Economic Substance Regulations (ESR) in the UAE: What it is and what it means for your business
Tax evasion is a serious offence on local and international levels that had to be controlled and regulated with new laws, in an international effort to combat this violation. As a part of the international community, the UAE had issued a law (Cabinet of Ministers Resolution No. 31 of 2019) in the same direction requiring all in-scope UAE entities to have demonstrable economic substance.
Tax is a compliance issue; in addition, it is a governance issue for the business community across the globe. Evasion of tax is an international threat for nation-states. International organisations see the fight against tax evasion as a roadmap to counter the elements which negatively affect the global economic sustainability. Profit shifting is a legitimate threat to tax compliance as it often operated through base erosion to tax-free jurisdiction.
Internationally, multiple factors need to be considered while placing any policy, including double taxation. Taxpayers ultimately explore for maximizing the profit without violating the statutory mandates. Therefore, it is upon the regulators to envisage the mechanism to prevent tax evasion through whatever the means. At any cost, the commercial wisdom shall not be restricted as it is fundamental to international trade and commerce.
Domestic rules for international taxation and internationally agreed standards are often undergoing serious changes to cop-up with the changing circumstances globally. International organisations play a crucial role in reviewing and developing the fairness and integrity of the tax system across the globe. OECD G20 inclusive framework on BEPS is one among that to promote, under which 130 countries are collaborating to put an end to the tax avoidance strategies that exploit the gaps and mismatches in tax rules.
The framework brought the 15 actions to equip the governments with domestic and international rules and instruments to address the tax avoidance, ensuring that the profits are taxed where economic activities generating the profits are performed and value is created.
The UAE has joined the BEPS Inclusive framework on 16 May 2018, through which the UAE is committed to implementing the minimum standards of BEPS packages and has become a BEPS associate. Economic Substance law is emanated from the commitment of the UAE towards BEPS inclusive framework.
On 30 April 2019, the UAE Cabinet of Ministers Resolution No.31 of 2019 (concerning economic substance regulations in the UAE) has been issued, requiring all in-scope UAE entities that carry relevant activity to have demonstrable economic substance from 30 April 2020. The Regulations apply to all UAE onshore and free zone companies that carry on a "Relevant Activity" (Banking, Insurance, Fund management, Lease-finance, Headquarters, Shipping, Holding company, Intellectual property (IP), Distribution and service centre).
Entities that are directly or indirectly owned by the UAE government (both federal and local) are specifically excluded from the Regulations. To satisfy the economic substance requirements in relation to a Relevant Activity, a Relevant Entity must:
Conduct the relevant "core income-generating activities" in the UAE.
Be "directed and managed" in the UAE and the level of activities performed in the UAE.
Have an adequate number of qualified full-time employees in the UAE.
Incur an adequate amount of operating expenditure in the UAE.
Have adequate physical assets in the UAE.
A Relevant Entity that only undertakes a Holding Company Business will be subject to less stringent economic substance requirements. Additional requirements apply if a Relevant Entity carries out "high-risk IP related activities".
The Regulations allow a company to outsource some or all of its activity to third-party service providers; however, these service providers must in their own right have adequate presence in the UAE, and the company must be able to demonstrate that it has adequate supervision of the outsourced activities. A Relevant Entity will be required to report certain information on its Relevant Activities on an annual basis to the relevant regulatory authority.
From the observatory view, it is a step ahead by the visionary leadership of emirates to prevent the exploitation of gap and mismatches in the tax rules. In addition, it would be a game-changer as UAE multinationals and businesses could be subject to additional compliance and reporting obligations. Businesses operating in the region need to revisit their operating and governance structure.
For more information or a more detailed conversation with regards to your business, please feel free to get in touch with us.