Economic substance is a requirement under tax laws, under which the transaction must have both a substantial purpose and an economic effect aside from the tax effect in order to be considered valid. These regulations are targeted at jurisdictions that offer minimal tax liabilities to the businesses and require certain entities conducting specific types of business activities to demonstrate that they have adequate economic substance in that jurisdiction.
As part of the UAE’s commitment as a member of the OECD Inclusive Framework and in response to an assessment of the UAE’s tax framework by the European Union Code of Conduct Group on Business Taxation, the UAE issued Economic Substance Regulations (Regulations) on 30 April 2019 and applicable from 1 January 2019. Further, the guidance on the application of the Regulation was issued on 11 September 2019.
The Regulation require UAE onshore and free zone companies and certain other business forms that carry out any of the defined “Relevant Activities” (as provided in the Regulation) to maintain and demonstrate an adequate economic presence in the UAE relative to the activities they undertake (“Economic Substance Test”).
The Regulation was amended on 10 August 2020 (Amendment Regulation). In terms of Amendment Regulation, the Licensees should re-evaluate their ESR categories and make relevant changes. It will require all the Licensees to consider refiling notification for the financial year 2019 on or before 31 December 2020. The portal will be live in December 2020.
Economic Substance Report
Licensees that earn income from a Relevant Activity during the relevant financial period and that are not exempt from the Regulations are required to demonstrate economic substance in the UAE and file an Economic Substance Report. Economic Substance Reports must be filed within 12 months from the end of the relevant financial period.
The key changes in the Amendment Regulations are as below:
Jurisdiction of National Assessing Authority and Regulatory Authority:
National Assessing Authority shall oversee the enforcement of economic substance tests and the Regulatory Authorities shall be responsible for collection and scrutinizing the notifications submitted by the license holders.
Amendment of the term Licensee:
The unincorporated partnerships, individuals who carry on with Relevant Activities in the Free Zones- Abu Dhabi Global Market and the Dubai International Financial Centre are included. Further, the sole proprietors, foundations and trusts are excluded from ESR.
Exemptions to Licensee:
The exemptions from complying with the Regulations are restricted to the following categories:
- A Licensee that is tax resident outside the UAE;
- An Investment fund and its underlying SPVs / investment holding entities;
- A wholly UAE resident-owned business that is not part of a multinational group and that only carries on business in the UAE;
- A branch of a foreign entity that is subject to tax on all of its Relevant Income in a foreign jurisdiction.
Consequences of non-compliance:
In case of failure of Licensee to submit the report or the requirements of the ESR, he shall be punishable with a penalty of AED 50,000 for the first year. In the second year, he is liable to pay AED 400,000. If the Licensee fails to submit notifications, then the penalty is AED 20,000. If there is continuous non-compliance, the license will be revoked.
The Regulations aims to ensure that the Licensee will undertake the required measures to adhere to the current ESR to streamline and fall within the purview of the government required compliances.