As part of the UAE’s obligations under the OECD Framework and in response to the EU Code of Conduct Group on Business Taxation’s assessment of the UAE’s tax framework, on 30 April 2019, the UAE Ministry of Finance issued a Cabinet Resolution on Economic Substance (the Regulations), which was subsequently amended in August 2020 to incorporate updated guidelines. In line with the international initiative to combat harmful tax practices, including unlawful tax avoidance or evasion, ESR has been introduced in countries where corporate taxes are not levied or are low. Compliance with the Economic Substance Regulation (ESR) is a requirement for every financial year. In order to submit financial statements to the UAE Ministry of Finance (MOF), companies must conduct an assessment of their activities and transactions for each financial year.
Any company that generates earnings and conducts relevant activities in the UAE, regardless of whether it is located on the mainland, in a free zone offshore, or in a financial free zone, must file an ESR in UAE. Licensees must notify the MoF via its dedicated ESR portal (‘MoFPortal’) within six (6) months after the end of their financial year, provided that Relevant Activities were undertaken during the Reportable Period. Economic Substance Test Declaration (filing a Report) must be made within 12 months of the end of their fiscal year (e.g. a report must be filed by 31st December if your last fiscal year ended on the 31st of December last year).
For an entity to pass the Economic Substance Test, it must prove:
There are 2 stages of compliance namely Notification and Annual Economic Substance Returns
During the relevant financial period, a company’s activities must be investigated to determine whether any of them are relevant. There are nine activities investigated to determine the relevance which are Banking, Insurance, Shipping Business, Lease-Finance Business, Headquarter Business, Holding Company Business, Investment Fund Management, Intellectual Property Business, and Distribution & Service Centre Business. The company must submit an ESR Notification before the deadline if it has engaged in any of these activities in the fiscal year.
The categories of companies as per the resolution are Licensees and Exempted Licensees. Out of these 2 classifications Licensees are mandated to submit ESR notification and Report whereas the Exempted Licensees need to submit only the notification substantiating their exemption with necessary documents.
The licensee can be either a legal person or an unincorporated firm registered within the UAE, as well as an economic free zone or financial free zone, and engage in relevant activities. An Exempted Licensee is, alternatively
a) An investment fund licensee
b) Tax residents of countries outside the UAE
c) A licensee whose owner is a UAE resident or multiple owners if it does not form part of an MNC group and does not operate outside the UAE
Financial penalties may be imposed by the relevant UAE authorities if they believe the above Economic Substance Tests have not been met for a given period. Fines can vary and can even range to t AED 400,000 should the entity fail to comply with the ESR regulations
The majority of non-compliant entities are penalized because they are uninformed about the ESR legislation or lack of knowledge. A lack of knowledge about the Relevant Activities or misconceptions about what qualifies as an Exempted Licensee and Licensee are common causes for non-compliance. Many companies also fail to meet the ESR deadline.
Therefore, companies must follow the deadlines and ensure the information provided in the notifications is accurate. Aside from penalties, non-compliance will result in the firm receiving a “red mark” overseas, since UAE authorities will share information about the ESR violation overseas. Therefore, it makes sense to seek the services of ESR consultants locally to ensure a proper assessment is made. As part of our ESR commitment, our advisers will also assist companies with passing the Economic Substance Test. If a company is not in compliance with ESR Test requirements, we will provide remedial measures to get them in compliance.