All About Economic Substance Regulations in UAE

UAE Economic Substance Regulations (ESR) is one of the initiatives introduced by the UAE in response to the requirements of OECD. The Economic Substance Regulations was introduced in UAE to honour the commitment of the country as a member of the OECD Inclusive Framework on Profit Shifting (BEPS) and Base Erosion in regards to a study of the Europen Union's UAE tax framework. The review resulted in the inclusion of UAE on the EU list of non-cooperative jurisdictions for tax purposes (EU Blacklist). Two resolutions were passed on ESR on 30th April 2019 and 11th September 2019; the issuance of the UAE Economic Substance Regulations on 30 April 2019, and the statement of instruction of the application of the Regulations on 11 September 2019, for the deletion of UAE from the EU Blacklist on 10 October 2019. Being the member of the OECD (Organisation for Economic Co-operation and Development) inclusive framework on BEPS (Base erosion and profit shifting) UAE is required to meet at the least a minimum number of action plans. The UAE Economic Substance Regulations make sure that UAE entities that engage in certain activities are not done to artificially draw profits that are not corresponding with the economic activity undertaken in the UAE. The regulation requires all the companies registered in the UAE conducting the relevant activities, to submit a simple notification to the concerned regulatory authority within the deadlines specified. The simple notification should state the below mentioned:

• The financial year-end of Licensee 
• The Relevant Activity of the Licensee
• If any income earned from the relevant activity
• If the income earned from the relevant activity is totally or partially subject to tax outside the UAE

There are administrative penalties ranging from AED 10,000 to AED 300,000 depending on the violations specified in the Cabinet Resolution No. 31 of 2019 Economic Substance Regulation. Licensees that are at the least directly or indirectly 51% owned by the Federal or an Emirate Government, or a UAE Government body or authority, are exempt from the Regulations.

Highlights of UAE Economic Substance Regulations

Economic Substance Regulations in UAE applies to the financial years from 01 January 2019.

For example, if a company’s financial year is 01st January 2019 to 31st December 2020; the assessable period would be 1st April 2019 to 31st March 2020. Likewise, if the financial year is 01st April 2019 to 31st March 2020; the assessable period would be 01st April 2019 to 31st March 2020

Relevant Activities include:

• 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 Centre Business​

For each financial period in which the Licensee earns income from the Relevant Activity, it will need to meet the Economic Substance Test:

• Assess the relevant activity performed during the financial period (substance over form approach – to look beyond the commercial license)
• Assess the income earned from the relevant activity during the financial period
• Hold board meetings as well as ensure the minutes are signed and maintained.
• Identify the number of full-time employees and their qualifications in performing the relevant activity.
• Identify the related expenses and premises (through agreements/documents)
• In the case of outsourcing arrangements, control and supervision by Licensee should be validated through the contractual agreements.

If a Licensee undertakes the relevant activity during the financial period but does not earn income; the licensee would only need to submit a notification to its Regulatory Authority and not required to file Economic Substance Return.

A Licensee should ensure to maintain appropriate and adequate records of all the utilized resources and incurred expenditures. Any relevant information that evidences the Licensee’s compliance with the ESR must be maintained for a period of 6 years.

Regulatory Authorities

The Regulatory Authorities are accountable for identifying possible licensees, r monitoring compliance with the notification, verifying information submitted, reporting obligations under Regulations, deciding whether an entity fulfils the requirements to be considered as exempt and sharing information with the FTA and the UAE Ministry of Finance. The regulatory authorities include the Ministry of Economy, Security and Commodities Authority, Central Bank of the UAE, Insurance Authority, Dubai World Trade Centre, DAFZ, DMCC, RAKEZ, SAIF Zone, DIFC, JAFZA, UAQ, AFZA, and several others. 

Economic Substance Test

• Assess the relevant activity performed during the financial period (substance over form approach – to look beyond the commercial license)
• Assess the income earned from the relevant activity during the financial period
• Hold board meetings as well as ensure the minutes are signed and maintained.
• Identify the number of full-time employees and their qualifications in performing the relevant activity.
• Identify the related expenses and premises (through agreements/documents)

In the case of outsourcing arrangements, control and supervision by Licensee should be validated through the contractual agreements

Why is ESR important to Companies Conducting “Relevant Activities”?

ESR helps to comply with specific requirements of the entities incorporated in the UAE to demonstrate that the companies are carrying out the actual economic activity in the State.

The implementation of the ESR in UAE should further strengthen and benefit the companies in the UAE in assisting reputational concerns. It helps to maintain good governance standards such as:

• Fair tax regimes: It prevents the companies from earning profits without real economic activities 
• BEPS implementation: Base Erosion and profits haring jurisdictions help the companies in tax planning, Value creation and to minimize gaps
• Ensures Transparency: Complying with international standards and multilateral conventions urges accuracy and fair view of financial information.

