Brave new world - economic substance requirements introduced in the UAE

United Arab Emirates

New regulations concerning economic substance (Cabinet of Ministers Resolution No.31 of 2019) (the “Regulations”) have been implemented in the UAE. The Regulations intend that all in-scope UAE entities (the “Relevant Entities”) have not been incorporated in the UAE for the sole purpose of benefitting from the country’s preferential tax regime, illustrating the UAE’s commitment to the Organisation for Economic Cooperation and Development’s (“OECD”) Inclusive Framework on Base Erosion Project Shifting (“BEPS”). The BEPS project is an international treaty signed by over 125 countries and jurisdictions, a principle aim of which is to look at tax planning strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations, where there is little or no economic activity. For an overview of BEPS, please click here.

To explain BEPS, it may help to take a take a typical example scenario. Let’s assume a Middle Eastern investor is acquiring a business or significant asset (e.g. an airport or hotel) located in a foreign jurisdiction (the “Target Jurisdiction”). Where the investor’s home jurisdiction does not currently have a favourable double tax treaty (a “DTT”) with that of the Target Jurisdiction, often the investor would be advised to hold and fund the investment via a structure based in a jurisdiction with which the Target Jurisdiction and the investor’s home jurisdiction, both have a favourable DTTs, giving overall tax efficiency upside to the investor via those two DTTs. In doing so, the holding/funding structure in that third party jurisdiction would be where the “profits” of the target business are “artificially shifted” to in order to avail of the chain of DTTs.

These kind of structures have commonly been used for the sole purpose of reducing the investor’s tax bill. Under the BEPS project, governments of over 125 countries have agreed that these practices are no longer acceptable. The UAE is implementing a suite of regulations designed to bring the UAE regulatory regime into line with BEPS requirements, and in doing so should minimise further risks that the EU, which has decided to police implementation of BEPS standards, might put the UAE back on a tax haven blacklist.

The UAE Regulations have effect as from 30 April 2019, and requires all Relevant Entities that carry on certain activities (the “Relevant Activities”) to have demonstrable economic substance in the UAE. This is to avoid the scenario where the investor could be, for example, an European business buying a target in Asia, and structuring the funding/holding vehicle in the UAE in order to avail of the DTT chains between the investor’s home jurisdiction and that of the target.

Scope of the Regulations

The Regulations will apply to all Relevant Entities conducting Relevant Activities in the UAE. “Relevant Activities” include:

  • banking, financial leasing, insurance and investment fund management;
  • holding company and headquarters activities;
  • intellectual property holdings - ownership, use or acquisition of income derived from intellectual property assets;
  • shipping, maritime transport, rental of ships, ticket sales/services, maintenance and operation of ships and containers for use in shipping, and management of vessel crew (outside the territorial waters of the UAE);
  • distribution centre, where goods are purchased from abroad, imported/stored and then resold outside of the UAE; and
  • services centre - provision of services to foreign persons outside of the UAE.

Where a Relevant Entity carries out more than one Relevant Activity, economic substance requirements must be met for each Relevant Activity. Some Relevant Activities are also subject to less stringent requirements than others. Pure holding companies, for instance, need to only satisfy two of the below requirements, whereas other Relevant Activities must generally satisfy a minimum of three requirements. Conversely, the Regulations will impose additional requirements for certain activities, as is the case with 'high-risk' IP-related activities, where Relevant Entities will have to provide the Ministry of Finance with additional information and documentation. It is currently unclear what constitutes ‘high-risk' IP-related activities; this is an element of the Regulations that we expect to see further clarification on in the upcoming guidelines (see below our commentary relating to ‘Upcoming Guidelines’).

Satisfying the Requirements

Any Relevant Entity which carries on a Relevant Activity in the UAE must demonstrate that it has satisfied the economic substance test (referred to as “Requirements of Real Economic Activities” in the Regulations).

Chiefly, the Relevant Entity will have to show that it is not only carrying out a Relevant Activity, but that it is “generating a major income” from that activity in the UAE. Article 5 sets out guidance for what constitutes “generating a major income” for each Relevant Activity.

Once this has been established, the Relevant Entity will then have to prove that it is directed and managed primarily in the UAE with respect to the Relevant Activity. The Regulations specify that this criterion will be complied with if the Relevant Entity is conducting frequent board meetings, keeping minutes of these meetings and having the directors physically present at meetings, amongst other factors demonstrating compliance. The Relevant Entity will also have to demonstrate that there is an ‘appropriate number of qualified personnel’ employed in the UAE who are responsible for carrying out the Relevant Activity.

The Regulations also provide guidance on a Relevant Activity that is exercised in the UAE and generating a major income (figures surrounding which are unknown), where the activity is undertaken by a third party service provider on behalf of a Relevant Entity. In these cases, the Relevant Entity should be able to monitor and control the third party’s implementation of that activity in order to comply with the requirements imposed by the Regulations.

All Relevant Entities are required to report evidence to the relevant authority (i.e. the authority from which the trade license was issued), or an annual basis, to confirm that they are complying with the requirements under the Regulations.

It should be noted that commercial companies owned directly or indirectly by the UAE government are excluded from the scope of the Regulations.

Consequences of non-compliance

Non-compliance with reporting requirements will result in fines, and the Ministry of Finance will inform the Relevant Entity of its rationale behind each individual decision. Such penalties are set to be not less than AED 10,000 but not exceeding AED 50,000 in the first year, and in subsequent years it would be not less than AED 50,000 but not exceeding AED 300,000 - subject to a 6-year limitation period.

Whilst these monetary penalties for non-compliance should be effective, it may be that the Ministry of Finance decide to impose additional penalties that may include suspending, revoking or refusing to renew the Relevant Entity’s trade licence (which may be a more disruptive and hard-hitting form of penalty).

Upcoming Guidelines

The Ministry of Finance plans to issue further guidelines detailing how a Relevant Entity can satisfy the requirements of the ‘economic substance test’. In these guidelines, we expect to see more specific definitions for terms used in the Regulations. We expect that this will include an allocated sum to define ‘major income’ and further guidance on what IP-related activities will be considered ‘high-risk,’ as well as more clearly defining regulatory authorities' scope to amend certain directives of the Regulations, as the decision does not specify the extent of their authority in this matter.


The UAE had its fingers burnt by alleged non-compliance with BEPS standards when the EU added the UAE onto a tax haven blacklist. While there is a clear desire to avoid that happening again, there is still a long way to go before the UAE’s legal framework is of a standard that is expected by the international investment and regulatory community.

Transparency and reliability is still a major challenge. The lack of publicly searchable registers of UAE businesses is a prime example. However, the development of a comprehensive VAT regime and these Regulations is a more comprehensive central reporting structure for contributing to UAE businesses. This should help form a platform on which further developments to boost transparency and reporting can be built.

Coupled with the recent introduction of the UAE's Foreign Direct Investment Law, the implementation of the Regulations forms part of the bigger picture for overseas companies to conduct business fairly and efficiently in the UAE within the constraints of a more robust regulatory framework.

If you are considering how this may affect your business, please feel free to get in touch with us to discuss in more detail.