UAE was included by the European Union in list for lack of framework on tax frauds and tax evasion strategies. To combat this, recently, the UAE enacted the Cabinet Decision No. 31 / 2019 relating to the Economic Substance Regulations (the “Regulation”). The Regulation came into force on April 30, 2019.
The purpose of the Regulation is to ensure that certain entities carry on business activities which have economic substance in the UAE and that they are not set-up to take benefits of the tax loopholes.
This Regulation is applicable to mainland and free zone companies carrying out activities such as banking, insurance, investment fund management, lease finance, headquarters, shipping, holding companies, intellectual property, distribution and service centers (“Relevant Activity”). Companies directly/indirectly owned by the federal or state government are exempted from the Regulation.
Subject to the list of core income generating activities, entities carrying out Relevant Activity are required to comply with the economic substance regulation test and are also required to submit requisite information and documents to the authority. Significant penalties will be imposed on companies for non-compliance and the companies that are unable to meet the economic substance regulation test.
The Regulation is a welcome move towards governance. If exercised properly, this Regulation will not only help to curb fraud to a large extent but will also help in effective management and operations. The stringent punishment prescribed would also act as a deterrent for non-compliance.