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How Businesses will be tested for ‘Adequate’ Economic Substance in the UAE?

The UAE enacted Economic Substance Regulations (ESR) pursuant to the global standards set by the OECD Forum on Harmful Tax Practices (FHTP), which requires the companies that conduct relevant activities to have an adequate economic presence in the UAE. The UAE has also taken into account the EU Code of Conduct Group’s resolution for business taxation. In accordance with the ESR, the companies that carry out one or more relevant activities and derive an income from it must meet the Economic Substance Test in the UAE.

Also read: ESR Compliance: 5 Requirements for the UAE Economic Substance Test

The companies licensed by the mainland, free zone, and offshore authorities are required to meet the UAE Economic Substance Test if they conduct the relevant activities and earn an income from it. The relevant activities are Banking, Insurance, Investment Fund Management, Shipping Business, Lease-FinanceDistribution and Service Centre BusinessHeadquarters Business, Intellectual Property Business and Holding Company Business.

Meaning of ‘Adequate’ and ‘Appropriate’ as per Economic Substance Regulations

The companies that come within the scope of the ESR in the UAE and are required to demonstrate economic substance vary in size. Considering this limitation in size, the ESR doesn’t mandate the small and medium-sized businesses to employ more staff or incur more expenditure, provided the companies are conducting genuine business activity and carrying out the CIGA with the employees, expenditure, and premises it already has.

In short, the ‘adequate’ and ‘appropriate’ is dependent upon the level of the relevant activity and the licensee should maintain the records to demonstrate the adequacy and appropriateness of the resources and premises utilized and expenditure incurred.

What are the Key Requirements to Meet the Economic Substance Test in UAE?

1. The Licensee Needs to Undertake Core Income Generating Activities in the UAE

The primary and most important requirement for demonstrating the economic substance in the UAE is that a licensee needs to undertake Core Income Generating Activities (CIGAs) in the UAE. The licensee needs to demonstrate economic substance and file economic substance return in respect of the financial period in which it earned gross income from the respective relevant activities. The CIGAs are the activities that are of central significance to the licensee for generating gross income from the relevant activity. If the CIGAs involve making substantial decisions, then the majority of individuals who took part in the process should be physically present in the UAE.

2. The Licensee Should Be Directed and Managed in the UAE

The directed and managed test is conducted to ensure that the licensee has held and attended an adequate number of board meetings in the UAE. The number of board meetings required to meet the test is determined on the basis of the level of relevant activity carried by the licensee in the UAE. The regulatory authority mandates that the licensee should have held at least one board meeting in the relevant financial year. The directed and managed test also require the licensee to ensure that

(a) A written minute of the meetings is maintained in the UAE and the attendees should sign on it

(b) A quorum of the meetings should be met and the attendees should be physically present in the UAE

(c) The board directors should have the necessary knowledge and expertise to deliver their duties

3. Licensee Should Ensure Adequate Number of Employees

The third criteria in the Economic Substance Test require the licensee to employ an adequate number of full-time staff to carry out the relevant CIGAs in relation to the relevant activities. The full-time employees who are in charge of the CIGAs should be physically present in the UAE and must be qualified enough to carry out the activities. The staff can be either employed by the licensee or any other entity on temporary or long-term contracts.

4. Licensee Should Incur Adequate Operating Expenditure

The licensee needs to incur adequate operating expenditure by it in the UAE or have adequate expenditure by outsourcing to third-party service providers. However, these third party’s activities, employees, and expenditure and premises should be within the UAE and should be adequate for carrying out the Relevant Activity being outsourced.

5. Licensee Should Have Adequate Physical Assets

The Regulatory Authority would also test whether the licensee has adequate physical assets in the UAE to carry out the Relevant Activity in the UAE.

How Jitendra Chartered Accountants Can Help?

The companies that conduct the relevant activities in the UAE and generate gross income from it are required to meet the UAE Economic Substance Test. The regulatory authority will test if the company is directed and managed in the UAE, has adequate full-time employees, physical assets, and incur adequate and appropriate expenditure in the UAE.

Also read: How to submit the report for Economic Substance in the UAE

The Economic Substance Test helps the authorities and the government to ensure whether or not the companies are engaged in harmful tax practices and hence the entities need professional assistance in meeting the test. This is where a prominent ESR consultant like Jitendra Chartered Accountants (JCA) comes handy for the licensees. The JCA offers professional assistance in,

  1. Provide crucial inputs whether the companies can meet the Economic Substance Test
  2. Provide Recommendations to pass the Economic Substance Test
  3. Help to File ESR Returns

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