UAE Economic Substance: Important Changes

UAE

We previously discussed the introduction of economic substance requirements in the UAE on 30 April 2019 in Law-Nows here and here. Its introduction meant that UAE entities were obliged to file economic substance notifications on or before 30 June 2020, which determined whether they were in scope for the purposes of the UAE economic substance regulations pursuant to Cabinet Resolution No. 31 of 2019 and Ministerial Decision No. 215 of 2019 (together, the “Previous ESR Legislation”).

However, important changes have been made to the Previous ESR Legislation: 

  • on 10 August 2020, Cabinet Resolution No. 57 of 2020 was issued; and
  • on 19 August 2020, a renewed Ministerial Decision No. 100 of 2020 was adopted,

(together, the “ESR”) both of which repealed and replaced the Previous ESR Legislation. The UAE Ministry of Finance has also updated its economic substance website with the amended position.

All UAE entities should be aware of the changes to the scope of UAE economic substance in the ESR, which have a retroactive effect from 1 January 2019. We outline the main changes below.

1. Relevant Authority

The authority responsible as the “National Assessing Authority” will now be the UAE Federal Tax Authority (“FTA”) rather than licensees’ regulatory authorities (such as individual free zones and the Ministry of Economy). The FTA will therefore determine whether licensees have met the economic substance test, impose penalties and hear appeals filed by licensees. However, the regulatory authorities will still be responsible for the collection and verification of information regarding their licensees and assisting the FTA in their role.

Decision 100 of 2020 states that the UAE Ministry of Finance (as competent authority) will launch a portal to facilitate the electronic filing of the notifications, reports and other relevant information. Businesses that already submitted an ESR notification to their regulatory authorities will be required to re-submit their ESR notification through the UAE Ministry of Finance portal once it goes live.  However, it is not yet known when this portal will be available. 

2. Licensee Definition

The ESR will only apply to (i) juridical persons (persons with separate legal personality), and (ii) unincorporated partnerships that carry on a relevant activity in the UAE. Therefore, natural persons, sole proprietors, trusts and foundations are no longer in scope of the ESR and will no longer need to file an ESR notification.

3. Exempted Licensees

Exempted licensees now also include (non-exhaustive):

  1. Investment funds.
  2. Licensees that are tax resident in another jurisdiction outside of the UAE.
  3. Branches of foreign entities which relevant income is subject to tax in a jurisdiction of the foreign head office/parent company outside the UAE.
  4. Entities that are wholly owned by UAE residents, which are not part of a multinational group and only carry out business activities in the UAE.

In order to enjoy their ESR exempt status, exempted licensees must file a notification and provide evidence demonstrating such position. The UAE Ministry of Finance will exchange information with foreign competent authorities on licensees that claim to be exempt from the ESR on the basis of (ii) and (iii) in the above list.

Separately, entities owned at least 51% by the UAE government (directly or indirectly) are no longer specifically exempt from the ESR. However, such entities may benefit from any of the newly introduced exemptions set out above.

4. Branches

Branches do not have separate legal personalities from their parent company or head office, so are therefore not strictly regarded as licensees. The ESR clarifies how branches should be treated, as follows:

  • UAE branch of a UAE business: the UAE business should file a single notification and (if applicable) an ESR report, which would report the relevant activities of itself and all of its UAE branches.
  • UAE branch of a foreign business: the UAE branch is not within scope of the ESR if its relevant income is reported in the tax return of the foreign business/head office.
  • Foreign branch of a UAE business: the UAE business does not need to report on the relevant activities of its foreign branch, provided that the foreign branch is subject to tax on its relevant income in the foreign jurisdiction.

5. Relevant Activities

Resolution 57/2020 details changes regarding relevant activities and what licensees performing such activities must demonstrate in terms of sufficient economic substance in the UAE. For example:

  • Distribution and Service Centre Business – the scope has been expanded such that there is no longer a requirement for; (i) the goods to be imported and stored in the UAE; or (ii) services to be provided in connection with a business outside the UAE, in order for an entity to be considered as a distribution and service centre business. Therefore, any service provided to a foreign related party will now be considered a “Distribution and Service Centre Business”.
  • High Risk Intellectual Property Licensee – the definition has been restricted to an intellectual property business that meets all of the conditions listed in the ESR.

6. Penalties

Along with the suspension of company licences for non-compliance, the penalty amounts have been amended, as follows:

  • The penalty for failure to submit the ESR notification has been increased from US$2,725 to US$5,450.
  • Penalties for failing the economic substance test have now been set at US$13,625 (previously there was a range between US$ 2,725 to US$13,625).

Action Required

The ESR provide important clarification on the UAE’s economic substance position, with a handful of amendments helping to reduce the burden on some businesses in the UAE.

The first deadline of 31 December 2020 for submitting the substantive ESR reports (for financial year ended 31 December 2019) is fast approaching. We suggest that all UAE entities therefore (i) re-assess their position by familiarising themselves and complying with the new ESR requirements, then (ii) swiftly take steps to draft the ESR report, so that there are no last-minute issues and to avoid penalties being imposed.

Please get in touch if you would like to discuss the contents of this article further, or if you would like assistance regarding ESR compliance.