Economic Substance Regulations In a bid to address base erosion and profit shifting, the United Arab Emirates (UAE) has enacted revised Economic Substance Regulations (ESR) as a member of the Organisation for Economic Cooperation and Development (OECD) inclusive framework. This move, outlined in Cabinet Decision No. 57 of 2020, alongside guidance in Ministerial Decision No. 100 of 2020, is designed to prevent UAE entities from attracting disproportionate profits relative to their economic activities within the country.
Targeted Business Activities and Exemptions
The ESR specifically focuses on nine business activities, including banking, insurance, investment fund management, lease finance, headquarters, shipping, holding companies, intellectual property, and distribution/service sector businesses. Entities not involved in these activities are exempt from the ESR. The regulations apply to juridical persons referred to as “licencees,” with exceptions for certain entities such as investment funds, trusts, foundations, businesses resident outside the UAE, and purely domestic UAE businesses owned by UAE residents. Sole establishments are granted exemption from the ESR.
Notification Requirements and Deadlines: Economic Substance Regulations
Eligible licencees engaged in relevant activities but not generating income are required to submit a notification. However, if income is earned, licencees must submit both a notification and an ESR report. The notification deadline is six months from the end of the relevant financial year and entails providing basic information about the business, its regulatory authority, and ownership.
Components of the ESR Test
The ESR test comprises three components: the functional test, management test, and adequacy test. The functional test mandates that licencees conduct core income-generating activities (CIGA) in the UAE, excluding those in holding company businesses. The management test requires UAE-based licencees to be directed and managed within the country, necessitating annual board meetings held in the UAE. The adequacy test demands licencees maintain sufficient employees, operating expenditures, and physical assets within the UAE.
Reporting Requirements for Relevant Income: Economic Substance Regulations
For licencees earning relevant income, the ESR report must be submitted within 12 months from the end of the relevant financial year. The report includes information from the notification and financial details such as revenue, employee count, and meetings.
FTA Assessment and Potential Penalties
The Federal Tax Authority (FTA) assesses compliance with the ESR test, usually within six years after the relevant financial years. Noncompliance may result in penalties ranging from Dh20,000 to Dh400,000. Persistent non-compliance may lead to license suspension, revocation, or non-renewal.
Year-End Deadline and Compliance Advisory: Economic Substance Regulations
With the year-end approaching, businesses must submit notifications or reports before December 31, 2023. Juridical persons are advised to assess their status and comply with the ESR requirements to avoid penalties.
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