Across the globe, governments amend their laws periodically to address common issues such as money laundering, financial threats, frauds, etc. The government of UAE takes mandatory responsibility and actions to amend and impose their laws in each and every state of UAE with utter transparency in their current procedures and advancements.
Economic Substance Regulation (ESR) in the UAE is a new test for firms to comply with. With its implementation in the year 2020, the 1st of Jan, the government of UAE has taken mandatory steps to ease tax payments with accelerated transparency in matters. The UAE government focuses on growth and fair tax competition.
The ESR is to address concerns regarding entities and firms having too little substance while they are operating in the UAE jurisdictions. It is applied to local companies, legal or natural persons located in the country in free zone areas and non-free zone areas to be defined as ‘relevant activities’. The Ministry of Finance has taken the initiative of implementing Economic Substance Regulations in the Cabinet Ministry Resolution (No 31) of 2019.
The Economic Substance Regulation requires each firm in the UAE and any other form of registered business to meet their new economic substance compliance with return filing obligations and notifications carrying out the relevant activity as per the Cabinet Resolution. This includes banking services, distribution services, holding companies, insurance, and investment services, shipping services, leaving and financing businesses, and so on.
According to the implemented ESR law in 2019, all the business segments and entities that fall under the subject to these regulations are required to take respective action while ensuring compliance with it whether they are offshore and free zone organizations, branches of companies, non-profit organizations, and partnerships termed as licensees. In other words, every licensee in the UAE associated with the above-mentioned segments has to submit an application with notification of complying with the respective regulations.
The Purpose of Economic Substance Regulation (ESR) in the UAE
The primary purpose of the Economic Substance Regulation issued with a series of directives is to curb harmful tax practices in the UAE in compliance with the international OECD standards. The UAE government is following the guidelines issued by the European Union Code of Conduct for their business taxation.
In most cases, these new regulations are considered to be a business disruptor in the UAE as the government is also taking strict actions as punishments. The companies that are operating in the UAE and are not taking the necessary steps to implement the new compliance requirements are the ones being targeted for license cancellation. The UAE government either wants them to restructure their business module, plan, and objectives. The government is ordering them to merge their business with a licensee that is in compliance with the new law or go with acquisition or cancellation.
The Economic Substance Test
Each business entity, whether new or old, with a license, has to comply with the Economic Substance Regulation in the UAE. To start the process and apply for the approval of the government of UAE, an application must be submitted. For the application to get approved, the licensee has to pass the economic substance test. The report of the test will then be submitted to the respective regulatory authority of the Cabinet Ministry within the financial period.
For the economic substance test to be carried out by the licensee whether manager, stakeholder, employee, or entrepreneur, the following facts must be considered for validation:
- The Licensee and their relevant business activity and segment are being operated and managed in the UAE as directed by the regulations
- The relevant core income-generating activities are mainly carried out within the UAE
- The employees of the company or firm and their physical assets, as well as their expenditures are being carried out in an adequate and appropriate number in the UAE
Moreover, if the company does not meet the criteria and satisfy the Economic Substance Test, it legally implies that the company is not undertaking genuine economic activities. It may be implied that the company is allegedly exploiting and avoiding paying their taxes in the UAE and other countries.
To avoid unpleasant situation and having to pay huge fines and taxes, companies may need to restructure their activities, re-apply for a new license, outsource their activities for some time, come up with new business module and plan, change contracts, work towards complying with the policies and regulations after paying fines, exit or cancel the license, and talk with the respective regulating authorities for more options.
Demonstration Whether Your Business Activity Is Relevant
The Economic Substance Regulation is no more than a complex set of rules that needs to be understood really thoroughly. According to the governing authorities of ESR, there are 2 methods available to demonstrate whether your business activities and its branches are relevant or not.
- Self-reporting and analysis with a team
- Contacting the regulating authorities for their guidelines and checklist
A self-reporting analysis requires you to either hire a team or create a team within the already hired employees to do the research and come to a conclusion. The team will also be able to contact the regulating authorities and see how your company can meet the mandatory requirements and/or conduct the test within the deadlines offered.
Receive Professional Advice With Accelerate Ideas
Receiving a set of information or guidelines is easy, but complying with the regulations and following up with the implementation and application procedure is complex and time-consuming. If you don’t want to go through any of the hassles alone, we are here for you as your concerned agents.
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Our team offers detailed reports and analysis while proposing legally accepted recommendations. We also offer tailored guidance with legal expertise with full consideration and transparency. All in all, wi help our clients fully comply with the Economic Substance Regulations (ESR) in the UAE.