The UAE introduced a resolution on “economic substance”. Those involved in “relevant activities” - need to ascertain that they are not a paper or shell company, and they have sufficient resources in the UAE to manage their activities. Image Credit: Shutterstock

The UAE introduced a resolution on “economic substance” on April 20, 2019. The underlying concept of this is to align the country to global norms and ensure that businesses carrying on certain activities maintain an adequate “economic presence” in the UAE.

In simple terms, it would mean that businesses - i.e., those involved in “relevant activities” - need to ascertain that they are not a paper or shell company, and they have sufficient resources in the UAE to manage their activities. The business would require resources in the form of employees, management, etc. to run the operations. If a UAE-based entity does not have the required resources and yet it is doing business of relevant activities, then economic substance would be difficult to prove.

There are only nine relevant activities that attract ESR provisions - activities pertaining to banking, insurance, investment fund management, lease-finance, headquarters, shipping, holding company, intellectual property, distribution and service centre. Beyond these, there are scores of companies in the UAE that will not attract ESR reporting as they are not involved in relevant activities.

Question of substance

The challenge for an entity is to identify and assess whether they are engaged in a relevant activity or not. Companies may have a licensed activity that apparently may not be a relevant activity. However, if such an entity has engaged in a deemed relevant activity, than it will fall within the ambit of ESR as “substance over form” will be take into consideration.

Some examples are:

* ABC LLC (UAE) is part of XYZ group and acts as the central treasury centre for the group. ABC enters into external borrowing arrangements and lends the borrowed funds to group companies at the same interest rate it is being charged by external funders. Despite ABC not applying a mark-up on the interest it is being charged, it offers financing to group companies for consideration, and is thus considered to carry on a lease-finance business.

* Alpha LLC (UAE) is part of a multinational with subsidiaries around the world. Each of the senior management team based in the UAE has responsibility for a different region, and regularly spends time at the subsidiaries, with the local management teams providing strategic direction and helping manage material risks. In addition, Alpha LLC supports the group in managing risk through the procurement of external advice centrally, and the associated costs are shared among the group. Thus, Alpha LLC’s activities are within the scope of a “headquarter” business.

For most entities, the matter will be clear. However, many others would need a reality check on transactions that could potentially attract ESR reporting where they have generated an income from those relevant activities.

The authorities have announced deadlines for filing of notification in reference to ESR. Notification is only a self-assessment to intimate the authority about the ESR status.

Notification is not reporting - ESR reporting will be applicable before the end of the financial year of an entity. ESR reporting would need to be complied with only where an entity’s one or more core income is generated from any relevant activity.

Bringing ESR up to speed

Most free zone authorities have made it mandatory for companies registered with them to file notification irrespective of whether or not they are involved in a relevant activity. With respect to mainland companies, the guideline denotes an ESR notification must be filed by a UAE business that undertakes any of the relevant activities during the relevant accounting period.

Penalties for non-filing or providing incorrect information in the notification range from Dh10,000 to Dh50,000. It is advisable then to file notification for all entities.

- Atik Munshi is Senior Partner at Crowe UAE.