Economic Substance Regulations (ESR) were introduced in the UAE in April 2019 to align with global standards established by the OECD (The Organization for Economic Cooperation and Development) and the EU (European Union) to prevent harmful tax practices. These regulations ensure that companies operating within the UAE, including offshore companies, onshore companies, free zone companies, and branches of local and foreign companies, maintain and demonstrate a substantial economic presence in the country.
The OECD's guidelines on Base Erosion and Profit Shifting (BEPS) form the foundation of ESR. These guidelines are designed to tackle tax avoidance strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations. By adopting ESR, the UAE aligns itself with these international standards, demonstrating its commitment to preventing harmful tax practices and fostering a fair global tax environment.
In consultation with the OECD guidelines, the Economic Substance Regulations of 2019 were amended by Cabinet Resolution No. 57 of 2020 in August 2020. Ministerial Decision No. 100 of 2020 provides further guidance and direction to entities carrying out one or more Relevant Activities.
Scope of ESR
Any business that constitutes a juridical person or unincorporated partnership that is registered in the UAE or undertakes Relevant Activities for financial years commencing on or after 1 January 2019 is subject to ESR. Businesses should take a substance over form approach (i.e. to look beyond trade license) to determine if they carry on a Relevant Activity.
Relevant Activities
Entities that conduct one or more of the .below stated activities will be subject to ESR:
Banking
Insurance
Investment Fund Management
Lease-Finance
Headquarters
Shipping
Holding Company
Intellectual Property
Distribution and Service Centre
ESR Compliance Obligations
Notification -
UAE entities that conduct any one or more of the Relevant Activities must file a notification within six months of the end of the financial year (FY) on the Ministry of Finance’s (MoF) online ESR portal. As part of this filing, entities must disclose which relevant activities were conducted, whether any income was earned from them, and whether such income was subject to tax outside the UAE. In the case of a UAE entity with multiple UAE branches, only one consolidated notification is to be submitted.
Economic Substance Tests -
UAE entities that have earned income from any Relevant Activity/s must demonstrate adequate substance in the UAE relating to such activity/s by satisfying the following three Economic Substance Tests.
Core Income Generating Activities (CIGA): Companies must conduct CIGA in the UAE.
Management and Control: The business must be directed and managed in the UAE.
Adequate Resources: Adequate levels of qualified employees, physical assets, and expenditure in the UAE are required.
Report
Entities that have earned income from any Relevant Activity/s must file a report on the MoF’s online ESR portal within twelve (12) months of the end of the relevant FY. As part of this filing, entities are required to disclose various details, including:
-Activities Conducted
-Relevant Income earned
-Location and assets used
-Operating expenditure and the number of full-time employees for each Relevant Activity
-Details of specific CIGAs conducted
-Other relevant details
Exempted Licenses
Subject to meeting certain conditions, the following entities conducting Relevant Activities are exempt from the requirement to maintain adequate economic substance in the UAE.
Non-UAE tax resident entities
Investment funds and their underlying special purpose vehicles (SPVs)/ Investment holding entities
Wholly UAE resident-owned UAE entities with domestic transactions (that are not part of a multinational group)
UAE branches of foreign companies that are subject to tax on all their Relevant Income in a foreign jurisdiction
An exempted Licensee must submit a notification and provide evidence to support their exempt status. Failure to do so will require these Licensees to submit an Economic Substance Report and meet the Economic Substance Test.
Penalties for Non-Compliance
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