The UAE Cabinet has recently repealed and replaced the Economic Substance Regulations (Cabinet Decision No. 31/2019) issued in April 2019 with the Cabinet of Ministers Resolution No. 57 of 2020 Concerning Economic Substance Requirements and its Directives under Ministerial Decision No. 100 of 2020 (“the New Regulations”).
The New Regulations provide more clarity and wants businesses in UAE to be accountable and thus avoid harmful tax practices.
Current Status of UAE Economic Substance Regulations
The UAE has since introduced further changes to its Economic Substance Regulations. In October 2024, the Ministry of Finance announced that Economic Substance Notification and reporting requirements were cancelled for financial years ending after 31 December 2022, following Cabinet Decision No. 98 of 2024.
Although businesses are no longer required to submit Economic Substance Notifications or Reports for financial years ending after 31 December 2022, obligations relating to earlier financial years may still apply. Businesses may need to respond to requests for information from the relevant authorities or address outstanding penalties relating to historical ESR compliance.
The information below explains the Economic Substance Regulations that applied to relevant financial years and remains relevant for businesses reviewing their historical UAE ESR compliance obligations.
Licensees required to meet the Economic Substance Test
The New Regulations define a Licensee as an entity that is:
- a juridical person (corporate legal entity with separate legal personality from its owners) incorporated inside or outside the State
- an Unincorporated Partnership (limited or general partnerships registered in the State including the free zones or financial free zones)
Branches registered in the UAE are regarded as an extension of their “parent” or “head office” and therefore are not considered to have separate legal personality. And if a Branch of a foreign entity carries out Relevant Activity in the State it is required to comply with the New Regulations unless the Relevant Income is subject to tax in a jurisdiction outside the UAE.
A Licensee which carries out a Relevant Activity and derives Relevant Income during the course of Liquidation or winding up is required to satisfy with the provisions of the New Regulations and submit the Economic Substance Notification and Report. The Liquidators (or their equivalent) must ensure that the entity complies with all requirements under the New Regulations.
The New Regulations has not introduced any new list of activities and the Relevant Activity list remains as below.
- Banking Business
- Insurance Business
- Investment Funds Management Business
- Lease Financing Business
- Headquarter Business
- Shipping Business
- Holding Company Business
- Intellectual Property Business
- Distribution & Service Centre Business
However, revisions have been made to the definition or scope of Distribution & Service Centre Business and Intellectual Property Business.
The New Regulations has also defines Relevant Income as all gross income from a Relevant Activity that is recorded in the books and records of the Licensee or the Exempted Licensee under the accounting standards applicable thereto.
Regulatory and Administrative Authorities
- The Ministry of Economy, Central Bank, Insurance Authority, Securities and Commodities Authority, Free Zone Authorities (including Financial Free Zone Authorities) are the Regulatory Authorities. These Regulatory Authorities are authorized to:a. collect the Notification and Economic Substance Report,
b. review the notification, report and supporting documents for correctness and ensure completeness,
c. assess if Exempted Licenses have submitted sufficient information
d. exercise any other powers of functions as required to implement the New Regulations
e. exercise any other powers or functions as may be required to implement any decision of the Competent Authority or the National Assessing Authority - The Ministry of Finance has been named as the Competent Authority responsible for exchange of information with Foreign Competent Authorities.
- The Federal Tax Authority (“FTA”) has been appointed as the National Assessing Authority and shall carry out the following functions:a. assess and determine whether a Licensee or Exempted Licensee has met the Economic Substance Test
b. impose administrative penalties as required
c. hear and decide on appeals
d. provide information to the Competent Authority
e. exercise any other powers or functions required to implement the New Regulations.
Economic Substance Test
A Licensee carrying out the Relevant Activity is required to comply with the “Economic Substance Test” and provide the required information to the Regulatory Authorities.
The Economic Substance Test in relation to the Relevant Activity carried out by the Licensee must satisfy the following criteria:
- the Licensee conducts the necessary Core Income Generating Activity (“CIGA”) in the State
- the Relevant Activity is directed and managed in the State
- with regard to the Level of Relevant Activity in the State the Licensee must ensure to employ adequate number of qualified full time employees resident in the State, incur adequate operating expenditure in the State and have adequate physical assets in the State
Where a Licensee has outsourced its CIGA to a third party in the State, the License shall be able to monitor and control this third party’s implementation of that activity.
