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Substance
in the UAE
Key Features, Risks, and Recommendations
The United Arab Emirates (UAE) stands as a pivotal player on the global business and investment stage. Entrepreneurs and companies worldwide are drawn to the country's favorable business conditions, low tax rates, and modern infrastructure.
However, recent years have seen changes to the UAE's tax system and economic presence requirements, impacting companies operating within the country. This article delves into the concept of economic substance in the UAE, its recent modifications, obligations, and steps businesses can take to avert penalties and issues.
However, recent years have seen changes to the UAE's tax system and economic presence requirements, impacting companies operating within the country. This article delves into the concept of economic substance in the UAE, its recent modifications, obligations, and steps businesses can take to avert penalties and issues.
Understanding Economic Substance in the UAE
Economic substance has gained significant importance in the global tax system. It assesses a company's real economic presence within a jurisdiction, countering practices of merely registering in low-tax countries to evade taxes. Businesses must actively participate in the economic processes and add tangible value within the country.
The UAE introduced Economic Substance Regulations (ESR) on April 30, 2019, adhering to its commitments as a member of the Organization for Economic Co-operation and Development's (OECD) Inclusive Framework and addressing evaluations by the European Union's Code of Conduct Group on Business Taxation. Significant amendments were made to these regulations on August 10, 2020, by Cabinet Resolution No. 57, clarifying companies' economic presence requirements.
The UAE introduced Economic Substance Regulations (ESR) on April 30, 2019, adhering to its commitments as a member of the Organization for Economic Co-operation and Development's (OECD) Inclusive Framework and addressing evaluations by the European Union's Code of Conduct Group on Business Taxation. Significant amendments were made to these regulations on August 10, 2020, by Cabinet Resolution No. 57, clarifying companies' economic presence requirements.
Activities Subject to ESR
ESR applies to specific business activities:
1. Banking Business
2. Insurance Business
3. Investment Fund Management Business
4. Shipping Business
5. Lease-Finance Business
6. Distribution & Service Centre Business
7. Headquarters Business
8. Intellectual Property Business
9. Holding Company Business
The UAE Ministry of Finance provides detailed guidance on these activities. Companies engaged in them must comply with ESR to avoid administrative fines and sanctions.
1. Banking Business
2. Insurance Business
3. Investment Fund Management Business
4. Shipping Business
5. Lease-Finance Business
6. Distribution & Service Centre Business
7. Headquarters Business
8. Intellectual Property Business
9. Holding Company Business
The UAE Ministry of Finance provides detailed guidance on these activities. Companies engaged in them must comply with ESR to avoid administrative fines and sanctions.
Obligations Under Economic Substance
The regulations concerning substance in the UAE apply to financial years starting from January 1, 2019. Companies under these regulations are required to fulfill the following obligations:
- 1
Submit an Economic Substance Notifications (ESR Notification)
Every company subject to the economic substance rules must submit an ESR notification to their regulatory authorities for each relevant financial year. This notification must be submitted within six months from the end of the financial year. - 2
File an Economic Substance Report (ESR Report)
A company, having informed its regulatory body of its applicability under economic substance guidelines, is required to submit a report. This report, containing necessary information to confirm an adequate level of presence in the UAE and documentation as per the ESR regulations, must be submitted within twelve months from the end of the applicable financial year. - 3
Pass the Substance Test
To affirm its level of presence in the UAE, a company must demonstrate active participation in business processes, essentially proving its substantial economic engagement within the country.
Ensuring Adequate Economic Presence
How can your business ensure it successfully meets the test? Demonstrate sufficient economic presence related to your operations:
- 1
Management and Control
Active management and control of your company must be conducted within the UAE. - 2
Core Income-Generating Activities
Identify specific activities that generate the primary income for your business. - 3
Ensure Adequate Resources for Operations
- Lease or own office space that meets your business needs, establishing a physical footprint.
- Employ qualified professionals who contribute to core activities, ensuring they are physically present in the UAE.
