Economic Substance Regulations (ESR)

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Background & key concept

The UAE introduced Economic Substance Regulations (“ESR”), effective from 1 January 2019, in response to European Commission concerns which resulted in the UAE being added to the European Union list of non-cooperative tax jurisdictions. The ESR effectively impose a legal requirement for UAE entities (including branches of local and foreign companies) that carry out any of nine relevant activities to maintain economic substance in the UAE specific to each relevant activity.

Key Concept

The purpose of the ESR is to prevent businesses, typically multinational corporations, from artificially shifting profits to jurisdictions that impose little or no income tax without having substantial activities in that jurisdiction to take advantage of their tax laws. The UAE is considered one of these jurisdictions.

Economic Substance Tests

UAE entities that have earned income from any Relevant Activity(ies) must demonstrate adequate substance in the UAE and satisfying following three Economic Substance Tests (ES Tests):

- Core Income Generating Activity (CIGA) test requiring the core activities to be performed in the UAE
- Directed and Managed test requiring the business to be directed and managed from the UAE in relation to the Relevant Activity(ies); and
- ‘Adequacy’ test requiring adequate resources (employees, expenses and assets) in the UAE

Administration

Regulatory authorities (like free zone authorities and mainland licensing authorities) and the Federal Tax Authority (FTA)

What business need to do

Who are exempt businesses?

- A Licensee that is tax resident outside the UAE;
- An Investment Funds
- Entities wholly owned by UAE resident that are not part of a multinational group and conduct business only in the UAE
- A branch of a foreign entity that is subject to tax on all its Relevant Income in a foreign jurisdiction.
- Any other Licensee at the direction of the Minister of Finance.

What is a Holding Company Business?

- A Holding Company Business: Only holds equity interest(s) and earns dividend and capital gains.
- If a UAE entity undertakes any other commercial activity or earns any other forms of income, it cannot be a Holding Company Business.

What to do

Timelines

ESR Notification	ESR Reporting
6 months from the end of financial year	12 months from the end of financial year

Penalties

Failure to comply with ERS regulations could warrant significant penalties:

Failure to file notification	– AED 20,000
Failure to file report	– AED 50,000 – Deemed failure to meet ES Tests
Failure to provide accurate or complete information	– AED 50,000 – Deemed failure to meet ES Tests
Failure to meet ES Tests	1st year – AED 50,000 Information exchange with foreign competent authorities2nd consecutive year – AED 400,000 Information exchange with foreign competent authorities Suspension, cancellation or non-renewal of trade license