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ECONOMIC SUBSTANCE REGULATION

What are the economic substance regulations?

UAE being a member of OECD (ORGANIZATION OF ECONOMIC COOPERATION AND DEVELOPMET) inclusive frame work introduced ESR Law in UAE in the year 2019 The purpose of this Law is to ensure that UAE entities do not artificially attract profit that are not commensurate with the economic activities undertaken by them in the UAE The Law and related regulations require that the businesses have an economic presence in the UAE related to their activities in UAE

On 30 April 2019, the UAE government issued Federal Cabinet Resolution No. 31 of 2019 Concerning Economic Substance Regulations.. The Regulations sets out certain requirements in relation to the "economic substance" of businesses licensed to operate in the United Arab Emirates (the UAE). Ministerial Decision No. 215 of 2019 issued by the UAE Ministry of Finance on 11 September 2019, provides guidance on how the economic substance test may be met for the purpose of complying with the provisions of the Regulations.

The regulations are designed to ensure that entities established in the UAE, with certain activities conduct appropriate types of economic activity within the UAE and that the entity has not been established to artificially attract profits that are not justified in light of the actual economic activity undertaken in the UAE.

Who does the Regulations apply to?

The Regulations applies to all UAE onshore and free zone companies, branches, partnerships and other UAE business forms Therefore all entities operating with the Dubai Airport Free Zone are subject to these requirements.

Who is exempt from the provisions of the Regulations?

Licensees in which the UAE federal government, the government of any emirate, or any UAE federal or emirate-level governmental authority or body holds at least 51% direct or indirect equity ownership are not subject to the Regulations. If a Licensee does not conduct a Relevant Activity or does conduct a Relevant Activity but does not generate any income then the Licensee will be also be exempt. However, in each case the Licensee will still need to make a notification filing. See further question ‎10 below.

What do the Regulations mean?

Any Licensee that is conducting a Relevant Activity (see question ‎5 below) will be required to show that:

  • (a)It and the Relevant Activity is being directed and managed in the UAE;
  • (b)The relevant core income generating activities (CIGA) are being conducted in the UAE; and It has adequate employees, premises and expenditure in the UAE.

What are the Relevant Activities?

The Relevant Activities are as follows:

  • (c)Banking Businesses;
  • (d)Insurance Businesses;
  • (e)Investment fund management Businesses;
  • (f)Finance leasing Businesses;
  • (g)Headquarter operations;
  • (h)Shipping;
  • (i)Holding company operations;
  • (j)Intellectual property operations; and
  • (k)Distribution and service centres.

It does not matter if these activities are listed on your trade licence or not, it is necessary to consider the actual activities that are undertaken by the Licensee. A substance over form approach will be taken to determine if a Licensee is subject to the Regulations.

What must the Licensee do to satisfy the Regulations?

Management and control

The Licensee must be directed and managed in the UAE in relation to the Relevant Activity and should ensure that there are an adequate number of board meetings held and attended in the UAE. The 'directed and managed' test requires that:

  • (l)the meetings are recorded in written minutes and signed by the attendees and that such minutes are kept in the UAE;
  • (m)the quorum for such meetings is met and those attendees are physically present in the UAE;
  • (n)the directors have the necessary knowledge and expertise in their duties. The minutes of the board meetings must refer to all the relevant decisions taken and must be signed by directors physically present and the quorum shall be determined in accordance with the law applicable to the Licensee, or as may be set out in its constitution of the Licensee. In the event the Licensee is managed by an individual (general manager or CEO), rather than a board, the above requirements will apply to such individual.
Employees

Having regard to the level of Relevant Activity, the Licensee must have either an adequate number of qualified full-time (or equivalent) employees in relation to that activity who are physically present in the UAE (whether or not employed by the Licensee or by another entity and whether on temporary or long term contracts) or an adequate level of expenditure on outsourcing to third party service providers whose activities, employees, expenditure and premises are in the UAE; and these activities, employees, expenditure and premises are adequate for carrying out the Relevant Activity being outsourced.

Expenditure

The Licensee must incur adequate operating expenditure in the UAE, or an adequate level of expenditure on outsourcing to third party service providers whose activities, employees, expenditure and premises are in the UAE; and these activities, employees, expenditure and premises are adequate for carrying out the Relevant Activity being outsourced.

Assets

The Licensee must have adequate physical assets in the UAE or an adequate level of expenditure on outsourcing to third party service providers in the UAE, for the activities of the Licensee.

What is CIGA?

CIGA or "core income generating activities" are the primary functions that are undertaken by a Licensee that underpin the Relevant Activity. The Resolution contains examples of what these activities may be but does not contain an exclusive list. This CIGA must be undertaken in the UAE.

Are there any exemptions?

A holding company business, which derives its income solely from dividends and capital gains arising from equity investments is considered a "pure equity holding company" and is therefore not required to demonstrate that it is carrying out CIGA in the UAE. However, a holding company business is required to be in compliance with filing obligations in the UAE and to maintain adequate employees and premises for holding and managing its investments.

A Licensee that is only a holding company will not need to show that it is directed and managed in the UAE or have or demonstrate adequate expenditure in the UAE.

What special rules apply in relation to IP Businesses?

Any business that is carrying out High Risk IP Business will be presumed to be in breach of the Regulations unless it is able to provide evidence that it is not. A High Risk IP Business is one which:

EITHER (A) satisfies each of the three tests below:

  • The Licensee did not create the IP asset which it holds for the purpose of its business
  • The Licensee acquired the IP asset either from
    1. (A)A connected person; or
    2. (B)In consideration for funding research and development by another person situated outside of the UAE; and
  • The Licensee
    1. (A)Licenses the IP asset to one or more connected persons; or
    2. (B)Otherwise generates income from the asset in consequence of activities performed by foreign connected persons.

OR (B):

The Licensee does not carry out research and development, or branding, marketing and distribution as part of its UAE CIGA. The evidence that must be provided in order to reverse the presumption is:

  • (a)Evidence of a high degree of control over developing the IP asset;
  • (b)The Licensee having adequate full-time employees with the necessary qualifications that permanently reside and perform their activities in the UAE (it will be necessary to provide employee information showing experience, contracts, qualifications etc.);
  • (c)The Licensee has a business plan showing the reasons for holding the IP in the UAE; and
  • (d)Relevant decision making has and continues to take place in the UAE.

What notifications does a Licensee need to make?

All licensees are required to file an annual notification as to whether or not they are conducting any Relevant Activities. The notification will indicate:

  • (e)the Licensee's financial year end;
  • (f)whether or not the Licensee exercises a Relevant Activity;
  • (g)whether or not the Licensee earned any income from the Relevant Activity;
  • (h)whether any income generated by the Relevant Activity is totally or partially subject to a tax system outside of the UAE; and
  • (i)whether or not the Licensee is exempt due to Government ownership.

The notification must be filed with FREE ZONE by 3 May 2020 and must be completed via FREE ZONE’s online CRM portal. Login in to the CRM portal -> Services -> Licensing Services -> Economic Substance Regulation Form (ESR Notification Form).

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