ESR Implications for IP Businesses and Corporate Franchise Agreements in the UAE
It is common for investors to form Intellectual Property Holding Companies (IPHCs) Or Special Purpose Vehicle Companies (SPVs) or sign a corporate licensing (franchisee) agreement with other companies to use their IP assets and make an income. However, such SPVs/IPHCs have to meet the requirements of Economic Substance Regulations (ESR) and show their presence including adequate staff and adequate office and presence of the directors in the state to avoid the penalties. Businesses forming IPHCs and entering licensing agreements with foreign companies for IP use are regarded as high-risk IPs as per ESR.
Since high-risk IPs are regarded as failing the economic substance test by default, such companies would be required to meet increased ESR requirements. Let’s have a look at the red flags high-risk IP businesses should be aware of before deciding to start operations in the UAE. Consult with top ESR consultants in the UAE to successfully meet the ESR requirements. Read on.
How Does a Business Become High-Risk IP Licensee as per ESR?
The definition of a High-risk IP business is based on the following conditions:
- The business did not create the intellectual property asset
- The business acquired the intellectual property asset from either:
from a connected person; or
In consideration for funding research and development by another person situated in a foreign jurisdiction; and
The business licenses or has sold the intellectual property asset to a Connected Person or earns separately identifiable income from a foreign connected person in respect of the use or exploitation of the Intellectual Property asset
The Case of IP Holding Companies
Investors form an IPHC by isolating their IP assets in a wholly-owned subsidiary. The IP assets can be trademarks, copyrights, patents, technical know-how or any other such intangible assets. The IPHC licenses the IP assets to its parent companies. Here it is important to note that such parent or sister companies carry out the main business of the enterprise.
The parent companies or other affiliates will be operating in a jurisdiction where the state imposes taxes on the entities. However, the IPHCs are established in zero or low-tax jurisdictions such as the UAE (the only tax here is VAT at a nominal 5%). The parent companies pay a royalty to the IPHCs and obtain state tax deductions on the amount paid, thereby reducing the state corporate tax liability.
In short, an IPHC is used to siphon profits from high-tax jurisdictions to low-tax jurisdictions such as the UAE. This complex nature of the legal structure allows the authorities to accuse the IPHCs of lacking adequate economic substance in the UAE or any tax-free states they are based. This makes the IPHCs be considered as a legal structure that enables tax evasion and hence requires to demonstrate adequate economic substance in the UAE.
How Does IPHCs become a High Risk?
The IPHC didn’t create the IP asset but acquired it from a foreign connected person (like the parent company). IPHCs earn a separately identifiable income (e.g., royalty) from a foreign connected person (parent and/or sister company) in respect of the use or exploitation of the Intellectual Property asset. The best ESR consultants in the UAE can help the IPHCs in implementing measures to demonstrate adequate economic substance.
ESR for Corporate Franchise Agreements
If a company owns a brand and licenses the brand’s rights to others in return for a royalty, it would come within the scope of ESR. In another case, consider a software company named ABC Co that develops a unique IT software platform for accepting, processing and tracking online orders that it holds and uses within its own business of online marketing. ABC also licenses the IP software platform to others to use within their online marketing businesses. The users pay the company a license fee in order to use the IT software platform. ABC Co then falls is within the scope of ESR.
UAE businesses that hold some form of Intellectual Property Asset but do not earn separately identifiable income from such assets don’t come under the scope of ESR. In such cases, the IP assets contribute to or protect the value of, the good or services these UAE businesses provide. Owning such an IP Asset would not be considered as carrying on an IP Business as the IP Asset is merely auxiliary to the main business of the UAE company.
What should IP Business Do to Meet ESR Requirements?
IP companies incorporated in the UAE with the sole purpose of getting tax reductions are regarded as lacking adequate economic substance. High-risk IP companies by default are considered to have failed the Economic Substance Test in the UAE and their information will be exchanged with the foreign competent authority.
IP businesses are required to submit the following information,
Business plan showing the reasons for holding the ownership in the IP Asset in the UAE;
Employee information, including the level of experience, type of contracts, qualifications, duration of employment
However, the high-risk IP businesses need to prove that there is more than local staff passively holding intangible assets whose creation and exploitation is a function of decisions made and activities performed outside of the jurisdiction. The businesses need to provide evidence that decision-making is taking place in the UAE. This means periodic decisions made by non-resident directors or board members won’t be enough.
Consult with ESR Consultants in the UAE
Investors earning royalties from IPHC or earning income from franchise or IP licensing agreements must demonstrate adequate economic substance in the UAE. Such companies are high-risk and must face increased ESR requirements in the UAE. This also affects new investors planning to form IP businesses or franchises in the UAE. In such a complex environment, it is better to consult with the best ESR consultants in the UAE such as Jitendra Chartered Accountants (JCA).
JCA has highly qualified auditors and business setup consultants who possess sound knowledge of the ESR rules. JCA assists the companies in complying with the UAE ESR requirements and helps them avoid fines and other actions. JCA offers the following specific ESR services in the UAE,
- Assist the companies in assessing whether they can meet the UAE Economic Substance Test
- Suggest Recommendations if the companies fail to meet the ESR test
- Help the companies to file the annual ESR Notification and ES Return