UAE and Economic Substance – Don’t be tempted to avoid its relevance
The implementation and management of Economic Substance Legislation (ESR) has been in existence for some time across much of the financial services industry.
Different jurisdictions have been introducing their own rules around this topic and the OECD has kept a watchful eye on its progress.
This article isn't intended to explain the history of ESR. It is meant to demonstrate how the UAE has gone about bringing in the legislation and what it means for the country. This follows the EU placing the UAE on its blacklist of non-cooperative jurisdictions (for tax purposes) which spurred the country to implement and align its legislative framework to meet international tax practice standards in addition to the standards set out in the OECD BEPS plan.
As a result legislation was introduced in 2020 and retroactively applied from 1 January 2019. In August 2020 the UAE went further and updated its guidance on the rules clarifying certain aspects of ESR.
This impacts all onshore offshore and free zone companies as well as any organisations situated in financial free zones that require companies and Licensees to report annually to ensure their endeavours fall within the scope of 'any relevant activity'. In this context the list of relevant activities includes all holding companies those with IP distribution and service companies and banking insurance and asset management entities. In addition leasing and headquartered companies are also considered relevant activities. Additional reporting requirements are now in place for all such entities on an annual basis. Specific Economic Substance tests are applied as part of these annual reporting requirements.
The regulatory authorities are responsible for the collection of this information. Penalties apply for failure to report and failure to accurately report. Said penalties are steep. Non-compliance with the ESR test can lead to a fine of AED 50'000 (just under 10000) for a first offence. Persistent repeat offenders can ultimately expect suspension of their activities and license.
This article is designed to summarise a couple of the key matters to be mindful of in regard to the ESR most of which will apply more generally in most jurisdictions but with a 'UAE twist'. Two prominent points are:
Consideration of Core Income Generating Activities (CIGA). This is the most important activity that a Licensee must continue (as a Licensee carrying on a relevant activity) within the UAE. These activities are detailed in the ESR rules but it is important to note that the list is not exhaustive. Equally it can be acceptable that some of the activities are not carried out in the UAE depending on the company's overall position.
Management and Control: Unsurprisingly the Licensee must be directed and managed locally in the UAE.
Board meetings must be held in the UAE as often as required. All meetings should be attended recorded and records of where meetings are held and the decisions made should always be kept. Records should include more than a bullet point summary of decisions and should inform accurate decision making. Always ensure a quorum is met and attendance is mostly physical even if the location is not a permanent one (i.e. a rented meeting room).
It is important that board members have the necessary qualifications to debate and consider the decisions on the agenda for discussion.
It is always best to use UAE resident directors. At the very least they should make up a majority even if outside experts are brought in to discuss specific issues.
The Licensee should have an adequate (and qualified) complement of employees located in the UAE to carry out day-to-day running and administration of the Licensee's business. Where the company does not employ sufficient employees itself it should contract third party service providers in the UAE. Essentially it's important to demonstrate that adequate employees or third-party contractors are on board as appropriate based on the business' level of complexity.
Having the right level of expenses in UAE and the right level of company assets is also a consideration (this can of course include leasehold premises). Therefore record keeping is key.
Companies operating in the UAE must be mindful as penalties for failing to comply with the regulatory authority are severe. It's very important to seek annual independent verification to ensure you are meeting the substance test especially if the exchange of information with foreign tax authorities or other bodies leads to questions. However tax relief may be available in other jurisdictions if the Economic Substance tests are considered adequate.
Please note that this article is intended to provide a general overview of the matters to which it relates. It is not intended as professional advice and should not be relied upon as such. Any engagement in respect of our professional services is subject to our standard terms and conditions of business and the provision of all necessary due diligence. © Praxis 2023