Everything You Need to Know About Economic Substance Regulations (ESR) in the UAE
The companies in the UAE, except those in which the government holds a share, are required to demonstrate they have adequate economic substance in relation to the relevant activities they carry out within the UAE. As per the UAE Economic Substance Regulations (ESR), the mainland and free zone companies are required to
- Notify the regulatory authorities whether they are carrying out the relevant activities
- Undergo Economic Substance Test, if they carry relevant activities and
- Submit an annual Economic Substance Report to the Authority
The Background of the Economic Substance Regulations (ESR) in the UAE
The ESR has been introduced by the UAE government to show its commitment as a member of the Organization for Economic Co-operation and Development (OECD) and as a response to the review of the tax framework by the European Union (EU). As a result, the UAE introduced the ESR to comply with standards of combating base erosion and profit shifting. The ESR has been rolled out in the UAE on 30 April 2019, to ensure that the UAE companies are not used to attract profits that don’t correspond with the economic activity they carry out within the UAE.
Applicable Legislation for the UAE Economic Substance Regulations (ESR)
During the course of 2019, the UAE has introduced various Federal Legislation regarding the ESR. The UAE released the UAE Cabinet of Ministers Resolution No. 31 Of 2019 concerning the Economic Substance on 30 April 2019. Following this, a Cabinet Resolution No. 58 of 2019 was issued on 04 September 2019 determining the regulatory authorities concerned with the business mentioned in Cabinet Resolution No. 31 of 2019, a Ministerial Decision No. 215 for the year 2019 was issued on 11 September 2019 that provided guidance on Cabinet Decision No.31 of 2019 and a Cabinet Resolution No. 7 of 2020 amending some provisions of Cabinet Resolution No. 31 of 2019. All these legislation are applicable across the whole of the UAE including all the free zones and financial free zones such as the Dubai International Financial Centre (DIFC). To comply with the UAE Economic Substance Regulations (ESR) guidelines, all the free zones such as Jebel Ali Free Zone Authority (JAFZA), Dubai International Financial Centre (DIFC), Dubai Multi Commodities Center (DMCC), Sharjah International Airport Free Zone (SAIF Zone), Dubai Silicon Oasis Authority (DSOA), Ras Al Khaimah International Corporate Centre (RAK ICC) etc have introduced regulations & guidelines regarding the UAE Economic Substance.
The Three Important Stages of ESR Companies Undergo in the UAE
Ensuring compliance with the UAE Economic Substance Regulations, it has become mandatory for the onshore and free zone companies across the UAE. For this, the companies need to assess the impact of the regulations on their operations and ensure compliance with the ESR for their relevant activities before demonstrating the Economic Substance to the relevant regulatory authorities. The process of demonstrating the Economic Substance is conducted in three stages
1. UAE Economic Substance Notification
All the companies across the UAE are required to submit an ESR Notification to the concerned regulatory authority. The companies need to notify the authority whether they are carrying out the relevant economic activity in the UAE and having income form the same. For example, a company operating in the Jebel Ali Free Zone, Dubai needs to file the UAE Economic Substance Notification with the Jebel Ali Free Zone Authority (JAFZA), which is the regulatory authority. If the company is proven to be carrying out the relevant activity, then the UAE Economic Substance Regulations apply and it has to undergo Economic Substance Test in the UAE. The filing of UAE Economic Substance Notification should be carried out in compliance with the standards as specified by the regulatory authorities, as incorrect or false information in the notification would attract a fine, the companies are recommended to consult reputed ESR Notification filing service providers in Dubai, UAE to ensure compliance.
2. UAE Economic Substance Test
After filing the UAE Economic Substance Notification, the companies need to undergo the UAE Economic Substance Test to demonstrate adequate economic substance in the relevant activities they carry out within the country. During the Economic Substance Test, the companies in the UAE mainland, as well as the free zones, need to demonstrate the following:
- Conduct the Core Income-Generating Activity (CIGA) in the UAE;
- Be directed and managed in the UAE;
- Adequate full-time employees, operational expenditure and physical assets present in the UAE to conduct the CIGA
The failure to demonstrate sufficient economic substance in the UAE during the Economic Substance Test may attract hefty fines as well as other actions.
3. UAE Economic Substance Reporting
The companies need to submit the annual Economic Substance Report to the regulatory authority after demonstrating adequate economic substance in the Economic Substance Test. The UAE Economic Substance Reporting should include details related to the relevant economic activity, income, expenses, and assets and declaring whether the economic substance test is fulfilled. The annual Economic Substance report should be submitted within 12 months of the end of each financial year. The ESR report needs to be prepared to adhere to the required standards as it would have an impact on the operations of the company in the UAE and therefore the assistance of efficient ESR service providers in Dubai can be sought. The failure to demonstrate the economic substance test in the first year or for providing inaccurate information may incur a fine in the range of AED 10,000 to AED 50,000 For repeating the offence in the second consecutive year, a penalty in the range of AED 50,000 to 300,000 will be imposed. In addition to that, the UAE may exchange information about the company with the foreign authority of the parent company and the ultimate beneficial owner. Further, the commercial license could be suspended, withdrawn, or not renewed.
How to Determine if a Relevant Activity in Accordance with the ESR is Taking Place?
The UAE Economic Substance Regulations (ESR) Guideline has issued a list of relevant economic activities in which the companies are generating earnings in the UAE. To determine if a company is carrying out a relevant activity, a substance form approach should be followed. This means the companies need to look beyond the permitted activities in their trade license and focus on the actual activity being conducted in the UAE. The following is a list of relevant activities for the onshore and free zone companies as per the UAE Economic Substance Regulations (ESR) Guidelines:
- Investment fund management
- Leasing and finance
- Headquarter Business
- Intellectual property Business
- Holding company business
- Distribution and service centre
How the Economic Substance Regulations (ESR) Compliance Services of Jitendra Chartered Accountants Help the UAE Companies?
Ensuring the UAE Economic Substance Regulations (ESR) compliance has become an absolute necessity for the onshore and free zone companies in the UAE. Non-compliance with the ESR requirements would affect the operations of the company and it would cost the investors dearly. However, ensuring the ESR compliance at present is a tough task for the companies as it is a fairly complex procedure. It is in this situation that the companies would require the assistance of a reputed UAE ESR compliance services provider like Jitendra Chartered Accountants (JCA).
JCA offers the following core advisory & ESR compliance services in the UAE:
- Assessing whether the companies are subject to the Economic Substance Regulations
- File the annual Economic Substance Notification with the regulatory authorities
- Prepare and submit the Economic Substance Report to the authority annually
- Recommendations on the Economic Substance test if the company is not satisfying the same.
The assistance of the highly qualified JCA auditors in Dubai is significant for the companies as non-compliance and improper submission of the Economic Submission Notification and report would attract hefty penalties as mentioned in the article. Apart from the fines, the non-compliance may even lead to the revocation of the trade license. JCA is committed to ensuring that the companies can avoid such unforeseen events and ensure the smooth operation of the business in the UAE.