contained in its website regarding Amended ESR. The MoF website can be accessed by clicking here.

Background

On 30th of April 2019, the UAE introduced Economic Substance Regulations in the UAE through the Original ESR. Guidance on the application of the ESR was issued on 11th of September 2019 (Ministerial Decision No. 215 of 2019), and the Regulatory Authorities required to administer the ESR was determined through Cabinet Decision No. 58 of 2019. The ESR requires UAE onshore and free zone companies and certain other business forms that carry out “Relevant Activities” to maintain and demonstrate an adequate “economic presence” in the UAE relative to the activities they undertake (“Economic Substance Test”).

Key changes in the Amended ESR

The Amended ESR sets out the following key changes: 

 

1. Scope of the Amended ESR

- Definition of a Licensee

  • The Amended ESR only applies to an entity that is (1) a juridical person (incorporated inside or outside the UAE; or (2) unincorporated partnership; registered in the UAE, including Free Zones and carries on a Relevant Activity.

For purposes of the Amended ESR, a juridical person is a corporate legal entity with separate legal personality from its owners.  Whereas, an unincorporated partnership includes those forms of partnerships that may operate in the UAE without having separate legal personality and are thereby identified separately under the Amended ESR.

  • Branches registered in the UAE are regarded to be an extension of their “parent” or “head office” and therefore are not considered to have separate legal personality, and thus, not considered as “Licensees”
  • A branch of a foreign entity registered in the UAE that carries out a Relevant Activity, is required to comply with the Amended ESR unless the Relevant Income of such branch is subject to tax in a jurisdiction outside the UAE.

 

- Exempted Licensees

The Amended ESR introduced exempted Licensees as follows:

  • an Investment Fund;
  • an entity that is tax resident in a jurisdiction other than the UAE;
  • an entity wholly owned by UAE residents and meets the following conditions:
    • the entity is not part of a Multinational Group;
    • all of the entity's activities are only carried out in the UAE;
  • a Licensee that is a branch of a foreign entity the Relevant Income of which is subject to tax in a jurisdiction other than the State.

Any entity which claims to be an Exempted Licensee must submit to the relevant Regulatory Authority, along with a Notification, sufficient evidence substantiating its status as an Exempted Licensee for each Financial Year.

In comparison to the Original ESR, the Amended ESR does not specifically mention that entities directly or indirectly owned at least 51% by the UAE government are exempted from the ESR requirements. However, such entities may still benefit from the exemption provided that fall within any of the conditions listed above.

 

- First Reportable Financial Year

All Licensees and Exempted Licensees are subject to the Amended ESR from the earlier of: (i) their financial year commencing on 1st of January 2019, or (ii) the date on which they commence carrying out a Relevant Activity (for a Financial Year commencing after 1st of January 2019).

 

- Changes to certain Relevant Activities

  • Distribution and Service Centre Business
    • Requirement for goods to be imported and stored in the UAE no longer applies for an entity to be considered a “Distribution Business”
    • Requirement for services to be “in connection with a business outside the UAE” no longer applies for entity to be considered a “Service Business”. As such, any service provided to a foreign related party falls within the Service Business under the Amended ESR.
  • High Risk IP Licensee
    • A High-Risk IP Licensee under the Amended ESR has been limited to IP Business that meets all of the following conditions:
  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;
    1. a Connected Person; or
    2. in consideration for funding research and development by another person situated in a 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.

 

- Relevant Income

For the purposes of the Amended ESR, “Relevant Income” means all of that entity’s gross income from a Relevant Activity as recorded in its books and records under applicable accounting standards, whether earned in the UAE or outside the UAE and irrespective of whether the entity has derived a profit or loss from its activities.

The new guidance further described that gross income means all income from whatever source derived, including revenues from sales of inventory and properties, services, royalties, interest, premiums, dividends and any other amounts, and without deducting any type of costs or expenditure. In the context of income from sales or services, gross income means gross revenues from sales or services without deducting the cost of goods sold or the cost of services. 

For the avoidance of doubt, gross income does not mean taxable or accounting income or profit.

 

 

2. Reporting Requirements

- Notification

Every Licensee and Exempted Licensee is required to submit a Notification to their respective Regulatory Authorities setting out the following for each relevant Financial Year: 

  1. the nature of the Relevant Activity being carried out;
  2. whether it generates Relevant Income;
  3. the date of the end of its Financial Year;
  4. any other information as may be requested by the Regulatory Authority.

A Notification submitted by an Exempted Licensee must be accompanied by sufficient evidence to substantiate the Exempted Licensee’s status. The Notification must be submitted electronically on the Ministry of Finance portal within six months from the end of the Financial Year of the Licensee or Exempted Licensee.

Licensees that have already submitted a Notification directly to their Regulatory Authorities are required to re-submit a Notification in accordance with the provisions of the Amended ESR on the Ministry of Finance Portal once available.

 

- Economic Substance Report

Every Licensee shall be required to meet the applicable Economic Substance Test requirements and submit an Economic Substance Report containing the required information and documentation prescribed under the Amended ESR within twelve (12) months from the end of the relevant Financial Year.

 

 

3. National Assessing Authority

The Federal Tax Authority has been appointed as the “National Assessing Authority”. The FTA will be responsible for assessing and enforcing compliance of UAE entities with the Economic Substance Test. 

 

 

How GT can assist:

Our tax team can support your businesses with:

  • Economic Substance Impact Assessment for UAE entities
  • Assistance in Filing Economic Substance notification
  • Assistance in Filing Economic Substance Return/ Report

Get in touch with our Head of International Tax, Steven Ireland, and our Tax Assistant Manager, Amisha Anil for more information.