On 30th April 2019, Cabinet of Ministers’ Resolution No.31 of 2019 was passed concerning Economic Substance Regulations (“ESRs”) in the UAE. On 12th September 2019, the UAE Ministry of Finance issued a guidance document clarifying certain aspects of the ESRs.
What are the ESRs, and why have they been introduced?
The OECD and the EU have raised concerns over the propensity of organisations adopting form over substance accounting techniques to ‘shift profits’ from higher tax regimes to regimes with no or low tax. Consequently, this has led the OECD to issue a new global standard - Base Erosion and Profit Shifting (“BEPS”) - which aims to assess the tax policies of no or low tax jurisdictions against the criterion of ‘economic substance’ as described below. It has also resulted in the EU publishing a list of noncooperative tax jurisdictions (“EU blacklist”) which failed to make sufficient commitments to the EU with regard to tax fraud and tax evasion.
The UAE was added to the EU blacklist in December 2017 but removed in January 2018 after commitments were provided to the EU. However, it was reinstated on the EU blacklist in March 2019 as it had failed to make sufficient progress towards those guarantees.
In this regard, the UAE compared unfavourably with countries such as Bermuda, British Virgin Islands (BVI), Cayman Islands, Isle of Man, Jersey, Guernsey,
Mauritius, Bahamas, and Seychelles which enacted Economic Substance Regulations from 1st January 2019.
The April introduction of the ESRs in the UAE has had the desired effect – the EU removed the UAE from its blacklist on 11th October 2019.
What do the ESRs seek to achieve?
The new law creates the basis for the UAE to meet the requirements of the European Union Code of Conduct Group (Business Taxation) (COCG) in respect of economic substance. The objective of the COCG is to ensure that the jurisdiction does “not facilitate structures or arrangements aimed at attracting profits which do not reflect real economic activity in the jurisdiction”.
What does Economic Substance mean, in practice?
Companies will need to prove that they have ‘economic substance’ in relation to relevant activities and will have to undertake the following:
- Conduct core income generating activities (“CIGA”) in the country
- Are directed and managed in the UAE in relation to that activity (guidance states that at least one board meeting must be physically held in the country)
- Have an adequate number of qualified full-time employees physically present in the UAE in relation to that activity.
- Have premises and an adequate level of expenditure in the country commensurate with the income that is being recorded.
To which firms do the ESR’s apply?
The ESRS apply to all firms in the UAE (including free zones) which conduct relevant activities:
- Banking business
- Finance and leasing business
- Fund management business
- Headquarters business
- Holding company business
- Insurance business
- Intellectual property holding business
- Shipping business
- Distribution and service centre business.
Do I need to make reports? If so to whom?
All companies with an accounting reference period starting on or after 1st January 2019, and which conduct relevant activities will be required to make reports under the ESRs. The authority to whom the reports are made has yet to be clarified but is expected to be the authority with whom the establishment is registered or incorporated.
What should you do next?
If you need further information on the ESRs or their impact on you in the UAE, please contact Nigel Pasea.