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Posted on Apr 07, 2021

To push its agenda of creating a OECD Inclusive framework in response to an assessment of the UAE’s tax framework by the European Union Code of Conduct Group on Business Taxation, the United Arab Emirates came up with and issued Economic Substance Regulation or ESR in Cabinet of Ministers Resolutions No. 31 of 2019. The guidelines for the application of regulations were issued on 11th September 2019. Later that year, a list of Regulatory competencies was made and the regulatory authorities were given the task to  enforce these regulations.

Get ESR Services in Dubai if you Conduct these relevant activities

As per those regulations, on shore and free shore companies active in UAE are required to demonstrate an adequate economic presence pertaining to the relevant activities as given below:

  1. Banking Business
  2. Insurance Business
  3. Investment Business
  4. Investment Fund Management Business
  5. Lease- Finance Business
  6. Shipping Business
  7. Holding Companies Business
  8. Intellectual property business
  9. Distribution and Service centre business

The above mentioned regulations became applicable from the financial year starting with January 2019. Entities that are within the scope of those regulations are required to submit an Annual notification form to the Regulatory authority. Within 12 months of submitting the notification form, they are also required to submit an Economic Substance Report.

In case the entity is beyond the scope of the ESR regulations or it has not earned income from a relevant activity as mentioned in the list above, that entity isn’t required to file the Economic Substance Report. However, that doesn’t exempt the aforementioned entity from filing the annual notification form.

In case the entities don’t comply to the regulations, they can face penalties that:

  1.  Suspension of trade license
  2. Revocation of trade license
  3. Non-renewal of trade license

Let’s now discuss some of the major questions associated with ESR – Economic Substance Regulations.

Who is enforcing the Economic Substance Regulations?

The responsibility of enforcing the ESR falls upon the shoulders of the “Regulatory Authorities”. As per the Article 4 of Economic Substance Regulations, these regulatory authorities are divided into two categories:  

  1. Federal Authorities: They are the primary overseers consisting of organizations listed below:
    1. Ministry of Economy
    2. Central Bank
    3. Insurance Authority
    4. Security and Commodities Authority
  2. Free Zones: Different overseeing regulatory authorities are given to different free zones. For Abu Dhabi, the regulatory authorities are:
    1. Abu Dhabi Global Market
    2. Media Zone Authority Dhabi
    3. Abu Dhabi Airports Free Zone
    4. Abu Dhabi Ports
    5. MASDAR City

For Dubai, the regulatory authorities are:

  • Dubai Airport Free Zone
  • Dubai Healthcare City Authority
  • Dubai International Financial Center
  • Meydan
  • Dubai South / Dubai Aviation City 
  • Jebel Ali Free Zone Authority/ DP World
  • Dubai World Trade Center
  • International Humanitarian City​
  • Dubai Development Authority
  • Dubai Silicon Oasis
  • Dubai Maritime City
  • Dubai Multi Commodities Centre

For Sharjah, following are the regulatory authorities:

  • Sharjah Airport International Free Zone Authority
  • Hamriyah Free Zone Authority
  • Sharjah Media City (Shams)
  • Sharjah Publishing City
  • Sharjah Research Technology and Innovation Park
  • Sharjah Healthcare City  

For Ajman, following are the regulatory authorities:

  • Ajman Free Zone Authority
    Ajman Media Free Zone Authority

For Ras Al-Khaimah, following are the regulatory authorities:

  • RAK International Corporate Centre
  • Ras Al Khaimah Economic Zone
  • RAK Maritime City 

For Um  Al-Quwain, following are the regulatory authorities:

  • UAQ Free Trade Zone

For Fujairah, following are the regulatory authorities:

  • Fujairah Free Zone
  • International Free Zone Authority 
  • Fujairah Creative City

What are the responsibilities bestowed upon the Regulatory Authorities?

As the regulatory authorities are responsible for enforcing the Economic Substance Regulations, following are the duties they have to abide by:

  1. Notifying and reporting entities coming under the scope of ESR with information about the regulations.
  2. Identification of all the requires licenses within the regulation.
  3. Analyzing the validity of the information received from the entities.
  4. Discerning whether an entity qualifies from being exempted from complying to the Economic Substance Regulation.
  5. Sharing the information with the UAE Federal Tax Authority and the UAE Ministry of Finance.

On which licensees the regulations are applicable on?

A licensee is referred to as a Juridical person or an incorporated business entity in the United Arab Emirates undertaking a relevant activities. A licensee can be:

  1. An LLC or Limited Liability Company
  2. A private Shareholding Company
  3. A public Shareholding Company
  4. A joint venture Company
  5. A partnership

What are the administrative requirements of the licensees who come under the scope of ESR?

The administrative requirements that licensees who come under ESR’s scope are as follows:

  1. Licensees must file an Annual Notification 6 months before the end of the relevant financial year.
  2. Licensees who have acquired income from their relevant activities are required to file an Economic Substance Report.

What does the licensee demonstrate by filing the Economic Substance Report?

Each Economic Substance Report or ESR that the licensee files has to meet the Economic Substance Test. As per the test criteria, the licensee is required to demonstrate the following through the report:

  1. That the licensee and the relevant activities are being directed and managed in the United Arab Emirates.
  2. That the Core Income Generating Activities (CIGA) that licensee partakes in are conducted in the UAE.
  3. That the licensee has an adequate premise, people and expenditure in UAE.

Which entities are exempt from regulations?

As we have hinted during the introduction of this article, there are certain circumstances under which an entity is exempted from being under the scope of Economic Substance Regulations. Following is the list of those circumstances:

  1. In case the entity is a tax paying resident of United Arab Emirates.
  2. In case the entity is running an investment fund and it’s SPVs/ Investment Holding Entities.
  3. If the entity is UAE resident owned business that’s not associated with a multinational group and only conducts business within the UAE.
  4. If the entity is a branch of a foreign business entity whose income through relevant activity is subject to tax laws in foreign jurisdiction.
  5. In case the licensee didn’t earn any income through relevant activities, it fails to meet the requirements of the Economic Substance Test. In that case, that entity is also exempted from filing the annual notification and the Economic Substance Report of that relevant financial period.

Conclusion

ESR came into existence to make the UAE’s industrial infrastructure become more inclusive to the OECD norms. By asking the entities that fall within the scope of regulations to have an adequate presence in the UAE, it has taken the first step to create better business policies in the free zones – both onshore and offshore.