- Overview
- Definition of Economic Substance?
- How does it affect “tax heavens”?
- What are the Economic Substance requirements?
- Which Entities are subject to the Substance Regulations?
- How is the information provided to the tax authorities?
- Which UAE businesses are required to submit an Economic Substance Report?
- What is a Relevant Activity?
- The Submission of the ESR Notification
- ESR Notification Filing – important clarifications
- Economic Substance Report and Notifications Have to be Submitted Annually
- Deadline for ESR Notification
- Penalties for Failure to provide a Notification
- Motei & Associates is in a position to offer you assistance in the below:
Whether you are an ambitious start-up, an individual entrepreneur investing in an existing business, or a foreign corporation establishing a formal presence in the UAE, clear and skilled advice will ensure that you are making the right business decision to reduce your risk and increase your chances of achieving a successful, well-managed business.
Drawing on our expertise of over two decades, our corporate team has gained comprehensive knowledge and developed the business acumen skills you need to guide you through selecting the most suitable legal form to set up your venture, whether as a mainland, free zone, offshore, or freelance.
We advise on the full spectrum of the UAE companies’ law and can efficiently contribute to the achievement of our clients’ goals and objectives and help them navigate the legal complexity and market challenges to successfully executing their business strategy.
Economic Substance Regulations (ESR)
- Economic Substance Regulations (Cabinet of Ministers Resolution No. 31 of 2019), (the “Regulations”) on 30 April 2019.
- Guidance on the application of the Regulations was issued on 11 September 2019 (Ministerial Decision No. 215 of 2019),
- and Cabinet Decision No. 58/2019 on the Determination of Regulatory Competencies lists the Regulatory Authorities tasked with the administration and enforcement of the Regulations.
- Amendments to the Regulations were made by Cabinet of Ministers Resolution No. (57) of 2020 on 10 August 2020, and updated Guidance was issued on 19 August 2020 (Ministerial Decision No. (100) of 2020.
Which UAE businesses are required to submit an Economic Substance Report?
During a Reportable Period, businesses that are not Exempted Licensees and who generate Relevant Income from any of the following Relevant Activities must file an Economic Substance Report:
- Banking Business
- Insurance Business
- Investment Fund Management Business
- Lease-Finance Business
- Headquartered Business
- Shipping Business
- Holding Company Business
- Intellectual Property Business
- Distribution and Service Centre Business
Definition of Economic Substance?
Economic substance refers to a transaction that has a purpose besides the reduction of tax liability. The concept is used in the examination of tax shelters to monitor if there is exploiting of the tax laws, and if such behavior is identified , to determine and prevent it from repeating.
Economic substance refers to the purpose and substance of a transaction or arrangement beyond merely reducing tax liabilities. It is a concept used to evaluate whether certain tax structures, often employed in offshore jurisdictions, are genuinely conducted for legitimate business reasons or if their primary intent is to exploit tax laws and avoid paying taxes.
Offshore jurisdictions are known for their favorable tax regimes and financial secrecy, making them attractive for individuals and businesses seeking to minimize their tax obligations. However, tax authorities, like Internal Revenue Service Departments, closely scrutinize these structures to determine if they meet the requirements of economic substance.
When tax authorities examine tax shelters or complex transactions, they evaluate whether these arrangements serve a legitimate business purpose and have genuine economic effects beyond mere tax savings. In essence, they assess whether the transaction involves actual economic activity and substance or if it is merely a superficial arrangement created to exploit tax loopholes.
By implementing economic substance, tax authorities aim to prevent tax evasion and ensure that tax planning is driven by genuine business considerations rather than solely by the desire to reduce tax liabilities.
This helps maintain the integrity of tax systems, promote fairness, and ensure that taxes are paid in accordance with the underlying economic activities and substance of transactions.
How does it affect "tax heavens"?
The BEPS Project aims to end the use of shell companies used to stash profits offshore or unduly claim tax treaty protection and neutralize all schemes that artificially shift profits offshore.