Overview of Free zones

As per UAE Law, free zones are called Designated zones. The following conditions meet up the definition for designated zones as per the criteria of Article 51 of the Executive Regulations:

• It is a specific fenced geographic area; and
• It has security measures and Customs controls in place to monitor the entry and exit of individuals and movement of goods to and from the area; and
• It has internal procedures regarding the method of keeping, storing and processing of goods within the area; and
• The operator of the Designated Zone must comply with the procedures set out by the Federal Tax Authority.

Therefore, any Free zone which fulfils the above conditions and is in the list of the cabinet will be treated and considered as Designated zones.

Free zones in the light of ESR

Free Zone, denotes free trade areas which promote foreign enterprise ownership. The businesses in Free Zones must comply with the rules and regulations of the free zone authority for conducting any business in this region. To abide by the UAE Economic Substance Regulations (ESR) recommendations, all the free zones such as Dubai International Financial Centre (DIFC), Sharjah International Airport Free Zone (SAIF Zone), Dubai Multi Commodities Center (DMCC), Ras Al Khaimah International Corporate Centre (RAK ICC), etc have introduced regulations involving the UAE Economic Substance.

Dubai International Financial Centre (DIFC) free zone

Dubai International Financial Centre is a global financial hub for the Middle East, Africa and South Asia (MEASA). It develops the diverse pool of industry talent in the region. It offers venture capital environments including cost-effective licensing solutions and funding for growth-stage start-ups. 

The key points are:

• All DIFC entities are required to submit an economic substance notification by 12 June 2020 in the DIFC Client Portal
• Follow the guidance mentioned in the relevant activities guide.
• File an economic substance return within 12 months of your financial year-end, to demonstrate that your business meets the ESR requirements. 

The exempted parties are:

• DIFC Licensees that are directly or indirectly owned 51% or more by the UAE government 
• DIFC Licensees that carry out a Relevant Activity but do not earn income from it

A DIFC Licensee (aside from those carrying out a “Holding Company” Business and those carrying

out a “High-Risk IP” Business) need to demonstrate all 3 of the following conditions:

1. Adequate employees, physical assets & expenditure in the UAE
2. Core Income Generating Activities (“CIGAs”) are undertaken in the UAE
3. Directed and managed in the UAE

Abu Dhabi Global Markets (ADGM) free zone

Abu Dhabi Global Market or ADGM free zone was opened for business on 21 October 2015. It acts as a global hub for business and finance.  ADGM free zone links between the growing economies of the Middle East, Africa and South Asia and the rest of the world. ADGM’s functioning strategy includes private banking, asset management and financial innovation. They are committed to their role in promoting financial integrity and stability. They provide:

• 100% foreign ownership with ease in the business set up
• 0% personal and corporate tax
• Unlimited repatriation of capital and No restrictions on employment
• State-of-the-art infrastructure and Grade A office space

In ADGM, ESR regulations are applied to Licensed Persons such as partnerships, foundations or branches of foreign companies that:

• Are located in ADGM,
• Earn income from one or more relevant activities, and
• Whose financial year commences on or after 1 January 2019.

ADGM Licensed Persons conducting Relevant Activities are required to notify the Registration Authority of the following annually the “Annual Notification Requirement”:

• Whether or not the Licensee is carrying on a Relevant Activity.
• If the Licensee is carrying on a Relevant Activity, whether or not all or any part of the Licensee’s gross income in relation to the Relevant Activity is subject to tax in a jurisdiction outside the UAE.
• The date of the end of Licensee’s Financial Year (Accounting Reference Period).

For ADGM Licensed Persons with a 31 December 2019 Financial Year the Annual Notification is due by 30 June 2020.ADGM Licensed Persons that are not exempt and undertake a Relevant Activity are required to:

• Meet economic substance requirements.
• File an Economic Substance Return.

RAS AL Khaimah Economic Zone

RAKEZ offers a cost-effective and world-class economic zone with customised packages and services as well as state-of-the-art facilities. It provides Free zone and non-free zone entity formation with:

• 100% ownership, industrial facilities and value-added services
• Connectivity to major logistical hubs and multi-lane superhighways
• Accessibility via an international spread of regional offices
• Easy access to markets across the MENA region, as well as Europe and Asia
• Close proximity to RAK and Dubai International Airports

The Important aspect to note is that it is mandatory to file the Economic Substance Return. Entities need to file the notification on the Portal on or before 30th June 2020. On the following conditions:

• Are registered in RAS AL Khaimah Economic Zone
• Earn income from one or more relevant activities
• Whose financial year commences on or after 1 January 2019. 

