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Amendment in Economic Substance Law: What UAE Businesses Must Do?

The UAE ESR Law has once again gained traction in the public domain as the government has brought some significant amendments to certain clauses. The businesses now need to resubmit the ESR notification as there are notable changes in aspects of the law including the regulatory authority, certain relevant activities (High-risk IP, Distribution & Service Centre Business), the scope of the ESR, requirements concerning branches and government entities and penalties for non-compliance.

The amendments were introduced in Cabinet Resolution No. 57 of 2020 (the “amended ES Regulations”).  What companies now need to do is reassess their ESR compliance position in line with the new amendments and resubmit the UAE ESR notification. The assistance of reputed ESR consultants in Dubai, UAE is recommended for saving your company from the complexities of filing requirements and the consequences of non-compliance.

Key Changes in the UAE Economic Substance Law You Should Take A Note Of

The ESR took effect in the UAE to curb the harmful tax practices as per the standards laid out by the OECD Forum of Harmful Tax Practices. To comply with the ESR in the UAE, the companies (mainland, free zone & offshore) are required to demonstrate adequate economic presence in the UAE.  In pursuant to the requirements, the companies that conduct the relevant activities and generate an income from them have submitted the annual ESR notification to the relevant mainland and free zone authorities. Now, the businesses must prepare themselves for ensuring they are complying with the amended ESR law based on the following changes:

1. Resubmission of Annual ESR Notification

The updated ESR law requires the Licensees to send the annual notifications in electronic mode through the UAE MoF website portal. The ESR notification should be filed within six months of the financial year-end of your company. Many companies have already submitted the notification to the Ministry of Economy and the relevant free zone authorities (JAFZA, DAFZA, DIFC, RAKEZ, RAK ICC, etc.) before the law got amended. Such companies should now initiate actions to re-submit the notification on the MoF portal after it goes live.

2. A Big Change in Administration

The power of administration regarding the assessment of the ESR is now vested with the Federal Tax Authority. Being the National Assessing Authority for ESR in the UAE, the FTA will oversee the key responsibilities such as assessment, levying of administrative penalties, hearing and passing verdicts on appeals, exchange of information with the competent authority, and enforcement of the UAE Economic Substance Test compliance on the businesses.  The role of the regulatory authorities is restricted to receiving and verifying the information of the Licensees as well as assisting the FTA in its functioning as National Assessing Authority.

3. Change in the Definition of the Licensee

The newly amended ESR Regulations define a Licensee as

(a) Juridical Persons that are persons with separate legal personality

(b) Unincorporated partnerships that are engaged in relevant activity in the UAE

Other entities that come under the definition of natural persons, sole proprietors, trusts, and foundations no more come under the scope of the ESR in the UAE. Such entities no longer need to file the notification to meet the Economic Substance Test in the UAE.

4. Revised Treatment for the Branch Companies

The ESR law has revised its previous compliance requirements set put for the branches. The new guidelines are here:

a. UAE branch of a UAE business

The UAE parent firm is required to submit an annual ESR notification and file an annual ESR Return (if applicable) regarding its own relevant activities and that of all its UAE branches.

b. UAE branches of a Foreign Business

The UAE branch of a foreign business doesn’t come within the scope of the ESR provided its income is reported in the tax return of the foreign parent/head office.

c. A foreign branch of a UAE business

The UAE entities are not required to notify the relevant activities of its branches and demonstrate economic substance in the UAE. However, such companies should ensure that the foreign branch is subject to tax on its relevant income in the foreign jurisdiction.

5. New Amendment Exempts Certain Licensees

The amended ESR Law has granted the exempt status to certain entities which are,

  1. Entities that are tax residents outside the UAE
  2. Investment Funds
  3. Entities wholly owned by the UAE residents provided they are not part of any multinational group and only conduct the activities in the UAE
  4. The UAE branches of foreign parent company whose income is subject to tax in the jurisdiction of the foreign head office/parent firm

However, the ESR law still requires the exempt entities to file the annual UAE ESR notification and also submit documentary evidence to prove the exempt status. For filing the ESR notification, such entities can seek the assistance of the best ESR consultants in Dubai, UAE.

