The Economic Substance Regulations (ESR) issued by the UAE curbs harmful tax practices and closely tracks the global standard set by the OECD (Organisation for Economic Co-operation and Development).
In 2017, the European Union’s Code of Conduct Group (COCG) evaluated the tax policies of “no or only-nominal tax jurisdictions” against the benchmark of economic substance. It stated that a jurisdiction should not create offshore structures or arrangements aimed at attracting profits that do not reflect “real” economic activity. Hence “noncooperative jurisdictions for tax purposes” was issued under which a number of no or only-nominal tax jurisdictions were “grey-listed”. (This meant they had to meet the expected standards within 12 months to avoid being blacklisted.)
The very next year, OECD announced a global standard on “Base Erosion and Profit Shifting” to stop business activities from moving to no or only-nominal tax jurisdictions.
Who is subject to the ESR?
All UAE onshore, offshore and free zone companies that carry on and generate income from one of these activities:
* Banking
* Insurance
* Investment fund management
* Lease-finance
* Headquarters
* Shipping
• Holding company
* Intellectual property
* Distribution and service centres
Scope of ESR
It applies to all companies established in the UAE (except those entities in which a minimum 51 per cent direct or indirect investment is from government authorities) and which have income from a relevant sector in any accounting period commencing on or after January 1, 2019.
Economic substance tests
All companies with activities and income in a relevant sector in an accounting period will be required to demonstrate adequate “substance” in the UAE for which the following criteria are required:
* Directed and Managed Test: The regulations contain specific requirement on how a company has to be directed and managed in the UAE.
* Core Income Generating Activities’ Test: The company has to establish these activities are undertaken in the jurisdiction and in relation to the level of income derived from the relevant activity.
Adequate Test: 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 here.
Penalties prescribed
* Failure to file a notification will result in a penalty of Dh10,000-Dh50,000.
* Failure to provide complete information will result in Dh10,000-Dh50,000.
* Failure to demonstrate sufficient economic substance in the UAE for the relevant financial year.
UAE-based multinationals operating in no or only-nominal tax jurisdictions should reexamine their corporate structure and ensure their activities fall within the definition of ESR. They must then evaluate the impact of these on their operations.
The entities should take the measures to increase the substance level to ensure compliance. Or consider the restructuring or re-domicile to another jurisdiction, or liquidate the company.
UAE companies - offshore, onshore or mainland - should notify the concerned regulator on or before the due date issued by their applicable regulator. All mainland companies have to notify the Ministry of Economy before June 30.
- Jitendra Gianchandani is Chairman of JG Group.