Dubai Airport Free Zone (DAFZA)

Dubai Airport Free Zone acts as a dynamic trading zone in the economy. Since the proximity to the world's busiest international airport, DAFZA acts as a link for the Middle East, Europe, the Indian Subcontinent and the Far East. DAFZA is now home to a large number of companies which are business-focused. DAFZA has issued the regulations to file an Economic Substance Notification which is now available on its client portal within the deadline 31 May 2020. The Notification must be submitted from DAFZAs online customer portal. If a Licensee conducts a Relevant Activity or not but does not generate any income then he will be exempt. 

For Economic Substance Test a DAFZA Licensee need to demonstrate all 3 of the following conditions:

1. Adequate employees, physical assets & expenditure in the UAE
2. Core Income Generating Activities (“CIGAs”) are undertaken in the UAE
3. Directed and managed in the UAE

DAFZA Licensees that undertake a Relevant Activity during the year 31 December 2019 must submit the Return by 31 December 2020 i.e. The 12 months after the financial year-end

Ajman Free Zone

Ajman Free Zone is one of the oldest free zones within the UAE. It’s situated in the Emirate of Ajman and adjacent to a seaport and welcomes any businesses. Ajman Free Zone company setup is attractive to start-ups because of its cost-effectiveness. Advantages are:

• Investors have 100% ownership and return on profit.
• Personal income tax exemption and Corporate tax exemption.
• Economical lease rents.
• Inexpensive prices of power and electricity.
• Zero duty tax on import and exports

For AFZ Licensed Persons with a 31 December 2019 Financial Year the Annual Notification is due by 30 June 2020.AFZ Licensed Persons that are not exempt and undertake a Relevant Activity are required to:

• Meet economic substance requirements.
• File an Economic Substance Return.

Dubai Silicon Oasis (DSO) Free zone

DSO provides a hi-tech eco-system to promote technological collaboration and innovation with the trade.it offers the latest infrastructure, in house business services along with residential properties. It provides

• 100% Ownership and capital repatriation.
• 0% corporate or personal Tax.
• No Import/Export Tax.
• Low cost of business operation.
• Law and Intellectual property support.
• On-site IT support.

All DOS entities are required to submit an economic substance notification by 31 March 2020 in the DOS Client Portal

• Follow the guidance mentioned in the relevant activities guide.
• File an economic substance return within 12 months of your financial year-end, to demonstrate that your business meets the ESR requirements. 

Dubai Multi Commodities Centre (DMCC)

The Dubai Multi Commodities Centre (DMCC) was established in 2002 and is located in a lake-front development called Jumeirah Lakes Towers within the Logistic Corridor. Its advantages are:

• 100% foreign business ownership and Full capital repatriation
• Zero taxes and duties
• No public disclosure of information
• Variety of freehold, commercial and residential property for sale or lease at competitive rates\ Legalisation of company documents is not required when used within the UAE
• Flexible office solutions such as Flexi desks and
• Service desks/offices

DMCC Licensed Persons conducting Relevant Activities are required to notify the Registration Authority within the deadline 30 June 2020, of the following annually the “Annual Notification Requirement”:

• Whether or not the Licensee is carrying on a Relevant Activity.
• If the Licensee is carrying on a Relevant Activity, whether or not all or any part of the Licensee’s gross income in relation to the Relevant Activity is subject to tax in a jurisdiction outside the UAE.
• The date of the end of Licensee’s Financial Year (Accounting Reference Period).

Hamriyah Free Zone Authority (HFZA)

Hamriyah Free Zone is ensuring flexible and dynamic management besides being an investor oriented free zone. It offers industrial, commercial, and service licenses. Providing competitive incentives and unique opportunities for start-ups in a tax-free environment. 

• 100% Foreign company ownership is allowed
• 100% Import and Export tax exemption, Repatriation of capital and profits allowed
• 25year leases available, renewable for a further 25 years
• No corporate profits tax No personal income tax
• Strategic location to access global markets and Access to the UAE and GCC markets
• Attractive investment incentives along with abundant and inexpensive energy
• Developed infrastructure, Land for lease for investor development
• Purpose-built office accommodation, warehousing and factory units
• Low labour costs

All HFZA entities are required to submit an economic substance notification by 30 June 2020 in the HFZA Client Portal

• Follow the guidance mentioned in the relevant activities guide.
• File an economic substance return within 12 months of your financial year-end, to demonstrate that your business meets the ESR requirements. 