Though the BEPS Project is not about dictating whether countries should have a specific corporate income tax rate, it will have an impact on regimes that seek to attract foreign investors without requiring any economic substance.
What are the Economic Substance requirements?
An entity (other than a holding entity, and entities that conduct intellectual property business, for which there are different criteria) conducting a relevant activity will satisfy the economic substance requirements if:
- it is managed and directed in the jurisdiction;
- core income generating activities (CIGA) are undertaken in the jurisdiction in relation to the relevant activity;
- it maintains adequate physical premises in the jurisdiction;
- there are adequate employees in the jurisdiction with suitable qualifications;
- there is adequate expenditure incurred in the jurisdiction in relation to the relevant activity; and
- it files a confidential economic substance report each year with the applicable authority in its jurisdiction which will assist the authority in assessing compliance.
Which Entities are subject to the Substance Regulations?
The precise scope of the Substance Regulations varies to a certain degree from jurisdiction to jurisdiction, however the general guidance rule is that most non-domestic companies, LLCs and partnerships will fall within the definition of “Relevant Entity” for the purposes of the Substance Regulations.
How is the information provided to the tax authorities?
The master file and the local file will be delivered by MNEs directly to local tax administrations. Country-by-Country Reports should be filed in the jurisdiction of tax residence of the ultimate parent entity and shared between jurisdictions through automatic exchange of information, pursuant to government-to-government mechanisms such as the Multilateral Convention on Mutual Administrative Assistance in Tax Matters, bilateral tax treaties, or Tax Information Exchange Agreements (TIEAs). In limited circumstances, secondary mechanisms, including local filing can be used as a backup.
Which UAE businesses are required to submit an Economic Substance Report?
All the entities holding a trade for the UAE (particularly the free zone and offshore entities) must notify their concerned Regulatory Authorities regardless of whether they are carrying out the Relevant Activities within the UAE.
Aside from informing the Relevant Activities to the Regulatory Authority, providing the information with reference to the Licensee also serves as the primary purpose of the ESR Notification. Therefore, all the information provided in the ESR Notification is highly required in filing the Economic Substance Report for the same period.
The Economic Substance Regulations do not apply to all corporate entities in the UAE – rather, ESR applies to specific relevant entities that are carrying out relevant activities as per the Cabinet Resolution. Affected businesses are required to have sufficient number of employees, physical presence, expenditure, and performance of core income-generating activities within the UAE.
What is a Relevant Activity?
While all relevant entities will be required to make a filing setting out particulars relating to their business, an in-scope entity will only be required to meet the economic substance test if it carries on a “relevant activity”.
During a Reportable Period, businesses that are not Exempted Licensees and which generate Relevant Income from any of the following Relevant Activities must file an Economic Substance Report
- Banking Business
- Insurance Business
- Investment Fund Management Business
- Lease-Finance Business
- Headquartered Business
- Shipping Business
- Holding Company Business
- Intellectual Property Business
- Distribution and Service Centre Business
The importance of full compliance with the newly introduced substance regulations can’t be understated with the potential liability to acquire extensive penalties.
- ESR Related Requirements for Headquarters Businesses
The Ministry of Finance provided a non-exhaustive list containing matters licensees are to consider prior to the end of any financial period:
- Hold board meetings (a quorum must be reached for directors that are physically present in UAE)
- Make sure minutes of the board meeting are duly signed and kept on record in UAE
- Assess all relevant activities the entity has performed during a financial period with the approach of substance over form
- Assess type and amount of income earned from relevant activities during a financial period
- Identify the type and amount of expenditure and assets based in UAE including premises with respect to relevant activities
- Make sure access to assets incl. premises of the business can be demonstrated may it be through financial records and/or agreements
- Ensure supervision and control over outsourcing arrangements of the entity can be demonstrated through contractual agreements
- Determine the number of full time employees and other personnel that are based in UAE and responsible for carrying out relevant activities of the licensee
The Submission of the ESR Notification
An entity conducting more Relevant Activities is regarded as a “Licensee.”
