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Economic Substance Regulations (ESR)
Overview
Staying compliant with evolving UAE Corporate Compliance Regulations such as Economic Substance Regulations (ESR), Anti-Money Laundry (AML), and Ultimate Beneficial Owner (UBO) is crucial for businesses to align with international standards.
We will support you in navigating these dynamic requirements, ensuring seamless integration and understanding of their implications on your operations. With our expert guidance, you can stay ahead of regulatory changes, safeguarding your business from compliance risks while maximizing global opportunities.
What is Economic Substance Regulations (ESR)?
As part of the UAE’s commitment as a member of the OECD Inclusive Framework, and in response to an assessment of the UAE’s tax framework by the European Union Code of Conduct Group on Business Taxation, the UAE issued:
- 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.
The Regulations require UAE Mainland, Free Zone and Offshore companies and certain other business forms that carry out any of the defined “Relevant Activities” to maintain and demonstrate an adequate “Economic Presence” in the UAE relative to the activities they undertake (“Economic Substance Test”).
Economic Substance Report
During a Reportable Period, businesses that are not Exempted Licensees and generate Relevant Income from any of the following Relevant Activities must file/submit 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
What is Economic Substance?
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.
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.
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;
- it’s 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.
Entities subject to 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.
Businesses required to submit Economic Substance Report
All the entities holding a corporate license in 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. It 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.
ESR related requirements for headquarters business in the UAE
The UAE Ministry of Finance provided a non-exhaustive list containing matters the business entity 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 includes 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.
Economic Substance Notification filling
- Notification filling 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.
- Notification filling for the 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 parent company is performing Relevant Activities.
- Notification filling for an entity under liquidation.Licensed entities in the process of liquidation which may perform Relevant Activities in the year of liquidation must file their ES Notifications and Economic Substance Reports (if applicable) for the period up to liquidation.
Notifications and reports must be submitted annually
Economic Substance notifications and reports must be submitted annually. Notification to be filled by 30th June (depending on the financial year of the entity) of each calendar year.
Depending on the business activities mentioned in the Notification, if applicable (as per our review/advice) a Report must be submitted to the UAE Ministry of Finance (MoF) by 31st December of the same calendar year.
Deadline for submitting ES Notifications
The Notification must be submitted within six months from the Licensee’s financial year-end.
* Example, if the financial year of an entity has ended on 31 December 2022, the entity shall need to submit a ES Notification by no later than 30 June 2023.
Penalties for failure to submit Notifications
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 AED 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, the Licensee is subject to a penalty amounting to AED fifty thousand (AED 50,000).
What do we offer?
- 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 submitting the Report (if applicable), 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.
Corporate Compliance/Ultimate Beneficial Owner (UBO)
History of UBO
The UBO history can be traced back to efforts of multiple international organizations among which are the Financial Action Task Force (FATF) and the International Monetary Fund to address the misuse of corporate structures for illegal purposes and provide guidance to help countries identify, design and implement appropriate measures as well as assess and mitigate the money laundering and terrorist financing risks associated with foreign companies to which their countries are exposed.
FATF makes recommendations for combating financial crime, reviews members’ policies and procedures, and seeks to increase acceptance of anti-money laundering regulations across the globe. Because money launderers and others alter their techniques to avoid apprehension, the FATF must update its recommendations every few years.
Global economy expansion / UBO concerns
In the wake of the rapid expansion of the global economy and increased international trade, the proliferation of financial crimes such as money laundering has become a pressing concern for countries worldwide. To address this challenge, the concept of Ultimate Beneficial Ownership (UBO) has gained significant prominence in recent years.
UBO refers to the individual(s) who ultimately enjoy the benefits and exercise control over a legal entity, often operating behind a complex network of corporate structures across geographical borders. Recognizing the detrimental impact of illicit activities on their economies and societal well-being, countries have been increasingly adopting UBO regulations to enhance transparency and combat such illegal practices.
By focusing on identifying the true beneficiaries and controllers of legal entities, UBO measures aim to:
- Establish Accountability:identify the individuals who ultimately benefit from and control legal entities, ensuring accountability and preventing anonymity.
- Prevent Anonymous Transactions:UBO’s Regulations assist in detecting and investigating financial crimes, enhancing law enforcement efforts, and protecting national security.
- Promote Financial Integrity:by implementing UBO’s acts, countries demonstrate their commitment to international standards, strengthen their financial systems, and foster trust and confidence among investors and business partners.
- Ensure Joined Commitment:by embracing UBO acts, countries demonstrate their commitment to international standards and best practices, fortify their financial systems.
The global adoption of UBO’s Regulations reflects a collective determination to create a transparent and accountable financial environment, ensuring the sustainable growth and prosperity of nations in the face of evolving financial crimes.
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 v. 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.
Ultimate Beneficial Owner Regulations (UBO’s Regulations) in the UAE
The Ultimate Beneficial Owner Regulations are governed by UAE Cabinet Resolution No. (58) of 2020 (“Regulations”), establishes mandatory compliance requirements for relevant entities in the UAE 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, beneficial owners, 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.
As well, Companies’ Registrars must maintain updated Beneficial Owner Register to include details as to shareholders, partners, directors/nominee directors which 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 of 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).
Additional clarifications
Key obligations placed on entities and highlights the strict confidentiality measures implemented to protect the submitted data, as below.
Maintenance of registers
All relevant entities are required to maintain specific registers at their headquarters. These registers include detailed information on partners/shareholders, their ownership interests, and voting rights.
Entities must record data on actual beneficiaries, stating the reasons for their designation and the dates when they assumed this role. Updated information on directors and nominee directors should be documented.
It is essential for entities to store other essential documents and Ultimate Beneficial Owner (UBO) forms that have been submitted to the relevant regulatory authority.
Undertaking to create the registry
To ensure compliance with the Regulations, relevant entities must submit an undertaking to create and maintain the registry accurately. This provision allows establishments with complex structures to initiate the process of determining their Ultimate Beneficial Owners, securely store the relevant data in registers, and submit it to the appropriate regulatory authority.
Notification of changes
Any amendments or modifications to the initial information provided by the relevant entities must be promptly notified to the relevant authority within fifteen (15) days of the change.
Entities are required to appoint a person residing in the UAE as a point of contact. This individual will facilitate communication between the licensing authority and the entity, specifically regarding UBO data and other essential information requirements.
Data entry and updates
Relevant entities are responsible for entering the Ultimate Beneficial Owner data into the licensing authorities’ systems and keeping it up to date. Regular communication from the authorities should be carefully monitored to avoid penalties for non-compliance.
Penalties for non-compliance
UAE Cabinet Resolution No. (53) of 2021 Concerning the Administrative Penalties against Violators of The Provisions of the UAE Cabinet Resolution No. (58) of 2020 Concerning the Regulation of Beneficial Owner Procedures.
The UAE Ministry of Economy has announced significant penalties for entities that fail to comply with the regulations. These penalties aim to enforce adherence to the Ultimate Beneficial Owner Regulations, thereby ensuring transparency and accountability within the UAE’s business landscape.
Confidentiality measures
To address concerns regarding data privacy, the Ministry has assured entities that all submitted data will be treated with the utmost confidentiality. The information will not be accessible to any individual for commercial purposes, including employees of the entity itself. In the event of official investigation, specific official entities may have access to the data as required. Such access will strictly adhere to internal policies and regulations, emphasizing the importance of maintaining the confidentiality and integrity of the submitted information.
