Introduction
On April 30 2019, the UAE Cabinet issued Cabinet of Ministers Resolution No. 31 of 2019 concerning Economic Substance Regulations in the UAE (the Regulations), requiring all in-scope UAE entities which conduct certain activities (Relevant Activities) (detailed below) to have demonstrable economic substance in the UAE, effective immediately.
What is this in relation to?
The introduction of the Regulations follows the UAE’s firm commitment to comply with the EU requirements in order to be removed from the EU’s list of “non-cooperative” tax jurisdictions and illustrates the UAE’s ongoing efforts to reach the highest standards on taxation including the OECD’s requirements.
Who is subject to the Regulations?
The Regulations apply to all UAE onshore and free zone companies (including in the financial free zones) that carry on and generate income from one of the “Relevant Activities” listed below (Relevant Entities):
How does this impact the Relevant Entities?
The Relevant Entities must satisfy the following criteria to meet the Economic Substance Test:
1. If the Relevant Entities conducts State Core Income-Generating Activity in the State.
2. If the Relevant Entities is directed and managed in the State in relation to that activity, provided the Relevant Entities’s board of directors meets in the State at an adequate frequency having regard to the amount of decision-making required at that level.
3. Having regard to the level of Relevant Activity, if there is an adequate number of qualified full-time employees in relation to that activity who are physically present in the State (whether or not employed by the Relevant Entities or by another entity and whether on temporary or long-term contracts), or adequate level of expenditure on outsourcing to third party service providers, whose activities, employees, expenditure, and premises are in the State; and these activities, employees, expenditures and premises are adequate for carrying out the Relevant Activity being outsourced.
4. If there is adequate operating expenditure incurred by it in the State, or adequate level of expenditure on outsourcing to third party service providers whose activities, employees, expenditure and premises are in the State; and these activities, employees, expenditures and premises are adequate for carrying out the Relevant Activity being outsourced.
5. If there are adequate physical assets in the State or adequate level of expenditure on outsourcing to third party service providers in the State, for the activities of the Relevant Entities;
6. In the case of State Core Income-Generating Activity carried out for the relevant Relevant Entities by another entity, if it is able to monitor and control the carrying out of that activity by the other entity.
There are certain regulations in respect of holding companies whose income and profits are derived only from their equity investments. Additional requirements apply if an entity carries out “high risk IP related activities”.
What does it mean in practice?
Each Relevant Entity must report specified information on its ‘Relevant Activities’ annually to the authority which has issued its trade license to demonstrate that it satisfies the economic substance requirements (this includes, for example, information on the relevant activities such as nature and amount of revenue, expenses, place of business and number of employees with qualifications). Existing entities will have to comply from 20 April 2019 onwards, with the first return due in 2020. New entities must comply with the Regulations upon receipt of their trade licences, with the first return due in 2020 (or later).
Sanctions for non-compliance
In the event of any non-compliance of the Economic Substance Test, the UAE legislation foresees penalties of up to AED50,000. If the UAE entity fails to comply with the ES rules in a subsequent financial year, penalties can be imposed at up to AED300,000 and other administrative actions can be applied including the suspension, exclusion or non-renewal of the company’s trade license.. Additionally, the Regulations provide that the UAE authorities may exchange information about non-compliant UAE-registered companies with the tax authorities in the states where their parent companies and UBO’s are resident.
Issuance of executive/implementing regulations
Because the Regulations are of a high-level nature only, it is expected that supplemental regulations or decisions will be issued in due course to set out the detailed application of the Regulations, the reporting requirements and how it will be implemented.