The filing of the ESR Notification is a must for those entities carrying out the Relevant Activities within the UAE during the relevant Financial Year.
These entities include:
a. A Corporate Entity
- Limited Liability Company
- Public Joint Stock Company
- Private Joint Stock Company
- etc.
b. Partnership
- Limited Liability Partnership
- General Partnership
ESR Notification Filing – important clarifications
- ESR Notification Filing for an entity that carries out a relevant activity for part of the year An entity may carry out a Relevant Activity for part of the year. Nevertheless, the Licensee must notify the Regulatory Authority of all relevant activities performed during the financial year, regardless of whether those activities are conducted throughout the year.
- ESR Notification Filing for the UAE Parent Company with UAE Branches Parent companies and head offices in the UAE are responsible for notifying their Regulatory Authority about their Relevant Activities and the Relevant Activities of their UAE branches. Accordingly, there is no difference between whether or not the UAE parent company is performing Relevant Activities.
- ESR Notification Filing for a Multiple Licensee For the UAE parent company/head office, it is their obligation to notify their Regulatory Authority regarding their Relevant Activities as well as the Relevant Activities of their UAE branches. This is applicable regardless of if the UAE parent company/head office is carrying out their own Relevant Activities or not.
- ESR Notification Filing for a Licensee which is in the process of Liquidation Licensed entities in the process of liquidation which may perform relevant activities in the year of liquidation must file their ESR Notifications and Economic Substance Reports (if applicable) for the period up to liquidation.
Economic Substance Report and Notifications Have to be Submitted Annually
Companies and establishments that are involved in ‘relevant activities’ in the UAE are required to submit economic substance notifications and reports to the regulatory authority on an annual basis.
In the affirmative, they are required to submit an ESR Notification by 30 June of each calendar year. Depending on their business activities, the entity would need to file an ESR Report with the UAE Ministry of Finance (MoF) by the end of their financial year, or by 31 December the calendar year.
Deadline for ESR Notification
The Notification must be filed within six months from the Licensee’s financial year-end.
Penalties for Failure to provide a Notification
If a tax shelter or transaction is deemed to lack economic substance and is deemed abusive, it can be disallowed by tax authorities. This means that the tax benefits sought by the taxpayer are denied, and the individual or business may be subject to penalties, fines, or other consequences imposed by the relevant tax authority.
- If the Licensee or Exempted Licensee failed to submit the Notification before the deadline, the Licensee is subject to an administrative penalty of dirhams twenty thousand (AED 20,000).
- If the Licensee or Exempted Licensee provides inaccurate information to the Regulatory Authority or the National Assessing Authority and knows of the inaccuracy at the time the information is provided but fails to inform the authorities, as mentioned earlier means the Licensee or Exempted Licensee is subject to a penalty amounting to dirhams fifty thousand (AED 50,000).
Motei & Associates is in a position to offer you assistance in the below:
- Assessing whether the business activities conducted by the entity fall within any of the Relevant Activities and whether any exemption can be availed
- Assistance in filing the notification
- Assessing whether the Economic Substance Tests are met
- Advising on documentation to be maintained by the entity to support any future inquiries from the authorities
- Assistance in filing the official report, as well as any supporting documentation
- Identify gaps between existing substance and the level of substance required under ESR and advise on remedial measures
- Assistance in responding to inquiries from the regulatory authorities/FTA
ULTIMATE BENEFICIARY OWNER
Ultimate Beneficial Owner Regulations (UBO Regulations)
The Ultimate Beneficial Owner Regulations (the “UBO Regulations”) issued by UAE Cabinet Resolution No. (58) of 2020 are aiming to regulate Beneficial Owner Procedures.