- Confirm that operational expenses, such as salaries, rent, and utilities, align with the scale of your business and its activities, indicating substantial economic involvement.
- 4
Document All Your Activities
Maintain detailed records of your business operations, meetings, and decision-making processes. Keep financial statements that reflect your economic presence in the UAE, underscoring the substance behind your operations. - 5
Legal and Tax Consultation
Seek professional advice from legal and tax experts specializing in UAE regulations. Regularly analyze your business structure and operations to maintain continuous compliance.
Avoiding Challenges
Before facing fines and sanctions, there are critical steps your company can take to comply with ESR legislation in the UAE:
- 1
Assess Your Status
Start by evaluating your company's status. Ensure you fully understand whether you fall under the ESR requirements. In case of doubts, it's wise to consult tax and corporate law experts. - 2
Develop a Strategy
If subject to ESR, devise a strategy to meet all requirements. This involves preparing for the Economic Substance Test, in addition to drafting and submitting the notifications and reports along with any relevant documents, to the appropriate regulatory authorities. - 3
Monitor Deadlines
A key aspect of ESR compliance is adhering to deadlines. Ensure your company submits all required reports and notifications on time. - 4
Consult Experts
For a deeper understanding of ESR requirements and to develop the best compliance strategy, turn to experienced tax and corporate law consultants. The team at MDC Consulting has the skills and expertise to provide comprehensive support to your business in the UAE.
Consequences of Non-Compliance
Companies not adhering to ESR requirements in the UAE can face severe repercussions and substantial fines. Violations subject to fines include:
Penalties can vary based on the duration of violations and recurrence, with potential fines up to 940,000 dirhams over two years for repeated breaches:
- Failure to Comply with ESR Requirements: Not presenting reports on economic presence according to ESR, possibly due to incorrect activity classification.
- Failing the Compliance Test: Not meeting the ESR requirements within the stipulated timeframe.
- Failure to Submit Notifications: Not providing notifications about economic presence within the specified deadlines.
Penalties can vary based on the duration of violations and recurrence, with potential fines up to 940,000 dirhams over two years for repeated breaches:
- 50,000 AED for failing to meet the requirements in the first year;
- 400,000 AED for the same infraction in the second consecutive year;
- 50,000 AED for failing the Economic Substance Test in the first year;
- 400,000 AED for a repeat of the same failure in the second year;
- 40,000 AED (20,000 AED for failing to submit notifications for two consecutive years).
Important Deadlines and Risks
When addressing ESR requirements, companies should consider statute limitations and associated risks. According to Cabinet Resolution No. 57, Article 16, administrative fines for ESR violations cannot be imposed after six years from the violation date. However, this period may extend if the violation was not detected due to fraudulent actions or gross negligence by the licensee or another party, potentially allowing for fines even after the typical limitation period.
For detailed consultation and evaluation of your position regarding ESR, we recommend seeking advice from experienced tax and corporate law consultants. Experts can help you devise a compliance strategy, minimize financial risks, and ensure successful business operations in the UAE.
If you have questions about ESR or any other legal issues related to doing business in the UAE, the experts at MDC Consulting are ready to offer advice and tailor solutions to your challenges.
For detailed consultation and evaluation of your position regarding ESR, we recommend seeking advice from experienced tax and corporate law consultants. Experts can help you devise a compliance strategy, minimize financial risks, and ensure successful business operations in the UAE.
If you have questions about ESR or any other legal issues related to doing business in the UAE, the experts at MDC Consulting are ready to offer advice and tailor solutions to your challenges.
Consequences of Non-Compliance
To confirm adequate economic presence, companies must:
- Exercise active management and decision-making in the UAE.
- Identify and conduct core income-generating activities within the UAE.
- Ensure sufficient resources for their activities, including appropriate office space and qualified staff physically present in the UAE.
- Maintain detailed documentation of business operations, meetings, and decision-making processes.
- Seek legal and tax consultancy for compliance strategies and continual analysis to align with UAE regulations.
