Like most federal laws, the ESR (Economic Substance Regulations) should apply equally to all the emirates, including free zones unless otherwise agreed upon. Free zones are exempted from UAE labour laws - that is not the case on this one.
Most of the free zones, being regulators of the companies operating in them, and the Ministry of Economy, which regulates the mainland companies, are not on the same page on notifications filing, as defined by Article (8) of ESR. What is the ambiguity about?
Article (1) defines the trade license or permit issued by the relevant regulatory authority, including that issued by the competent authority of a free zone. The ESR defines a “licensee” as the juridical person licensed by the competent licensing authority to carry out a “relevant activity” in the state, including a free zone.
The relevant activity as per the ESR are banking and insurance, investment fund management, lease finance, operating the headquarters, shipping, having a holding company, Intellectual Property (IP) rights, and distribution and service centres.
Outlining the operational parameters
Article 3 defines the scope:
1. The provisions shall apply to a licensee that carries out any relevant activity.
2. The provisions shall not apply to any commercial company in which the government of the state or the government of any emirate of the state, or any governmental authority or body of any of them has any direct or indirect ownership in its share capital.
Article 8 on the requirement to provide information says: “A licensee shall notify the regulatory authority annually whether or not it is carrying on a relevant activity.”
What it means for investors
The doubt on applicability will add an extra administrative burden and cost on a majority of companies that are not carrying out any relevant activities. This may also expose them to penalties of Dh10,000 to Dh50,000, which will be unfair if charged. The ambiguity on applicability may discourage existing and potential investors - hence there is a need by the concerned ministry to clarify.
The Ministry of Economy has not asked mainland companies that are not carrying out relevant activities to notify on or before June 30. Also, the free zone, Creative City Fujairah, and ADGM (Abu Dhabi Global Market) are asking companies to notify only if carrying on relevant activity.
The regulatory authorities of free zones such as Jebel Ali, DAFZA and DMCC, among others have made it mandatory for all licensees, irrespective of whether relevant activity is carried out or not, to notify before the due date or face the penalties.
In spite of the ESR being introduced in 2019, most regulatory authorities issued the guidelines post the reportable year, which was December 31, 2019. The three ESR tests are:
1. Be managed in the UAE;
2. The company has to establish that CIGAs (core income generating activities) have been undertaken in the jurisdiction, in relation to the level of the income derived from the relevant activity.
3. The company should have an adequate number of qualified full-time employees in the UAE, incur an adequate amount of operating expenditure in the UAE, and hold adequate physical assets in the UAE.
- Jitendra Gianchandani is Chairman of JGC.