6. Definition of Certain Relevant Activities Changed

Significant changes have been brought to the definition of the following ESR Relevant Activities:

a. Distribution and Service Centre Business

In a sharp departure from the original law, the entities are not required to import goods and store them in the UAE to satisfy the definition of ‘Distribution and Service Business.’ Further, the entities don’t need to provide services in connection with a business outside the UAE resulting in any service provided to a foreign-related party being considered a “Distribution and Service Centre Business”. This means high-seas sales from a related party will fall under the definition of Distribution and Service Centre Business.

b. High-Risk IP Licensee

The requirement for an entity to be considered as a High-risk IP Licensee has been narrowed down to the following conditions:

  1. The entity is not responsible for the creation of the IP asset
  2. The Licensee acquired the asset from either a connected person or in consideration for funding research and development by another person located in a foreign jurisdiction.
  3. The entity has licensed or sold the IP asset to a connected person or generates separately identifiable income from a Foreign Connected Person through the exploitation or use of the IP asset.

Here you must note that the definition of the connected person has changed in the amended ESR Law. A connected person is an entity, which is part of the Group in which the Licensee or exempted Licensee is a part.  Also, the amended law defines the Group as “two or more entities related through ownership or control such that they are required to prepare consolidated financial statements for financial reporting purposes under the accounting standards applicable thereto”.

7. Rules Regarding Exchange of Information

The MoF will exchange the information about the Licensee with the foreign competent authority in case the Licensee is claiming for the exempt status on the basis of being a tax resident in the UAE or being a branch of a foreign company who is subject to tax outside the UAE.

8. Clarification Regarding Gross income, Board Meetings

The revised ESR law in the UAE defines gross income as the income earned from any sources from which it was generated without deducting any type of costs & expenditure.  Conducting an adequate number of board meetings in the UAE is a core requirement to meet the UAE ESR Test and the revised law says the board members are no longer needed to be a resident in the UAE.

However, the physical presence of the board members is mandatory when making strategic decisions related to the Core Income Generating Activities (CIGAs). Licensees are now allowed to outsource activities except CIGAs such as back-office functions, payroll, IT, legal services, or other expert professional advice or specialist services provided outside the UAE.

9. Amendments to ESR Administrative Penalties

If a licensee or an exempted licensee fails to file an ESR Notification, the FTA will impose a fine of AED 20,000 for non-compliance. The Licensees that submit inaccurate information will attract a penalty of AED 50,000. A penalty of AED 50,000 will be slapped on the entities failing to file ESR Return and also failing to meet the ESR test. If the Licensee fails to submit the ESR Return and meet the ESR test in the subsequent year a penalty of AED 400,000 will be imposed.

Ensure ESR Compliance with the Help of ESR Consultants in Dubai

The business community, in general, has welcomed the new amendments to the ESR Law in the UAE as it provides more clarity on the scope and application of the ESR requirements. The changes regarding the definition of Licensee, clarification on the treatment of branches and are expected to provide much relief to the companies with regard to the ESR requirements in the UAE.  Now, the companies are required to assess or reassess to see whether they are standing now in regard to the ESR compliance.

The companies need to check whether they are exempt or are subject to the ESR law in view of the redrawn definitions of relevant activities. If the new definition requires the companies to meet the ESR test they need to conduct an in-depth assessment immediately for which the assistance of reputed ESR consultants in Dubai will come in handy. Jitendra Chartered Accountants (JCA) is one of the prominent ESR consultants in Dubai providing efficient services related to ESR notification filing and ESR Return filing. JCA helps the companies in performing quantitative and qualitative assessments to check their position of compliance in view of the revised ESR Law.

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