Why ESR was introduced In the UAE?
ECONOMIC SUBSTANCE REGULATIONS: NEED OF THE HOUR FOR THE UAE
A country relies on economic growth and prosperity to propel a better standard of living for its citizens. True economic growth results in the government earning taxes from revenue generated within the country by businesses. However, tax evasion is a harsh reality of today and governments and governmental organizations must take steps to address the phenomenon. For a country like the UAE, where foreign investment and business play a huge role in economic activity of the country, it is imperative to ensure that business do not shift their profits elsewhere to escape tax liability. Hence, the UAE issued Economic Substance Regulations to address loopholes in the existing tax regime.
Why ESR was introduced?
The Organisation for Economic Development and Cooperation (OECD) has standards to counter risks of base erosion and profit shifting in jurisdictions where there is a nominal or no tax regime. All members of the OECD must adhere to such standards. As a member, the UAE’s legal and commercial framework must be in consonance with global standards. The OECD required the UAE to introduce economic substance requirements in their domestic legislation. The EU lists “tax haven” countries where tax regimes make it so that profits are earned without real economic activity. Reviewed by the EU, UAE’s tax framework was included on the EU’s list of non-cooperative jurisdictions for tax purposes.
The UAE entered into the OECD’s Measures to Prevent Base Erosion and Profit Shifting (“BEPS”) Convention, which came into force on 1 September 2019. To fulfil its obligations under the Convention, the UAE has passed UAE Cabinet of Ministers Resolution No. 31 Of 2019 Concerning Economic Substance Regulations, issued on 30 April 2019 to implement the convention which applies across the UAE in every jurisdiction, including all Free Zones and Financial Free Zone.
Applicability of ESR
A “Licensee” under the Regulations is a natural or juridical (legal) person licensed by the competent licensing authority/authorities in the State to carry out a Relevant Activity in the UAE, including a Free Zone (including an offshore free zone) and a Financial Free Zone (eg DIFC)
The Regulations apply to UAE onshore and free zone companies, branches, partnerships, and other UAE business forms (referred to as Licensees) that carry out any of the Relevant Activities mentioned in the ESR. Relevant Activities include:
- Banking Businesses
- Insurance Businesses
- Investment Fund Management Businesses
- Lease-Finance Businesses
- Headquarter Businesses
- Shipping Businesses
- Holding Company Businesses
- Intellectual Property Businesses
- Distribution and Service Centre Businesses
The test for economic substance
An Economic Substance Test will be implanted for each relevant financial period where the Licensee earns income from a Relevant Activity. The Economic Substance Test requires a Licensee to demonstrate that:
the Licensee and Relevant Activity are being directed and managed in the UAE;
the relevant Core Income Generating Activities (CIGAs) are being conducted in the UAE; and
the Licensee has adequate employees, premises and expenditure in the UAE. In addition to an annual notification requirement, Licensees that undertake and earn income from a Relevant Activity are also required to file an Economic Substance Return within 12 months from the end of the relevant financial period.