A Quarterly Newsletter from UAE and Oman

VOL 22 ISSUE 4 October 2020

Economic Substance Regulations in the UAE

 

The UAE Cabinet issued the Cabinet of Ministers Resolution No.31 of 2019 (concerning economic substance regulations in the UAE, “the Regulations”) on 30th April 2019, requiring all in-scope UAE entities “Relevant Entities”) that carry on certain activities (“Relevant Activities”) to have demonstrable economic substance in the UAE with effect from 30th April 2019 and report to the concerned UAE authorities.

The genesis of this regulation can be found in the backdrop of the European Union (‘EU’) and the Code of Conduct Group on Business Taxation (‘the EU Council’) meeting in December 2017 to assess the tax policies of jurisdictions with no or only nominal tax against the criterion of ‘economic substance’ against its good governance criteria regarding tax transparency, fair taxation, and implementation of measures to combat base erosion and profit shifting.

Potentially Covered Entities

The economic substance laws essentially require specific types of entities that are resident in the respective jurisdictions and carry on relevant activity to satisfy certain economic substance requirements.

In the UAE, the regulations apply to all UAE onshore and free zone companies that carry on a “Relevant Activity”.

Relevant Activity

Any of the following activities shall be considered as “Relevant Activity”:

  • Banking;
  • Insurance;
  • Fund management;
  • Financing;
  • Leasing;
  • Headquarters;
  • Shipping;
  • Distribution and service centres;
  • Holding intellectual property (IP); and
  • Holding Company.

Economic Substance Requirements

The jurisdictions should provide that the economic substance requirements are satisfied if:

  • Entity is managed and directed in or from the jurisdiction;
  • Relevant activity’s core income-generating activities are undertaken in the jurisdiction;
  • the entity maintains an adequate physical presence in the jurisdiction;
  • there are adequate full-time employees with suitable qualifications in the jurisdiction; and
  • adequate operating expenditure relative to the relevant activity is incurred in the jurisdiction.

Core Income-Generating Activity

What constitutes core income-generating activity depends on the type of relevant activity being undertaken and the entity’s circumstances. Guidance issued includes examples to demonstrate what constitutes adequate premises, employees, and expenditures. Outsourcing to affiliates or service providers in the jurisdiction may count toward the satisfaction of those requirements.

Annual Reporting

Entities subject to the economic substance requirements must file an annual economic substance report (or declaration, as the case may be) with the relevant authority. The relevant government authority will primarily rely on those reports to determine if entities have complied with the economic substance requirements.

Under the economic substance laws, annual declarations must include minimum information, including the following regarding the entity’s financial year:

  • Whether the entity is carrying on relevant activity and the type of relevant activity undertaken;
  • Whether the entity is engaged in high-risk IP activity;
  • The entity’s physical premises in that jurisdiction;
  • The names and physical addresses of directors (for companies) or equivalent (for other entity types) who are ordinarily resident in that jurisdiction;
  • The entity’s holding entity, ultimate parent entity, owner, or beneficial owner;
  • The gross income, operating expenses and assets, and number of full-time employees;
  • Details of core income-generating activities conducted in that jurisdiction for the relevant activity;
  • A declaration regarding whether the entity satisfies the economic substance requirements; and
  • Such other information as the Registrar may reasonably require.
  • The economic substance regulations further require entities to provide information demonstrating:
    • The management and direction of the entity in the jurisdiction;
    • The nature and extent of the relevant activity engaged in by the entity and its core incomegenerating activities for each relevant activity; and
    • whether employees or persons responsible for the oversight and assessment of the implementation of outsourcing to affiliates or service providers in the jurisdiction are suitably qualified and able to monitor and control the outsourcing arrangement to ensure the outsourced entity has adequate capacity to execute the outsourcing arrangement.

Exchange of Information

UAE’s Economic Substance Regulations provides that when an in-scope entity type that carries on a relevant activity in a relevant financial period does not satisfy the economic substance requirements or is engaged in high-risk IP activity, UAE’s competent authority must provide information about that entity for that period to the competent authorities of the EU member states in which the holding entity, ultimate parent entity, owner, or beneficial owner of the entity is incorporated, formed, registered, or
resident.

Enforcement

UAE provides for the issuance of remediation notices and civil penalties for noncompliance, as well as fines and imprisonment for some offenses, such as knowingly reporting false information. Failure to comply would result in administrative penalties (not less than AED 10,000 but not exceeding AED 50,000 in the first year, increased to an amount not less than AED 50,000 but not exceeding AED 300,000 in the subsequent year), subject to a 6-year limitation period. Additional penalties such as suspending, revoking or not renewing the UAE Relevant Entity’s trade license could also apply.

Commencement and Transition

The UAE Regulations are applicable from 30th April 2019.

New Guidelines

To provide further clarity and guidance on certain provisions of the Regulations, the UAE Cabinet recently issued directives for the implementation of the Regulations (‘the Guidance’). Key highlights are given below:

  • License includes commercial license, certificate of incorporation or other form of permit.
  • Companies exempted from Regulations –
    • Commercial companies in which the Government of the UAE, or the Government of any Emirate of the UAE, or any governmental authority or body of any of them has any direct or indirect ownership.
    • Companies having at least 51% of directly or indirectly held by Federal Government, Government of any Emirate of the UAE.
  • Meaning of adequacy and appropriate –
    • The Guidance states that the Licensee is required to maintain sufficient records to demonstrate the adequacy and appropriateness of the resources utilized, expenditures incurred and so on;
    • Business should be engaged in genuine business activity and carrying out core income generating activities in the UAE with such employees, expenditures and premises which belongs to them;
    • The Regulatory Authority of the Licensee shall review the adequacy and appropriateness of records and information submitted by the Licensee to demonstrate such adequacy and appropriateness, considering the nature and level of relevant activity conducted
    • By such Licensee;
  • The Guidance has explained in detail the important conditions with respect to outsourcing of state core income generating activities.
  • The Guidance has clarified that it is advisable to retain any relevant information evidencing compliance with the provisions of the Regulations for a period of 6 years after the end of each financial year.
  • Sector specific guidance is provided for Holding Company Business, Headquarter Business and High-Risk Intellectual Property Activity. Headquarters Business should be determined based on the services provided to other group companies and not basis the position of such Licensee in the group structure
  • Licensee is required to submit notification to the Regulatory Authority w.e.f. January 1, 2020 containing the following:
    • Whether or not Licensee is carrying on a Relevant Activity;
    • Gross income in relation to such Relevant Activity and whether the same is taxed in jurisdiction
      outside UAE; and
    • Date of end of financial year;
  • Licensee carrying on a Relevant Activity who is required to satisfy the economic substance test shall within 12 months from the end of its Financial Year (commencing on or after January 1, 2019) submit the report with the required information as per provisions of the Regulations

(This article is compiled by Chaitanya Kirtikar, Senior Manager, Offshore and Free Zone Department)