All companies licensed and registered in the UAE – except those that are wholly owned by a local or federal government body, or those set up in the DIFC or ADGM financial free zones – are required to maintain registers with updated information and adequate records of its ultimate beneficial owners (UBOs), beneficial owners (BO’s), shareholders, and nominee directors.
Companies Registrars must maintain, at all times, updated UBO Register to include the following information for each UBO:
- Full name, nationality, and date and place of birth.
- Place of residence or notice address.
- Valid Passport or identification number, country, and date of issue and expiry.
- The basis on which the natural person is identified as a beneficiary.
- The date on which the person became a UBO, and if applicable, the date on which they ceased to be one.
The BO Register – identifying shareholders, partners, directors/nominee directors to be maintained by Registrars must include the following information for each partner or shareholder:
- The number and class of shares/equity held, and the voting rights attached.
- The date on which the shareholder/partner acquired the shares/equity.
- For shareholders/partners that are natural persons, the same information is required as for UBOs.
For shareholders/partners that are legal entities:
- Name, legal form, and memorandum/articles association.
- Address of main office or headquarters, and if the legal entity is foreign, the name and address of its legal representative in the UAE must be included.
- Names of the persons holding senior management positions (including their passport or identification number, country of issue, date of issue, expiry date).
Who is an Ultimate Beneficial Owner?
A UBO is a natural person that directly hold or control at least 25% of a company’s shares or has voting rights over a certain percentage of that company. Or indirectly via the control of another company, entity or structure that controls or has influence over that company’s business, and its strategic plans, decisions, transactions, and financials.
Ultimate Beneficial Owner Vs Beneficial Owner
Legally, an ownership can be classified into two; 1. Legal and 2. Beneficial ownership. A legal owner is a person who holds the legal title under their name. Alternatively, a beneficial owner is the person who enjoys the benefits of ownership even though the title is in another name.
In other words, a registered shareholder (person or company) is deemed as the legal owner of the shares registered under his/its name, but he/it may be holding such shares for the interest and benefit of a beneficial owner pursuant to a trust or nominee arrangement.
There can be multiple beneficial owners in one company, but the Ultimate Beneficial Owner (UBO) is often the natural person who ultimately owns and controls a company, hence, benefits the most from all beneficial owners, however, this person does not have to be known directly as the owner.
CORPORATE TAX
Insights
Floating Villa in Dubai – Court Upholds Buyer’s Rights in Refund
CASE OVERVIEW We filed the case before Real Estate Courts in Dubai requesting 1. Cancelation of the purchase agreements for failure to handover the villas
Dubai Court Upholds Tenant’s Right to Lease Renewal at Initial Rental Amount
The robust market conditions have led to tenants choosing to renew their current tenancy contracts to maintain previously agreed retail price and landlords looking to
Court Approved Seller’s Right to Terminate the Sales and Purchase Agreement and Retain the Buyer’s Deposit
In a landmark case, our Litigation Team successfully represented a seller in a real estate dispute, where both parties had mutually agreed upon the terms
EU Passes Landmark AML Legislation
This landmark legislation represents a critical step forward in the EU’s ongoing efforts to combat financial crime and ensure a safer economic environment for all
Floating Villa in Dubai – Court Upholds Buyer’s Rights in Refund
CASE OVERVIEW We filed the case before Real Estate Courts in Dubai requesting 1. Cancelation of the purchase agreements for failure to handover the villas
Navigating the Legal Landscape: Understanding UAE’s Laws on Bank Loan Default
In the dynamic economic environment of the United Arab Emirates (UAE), understanding the legalities of bank loan default is paramount for both lenders and borrowers.
Need Legal Advice?
enquire now
What clients say...
"Euismod quis viverra nibh cras pulvinar. Nulla malesuada pellentesque elit eget gravida cum sociis natoque Pellentesque habitant morbi tristique senectu"
Salvador Williams
"Pellentesque habitant morbi tristique senectus et netus et. Massa sapien faucibus et molestie. Sit amet facilisis magna etiam tempor"
Christina Phillips