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Economic substance Regulations

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In April 2019, the UAE government issued the economic substance regulations, later amended by cabinet resolution No. 57 of 2020 in August 2020. Simply put, it is a requirement set by the UAE for entities in the UAE to maintain a standard ‘economic presence’ in the UAE in relation to the activities they undertake.

This resolution was made to address the main concern of certain mobile businesses not contributing to the local economy and their profits being shifted to no-tax or nominal-tax jurisdictions. Meaning the economic presence of the company must be present in the local environment, or in this case, the UAE. This decision aligns with decisions made by other countries like the Cayman Islands, Bermuda, etc., and is part of the UAE’s policy to keep up with international standards of economic laws. This means that a business requires accounting services and advices to keep up with these regulations.

What kind of entities comes under the economic substance regulations (ESR)?

The ESR applies to UAE onshore and free zone companies that engage in specific Relevant Activities. These activities include banking, insurance, fund management, lease-finance, headquarters, shipping, holding company, intellectual property, and distribution and service center business.

Requirements that UAE entities need to meet

The entities that are generating income from relevant activity should perform the core income-generating activities in the UAE. Companies engaged in Relevant Activities are required to meet an Economic Substance Test to demonstrate that they have a substantial economic presence in the UAE. This evaluates whether the company carries out core income-generating activities in the country, has an adequate number of qualified employees, incurs adequate operating expenditure, and has appropriate physical assets in the UAE. Basically, the operations of the business should be based in UAE.

What are the relevant activities?

The relevant activities in which the economic substance regulations are applicable are

Banking Business
Insurance Business
Investment Fund Management Business
Lease – Finance Business
Headquarters Business
Shipping Business
Holding Company Business
Intellectual property Business (“IP”)
Distribution and Service Center Business

Reports to be made and when

Entities in the United Arab Emirates (UAE) that engage in a Relevant Activity are required to file an annual notification within six months of the end of their financial year. The notification should disclose whether they conducted a Relevant Activity during that financial year and whether any income from that activity was subject to taxation outside the UAE.

Even if an entity qualifies for an exemption from the Regulations or did not earn any income from their Relevant Activity during the financial period, they are still required to file a notification. This requirement ensures that all entities operating in the UAE are accounted for and that the relevant authorities have complete and accurate information about their activities.

If UAE entities engage in a Relevant Activity and generate income from it, they are required to file an annual economic substance report. This report serves to self-assess whether they have met the economic substance requirements. The report must include information about the Relevant Activity income earned, the number and qualifications of the staff involved, as well as details about the premises and other assets used in conducting the Relevant Activity.

The entities must comply with the regulations starting from the end of their financial year starting on or after 1st January 2019 and must produce the annual report. As for new entities, they must follow the regulations from the commencement of the financial year and submit the report with a due date 12 months after the financial year end.

Penalties involved

Non-compliance with the regulations could have severe consequences, including administrative penalties and the possibility of suspension, revocation, or non-renewal of the UAE entity's trade licence. Specifically, failure to comply may result in administrative penalties of AED 50,000 in the first year of non-compliance, which may increase to AED 400,000 in subsequent consecutive years, subject to a six-year limitation period. Therefore, it is imperative that UAE entities comply with the regulations to avoid such penalties and ensure the continuity of their business operations.

It is important to note that Economic Substance Regulation is a complicated area of law, and businesses should obtain professional guidance from legal and tax professionals to ensure compliance and to understand their individual requirements based on their business activities and circumstances. Alchemist Accounting can provide all-round services related to accounting and financial planning. Talk to our consultants by calling us at +971582660929.