Avoiding Pitfalls
To prevent penalties and sanctions, companies should:
- Assess their status to understand ESR applicability.
- Develop a compliance strategy, including preparation for substance verification and timely submissions of notifications and reports.
- Adhere to deadlines for all submissions.
- Consult with experienced tax and corporate law advisors for deep compliance insights.
Consequences of Non-Compliance
Non-compliance can result in severe financial penalties and operational sanctions, including license suspension or revocation. Penalties can escalate with repeated offenses, potentially reaching up to 940,000 dirhams over two years for various infractions.
Key Deadlines and Risks
Companies must consider statutes of limitations and associated risks. According to Article 16 of Cabinet Resolution No. 57, administrative fines for ESR violations cannot be imposed after six years from the date of the violation. However, this period may extend if the violation was concealed through fraud or gross negligence.
For detailed consultation and compliance strategy, we recommend seeking advice from experienced tax and corporate law consultants. They can help devise a compliance strategy, minimize financial risks, and ensure successful business operations in the UAE.
Should you have any questions regarding ESR or other legal aspects of doing business in the UAE, experts at MDC Consulting are ready to provide consultancy and tailored solutions.
For detailed consultation and compliance strategy, we recommend seeking advice from experienced tax and corporate law consultants. They can help devise a compliance strategy, minimize financial risks, and ensure successful business operations in the UAE.
Should you have any questions regarding ESR or other legal aspects of doing business in the UAE, experts at MDC Consulting are ready to provide consultancy and tailored solutions.
Important Update
October 2, 2024
On October 2, 2024, the Government of the United Arab Emirates (UAE) implemented substantial revisions to the UAE Economic Substance Regulations (ESR) through Cabinet Decision No. 98/2024.
The effect of these amendments is that the Economic Substance Regulations will now apply to accounting periods that conclude on or before December 31, 2022. Businesses with accounting periods commencing on or after January 1, 2023, are no longer obligated to submit a UAE economic substance notification or report.
Published in the Official Gazette on September 16, 2024, Cabinet Decision No. 98 of 2024 modifies Cabinet Decision No. 57/2020 regarding Economic Substance Requirements by introducing Article (2) B, which limits its overall applicability to fiscal years from January 1, 2019, to December 31, 2022.
The removal of the obligation to adhere to the economic substance regulations is welcomed, especially since the UAE corporate tax law imposes similar requirements on Free Zone Persons seeking status as a Qualifying Free Zone Person (QFZP) under UAE corporate tax legislation.
Entities wishing to qualify as a QFZP must still demonstrate sufficient economic substance within the UAE and must declare this in their UAE corporate tax return submitted via the Federal Tax Authority portal, EmaraTax.
Implications for Your Business:
Analysis
The effect of these amendments is that the Economic Substance Regulations will now apply to accounting periods that conclude on or before December 31, 2022. Businesses with accounting periods commencing on or after January 1, 2023, are no longer obligated to submit a UAE economic substance notification or report.
Published in the Official Gazette on September 16, 2024, Cabinet Decision No. 98 of 2024 modifies Cabinet Decision No. 57/2020 regarding Economic Substance Requirements by introducing Article (2) B, which limits its overall applicability to fiscal years from January 1, 2019, to December 31, 2022.
The removal of the obligation to adhere to the economic substance regulations is welcomed, especially since the UAE corporate tax law imposes similar requirements on Free Zone Persons seeking status as a Qualifying Free Zone Person (QFZP) under UAE corporate tax legislation.
Entities wishing to qualify as a QFZP must still demonstrate sufficient economic substance within the UAE and must declare this in their UAE corporate tax return submitted via the Federal Tax Authority portal, EmaraTax.
Implications for Your Business:
- If you were previously required to comply with the Economic Substance Regulations, you are no longer obligated to meet these requirements for fiscal years ending after December 31, 2022.
- All penalties imposed under Cabinet Decision No. 57/2020 for fiscal years concluding after December 31, 2022, will be annulled. Any fines paid related to a financial year that ended after December 31, 2022, will be refunded.
