11 Apr 2022
Introduction:
The UAE issued the Economic Activities Regulations (Cabinet Resolution Number 31 of 2019), (the “Regulations”) on April 30, 2019, in response to the European Union Code of Conduct on Commercial taxes assessment of the UAE Tax Framework and its commitment as a member of the OECD Comprehensive Framework. Directives were issued on the implementation of the aforementioned regulations (Ministry Decision Number 2015 of 2019 on September 11, 2019), after which Ministerial Decision Number 58/2019 on defining the regulatory powers identified the authorities in charge of administering and enforcing regulations. Amendments were made to the regulations pursuant to Cabinet Resolution Number (57) of 2020 dated August 10, 2020. Subsequently, on 19 August 2020, updated Guidance was issued through Ministerial Decision Number (100) of 2020
The regulations apply to fiscal years beginning on or after January 1, 2019. For example, A UAE company whose fiscal year begins on January 1, 2019, and ends on December 31, 2019 will have its first evaluable period from January 1, 2019 to December 31, 2019.
Scope of Regulations:
A licensee is a legal person, a sole proprietorship, or a joint liability company registered in the United Arab Emirates and engaged in related activities. A Licensee also comprises those bodies registered in any of the UAE’s free zones including the financial free zones i.e., Abu Dhabi Global Market (ADGM) and Dubai International Financial Centre (DIFC). The ambition of the arrangements is to confirm that the UAE entities report actual profits proportionate with the economic activity being conducted within the UAE.
Natural persons, sole proprietorships, trust funds, and foundations do not fall within the scope of the Regulations under the amended regulations.
The “Relevant Activities” defined and listed below must maintain and demonstrate an adequate “economic presence” in the United Arab Emirates in relation to the activities in which they are undertaken (“Relevant Economic Activity Test”).
a) Banking Business
b) Insurance Business
c) Investment Fund management Business
d) Financial leasing Business
e) Headquarters Business
f) Shipping Business
g) The Business of the Holding Company
h) Intellectual property Business
i) Distribution center Business or services
An annual notification form has to be presented by the establishments within the scope of regulations to their regulatory authority along with writing and submitting a report on actual economic activity within 12 months following the end of their fiscal year to the same regulatory body. As for the establishments that did not generate revenues from a related activity or those that meet the conditions of the exemption, are not obliged to fulfill the test of real economic activity. However, a notification must be filed within six months from the end of the financial year, and Economic substance regulations report within twelve months from the end of the financial year and this applies to both the Licensee and the exempted licensee.
Economic Activity Test:
A Licensee is required to meet all of the criteria mentioned below so as to meet the economic substance test:
- It manages the relevant “Core Income-Generating Activity,” as stated in the Regulations, in the UAE;
- It is directed and controlled in the UAE in relation to that activity;
- It has a sufficient number of qualified full-time employees who are physically present in the UAE;
- It sustains adequate operating expenditure in the UAE;
- It has a sufficient amount of physical assets in the UAE.
Exemption from the Regulations:
The below-mentioned licensees are excluded as per Cabinet Resolution Number 57/2020 from submitting real economic activities reports and from the condition to prove actual economic activities in the United Arab Emirates:
- Licensees whose tax headquarters are outside the UAE;
- Investment funds and their affiliated special purpose entities and entities/investment holding entities;
- Entities wholly owned by residents of the UAE that are not part of a multinational group and carry out exclusively local transactions in the UAE;
- UAE branches of foreign establishments if the related income of the branch is subject to tax in the foreign country.
Sufficient proof must be provided in addition to the notification form to claim exemption from any of the above requirements.
Regulating bodies:
The systems are managed by the regulatory authorities listed in Article (4) of the Regulations, which are described below:
a) Federal authorities
b) Ministry of Economy
c) Central Bank of the UAE
d) Insurance Authority
e) Securities and Commodities Authority
Ground rules on branch operations:
The branches registered in the United Arab Emirates constitute an extension of its “parent company” or its “head office” and do not have a separate legal personality. Therefore, the “parent company” or the “head office” registered in the United Arab Emirates should submit a single notification and/or composite report on actual economic activities as a single licensee reporting the relevant activities that it engages in itself and through all of its subsidiaries.
The UAE branch of a foreign entity that carries on a related activity needs to follow the regulations as if it were a separate legal personality except if the related revenues of the relevant branch are taxed in the country of the parent company/head office. The ‘Taxable’ test is faced where the income of the UAE branch is taken into account when calculating the taxable income of the foreign parent company/headquarters or other related entity that submits a return of the relevant income to the UAE branch for corporate income tax purposes, regardless of whether the revenue of the UAE branch may benefit from the exemption or any other form of tax exemption in the foreign country under the local tax law or under a double taxation agreement.
The UAE establishment is not required to consolidate the activities and revenues of its foreign branches for the regulations, provided that the related revenues of the foreign branch are subject to tax in the foreign country in which the branch is located.
Penalties for non-compliance:
Failure to comply with the regulations may result in fines, automatic exchange of information with the foreign competent authority (as defined in Article 1 of the regulations), as well as other administrative penalties ranging from AED 20,000 to AED 50,000 significantly increasing to AED 400,00 in the subsequent years as well as suspension, cancellation, or non-renewal of the business license or permit of the facility in question.
Conclusion:
Nature of UAE being an international business hub, it is expected that a great number of companies fall under the scope of UAE Economic Substance Regulations. Simultaneously, this also provides these companies with tools and instruments to successfully meet the substance test. Consultation with legal experts is recommended in order to assess the ESR position of any relevant Licensee and meet, within the given deadlines, the ESR requirements.