When a Licensee carries out more than one Relevant Activity during a financial year, the Licensee will be required to demonstrate Economic Substance with regard to each Relevant Activity.
A Licensee is not required to meet the Economic Substance Test in a Financial Year in which it has no Relevant Income.
An Exempted Licensee is required to submit a Notification to their respective Regulatory Authority for each Relevant Financial Year.
A Licensee carrying out the activity of Holding Company has reduced Economic Substance requirements to be complied.
The FTA is subject to a 6 year limitation from the end of the relevant financial year to determine if the Licensee has met the Economic Substance Test. However, this limitation period of 6 years is not applicable if the FTA is not able to make determination during this period due to gross negligence, fraud or deliberate misrepresentation by the Licensee.
Reporting Requirements
A Licensee that is required to meet the Economic Substance Test shall no later than 12 months from the end of each Financial Year (commencing on or after 1 January 2019) prepare and submit to the Regulatory Authority an Economic Substance Report.
For financial years covered by the previous ESR regime, businesses were required to comply with the applicable Economic Substance reporting requirements. However, Economic Substance Notifications and Reports are no longer required for financial years ending after 31 December 2022.
Businesses should nevertheless retain relevant records relating to historical ESR periods and be prepared to respond to requests from the relevant authorities concerning previous financial years.
Economic Substance Notification & Report
The New Regulations state that the Notification should be submitted by the Licensee electronically within 6 months from the end of the financial year of the Licensee to the Regulatory Authority. Those Licensees who have already submitted the Notification would be required to re-submit the Notification.
The Economic Substance Report shall include the following information and documents with regard to the Licensee for the relevant Financial Year:
- the Type of relevant activity conducted
- the Amount and type of Relevant Income earned
- the Amount and type of operating expenses and assets in respect of the Relevant Activity
- the Location of the place of business, property, plant or equipment used for the Relevant Activity
- the Number of full time employees with qualification and number of personnel who are responsible for carrying out the Relevant Activity
- the Core Income Generating Activity in respect of the Relevant Activity
- the Financial Statements
- a Declaration as to whether or not the Licensee satisfies the Economic Substance Test
- in the case of Intellectual Property Business, a declaration as to whether or not it is a High Risk IP License
The Ministry of Finance is in the process of launching an Online Portal to facilitate the electronic filing of Economic Substance Notifications and Reports along with all other relevant information and documents.
These filing requirements relate to the previous ESR regime and should not be presented as current filing obligations for financial years ending after 31 December 2022.
Penalties
The New Regulations have increased the penalties and A Licensee may appeal to the National Assessing Authority against any fines imposed on it. Penalties include:
- A fine of AED 20,000 for failure to submit the Notification
- A fine of AED 50,000 for failure to submit Economic Substance Report and a Fine of AED 400,000 for repeating the violation.
- A fine of AED 50,000 for providing inaccurate information
While the ESR notification and reporting requirements have been cancelled for financial years ending after 31 December 2022, historical penalties and compliance matters may still need to be addressed. Businesses that conducted a Relevant Activity during an earlier ESR period should review their records and seek professional advice if they receive a request from the relevant authorities.
UAE Economic Substance Compliance
Although the UAE Economic Substance Regulations are no longer applicable to new financial years after 31 December 2022, businesses should ensure that any historical ESR obligations have been properly addressed. This may include reviewing previous Economic Substance Notifications and Reports, supporting documentation, Relevant Activities and any correspondence received from the Federal Tax Authority or other relevant authorities.
Businesses should also consider their wider UAE tax and regulatory obligations, including compliance with the UAE Corporate Tax regime, where applicable.
James Berry & Associates has experienced corporate lawyers in Dubai who can assist businesses with UAE corporate and commercial matters, including reviewing historical Economic Substance compliance issues and advising on related regulatory and tax matters.
For further information or advice, please contact our Corporate Department or email [email protected].