Sharjah Airport International Free Zone (SAIF Zone)

Sharjah Airport International Free Zone provides versatile incentive services accommodating every business scenario. As one of the most dynamic Emirates in the UAE, Sharjah accounts for over a third of the country’s industrial activity. It offers an unlimited workforce to support businesses. Along with the facilities like Warehouses and Storage areas, Container parking and Bunkers and labour housing are at the lowest costs and highest quality. Other Advantages are:

• 100% repatriation of capital and profits
• 100% foreign ownership
• 100% free transfer of funds
• Abundant and low-cost supply of energy
• No currency restrictions100% exemption on imports g24-hour licensing services
• Cheaper lease rents, Low-cost labour and warehouse facility 
• Easy access to big ports and Sharjah International Airport

For SAIF Zone Licensed Persons with a 31 December 2019 Financial Year the Annual Notification is due by 30 June 2020.SAIF zone Licensed Persons that are not exempt and undertake a Relevant Activity are required to:

• Meet economic substance requirements.
• File an Economic Substance Return.

How CDA helps you?

CDA Accounting and Bookkeeping Services LLC offers specialised accounting services that meet the financial needs of any business in the international market. We safeguard the company’s interests by complying with the Economic substance Regulations and are steadfast to keep the uppermost level of professional canons and excellence.

We offer the following services to comply with UAE Economic Substance Regulations:

• We conduct a systematic study on the business activities and provide guidance in complying with ESR
• Compliance tests and economic substances tests are done to check the adherence with the regulations
• Provide supervision on the contractual agreements whether ESR laws are included or not
• Submit ESR reports to the regulatory authority on time
• Our other services are Business Services, Accounting & Bookkeeping Services, Auditing Services, Tax & VAT Filing Services and Due diligence Services to the business tycoons in Dubai.

Need to know more about UAE Economic Substance Regulations? Contact Us! Our experts will give you a one-hour free consultation on your queries.

Frequently Asked Questions [FAQ]

1. How Economic Substance Regulations test is done?

Economic substance requirements of the Regulations stated are:

• Core income-generating activities (CIGA) in the UAE is measured: Activities managed and directed in the UAE with regards to its CIGA
• The number of qualified full-time employees in relation to relevant activity and who are physically present in the UAE, or being outsourced in the UAE
• Measures adequate operating expenditure in the UAE or that adequate expenditure is incurred in out-sourcing to third parties in the UAE 
• Physical assets or levels of expenditure in the UAE are measured
• Outsourced CIGA, if any, to monitor the activities of the service provider.

2. What is the first reportable Financial Year?

The Regulations apply to financial years starting on or after 1 January 2019 in two instances are:

• The UAE company with 1 January 2019 - 31 December 2019 as financial year: First assessable period would be 1 January 2019 - 31 December 2019. 
• The UAE company with 1 April 2019 - 31 March 2020 as financial year: First assessable period would be 1 April 2019 - 31 March 2020. 

3. Do the activities listed on the commercial license determine whether a Licensee undertakes a Relevant Activity?

No, the commercial license may indeed to state the Relevant Activity, therefore, a ‘substance over form’ approach must be used to determine whether a Licensee undertakes a Relevant Activity and is within the scope of the Regulations. Which means to look beyond what is stated on the commercial license regarding the activities performed in the financial year. 

4. What if a Licensee undertakes a Relevant Activity, but does not earn any income from that activity during the financial period?

If a Licensee undertakes a Relevant Activity but does not earn income from that activity in the financial period, he is not required to meet the Economic Substance Test and not required to file an Economic Substance Return for the relevant financial period.

5. Do the directors of the Licensee need to be resident in the UAE?

No, directors of the Licensee need to be a resident in the UAE and his physical presence is optional during the board meeting.

6. Who needs to file an Economic Substance Return and by when?

Only Licensees who earn an income from a Relevant Activity during the relevant financial period and that are not exempt from the Regulations are required to demonstrate economic substance and to file an economic substance return. Within 12 months from the end of the relevant financial period, Economic Substance Return must be filed.

7. What are the penalties for non-compliance?

The penalties include:

1. Failure to Notify: AED 10k to 50k
2. Failure to provide accurate or complete information: Penalty of AED 10k to 50k; and Deemed failure to demonstrate economic substance in the UAE
3. Failure to demonstrate sufficient economic substance in the UAE for the relevant Financial Year

First failure

• A penalty of AED 10k to 50k; and
• Information exchange with the foreign competent authority of parent company, ultimate parent company, and ultimate beneficial owner.

Second consecutive instance of failure

• Information exchange with the foreign competent authority of parent company, ultimate parent company, the ultimate beneficial owner; and
• Penalty of AED 100k to 300k; and Trade license could be: suspended, withdrawn or not renewed.