Category: Tax

As part of the UAE’s commitment as a member of the OECD Inclusive Framework, it introduced a Resolution on the Economic Substance (Cabinet of Ministers Resolution No.31 of 2019, the ‘Regulations’) on 30 April 2019 (hereinafter referred to as the ‘Erstwhile Regulations’). The concerned Ministry also released multiple guidance and Frequently Asked Questions (FAQs) for ease of understanding the requirements of the law.

Recently, the Ministry, in an attempt to revamp the Erstwhile Regulation has issued an amended Regulation (vide Cabinet Resolution No 57 of 2020) and guidance (Ministerial Decision No 100 of 2020) that repeals and supersedes the Erstwhile Regulation and guidance with retrospective effect. The said amended Regulations are hereinafter referred to as New Regulations.

Notably, the New Regulations have introduced significant amendments to the extent of changing the governance mechanism, scope and applicability, compliance procedure, and also enhanced the quantum of administrative penalties for non-compliance.

This alert summarizes the key changes and its possible implications on the compliance requirement of the businesses in the UAE.

Re-asses | Scope and Applicability

Licensee

The Erstwhile Regulation was applicable to all the licensees, whether a natural or juridical person, who has been licensed by the competent authority to carry out an activity in UAE. Whereas, the New Regulation covers private/public shareholding company, joint venture company, partnership firm, etc. In other words, the New Regulation does not cover individuals, sole proprietorship, trust, or a foundation under its ambit.

Exemptions

• Earlier, licensee owned (more than 51%) by Federal or Emirate Government, directly or indirectly, were exempt from Regulation. This exemption has been removed by the New Regulation.
• Additionally, the amended Regulation has enlarged the exemption to the following categories:
  • Investment Fund;
  • A company that is a tax resident of a country outside the UAE;
  • A licensee who is completely domiciled in the UAE (not part of a MNE group and no cross border activities);
  • Branch of a foreign entity which is taxed outside the UAE.
• However, the exemption to the above categories will be applicable only upon submitting evidence to fulfill the conditions prescribed for exemption.

Applicability to Branch

• Earlier, the Regulation required all the licensee (including branches) who have undertaken Relevant Activity to comply with the Regulation.
• The amended Regulation clarifies the compliance requirement for UAE as well as foreign branches as under:
  • UAE branch of UAE entity – It is merely an extension of ‘parent’ or ‘head office’ and, therefore, not considered as a separate entity for this Regulation.
  • Foreign branch of UAE entity – UAE entity is not required to consolidate activities/income of foreign branch for ESR provided that the income of such branch is subject to tax outside the UAE. In this context, the branch includes a Permanent Establishment or any other form of taxable presence for corporate income tax purposes.
  • UAE branch of a foreign entity – It is clarified that such an entity is required to comply with Regulation unless the Relevant Income of such branch is subject to tax outside UAE.

Re-validate | Definition of Distribution, Service Center and Intangible transactions

Amendment in Definition of Distribution and Service Centre Business

• Earlier, for an activity to be qualified as a Distribution Business, the following conditions were required to be fulfilled:

✓Purchasing from Foreign Connected Person
✓ Importing  and storing in the UAE
✓ Re-selling such component outside the UAE

• The New Regulation has significantly amended the above definition, perhaps for the right reason. The New Regulation has removed the condition for importing/storing in the UAE. Also, the re-selling of goods within the UAE will now qualify as ‘Distribution Business’ under the New Regulation.
• Similarly, as regards the Service Centre Business, it is now clarified that any services provided to foreign connected persons shall qualify as the Service Center Business, regardless of the business of the foreign connected person.
• In effect, the scope of Distribution and Service Center Business has now been enlarged to certain activities that were previously falling outside the definition due to the language of the law.

High-Risk Intellectual Property Licensee

The New Regulations have provided much-needed clarity on this relevant issue, which is at the center of profit shifting in most cases – the intangible-related transactions.

The New Regulations have now clarified that a licensee would be covered under the Regulations if it derives income from licensing or selling of an intellectual property to a foreign-related party. Also, if such an intellectual party was previously acquired from (a) Connected Person or (b) in consideration for funding research and development by another person situated in a foreign country.

Re-Notify | Furnish Notification to Ministry

• Earlier, the notification was required to be filed at the time specified by the Regulatory Authority in the form and manner prescribed by them. It is pertinent to note that most of the businesses in the UAE have already furnished the notifications to their respective Regulatory Authority. The due date in most cases to file such notification with the Regulatory Authority was 30 June 2020 for the financial year ended on 31 December 2019.
• As per the amended Regulation, the notifications must be submitted electronically on the Ministry of Finance Portal within six months from the end of the financial year of the licensee.
• Guidelines also clarified that licensees that have already submitted a notification to their Regulatory Authorities would be required to re-submit the notification on the Ministry of Finance portal once the portal is active. At present, no deadline is mentioned for this re-submission.

Re-strategize | More Stringent Administrative Penalties

• The amended Regulation has increased the administrative penalty in certain offenses. We have summarized the administrative penalties as under:

• Additionally, in certain cases, the penalty included sharing of information with foreign competent authority as well as suspension/cancellation of license.

Changes in the Governance Mechanism

Regulatory Authority and National Assessing Authority

• The Erstwhile Regulation/Ministerial Guidance suggested that the ESR report was to be furnished to various Regulatory Authorities within the UAE, depending upon the type of Relevant Activities.
• Under the New Regulation, the Ministry has appointed Regulatory Authorities for different Relevant Activities, and at the same time, it has appointed Federal Tax Authority (‘FTA’) as National Assessing Authority.
• It has been clarified that the role of the Regulatory Authorities is mainly to collect/verify information/ documents from the licensees, whereas National Assessing Authority is required to undertake the assessment for determining Economic Substance Test, imposing a penalty, or hearing appeals.

Exchange of Information

• The Erstwhile Regulation specified that Information should be exchanged with foreign competent authorities under the following circumstances:
     ✓ Licensee fails to satisfy substance test
     ✓ Licensee is High-Risk IP Licensee
• In addition to the above, the amended Regulation has also included a circumstance for exchanging information when an entity/ branch of a foreign entity claims to be a tax resident outside the UAE.

Way Forward

With less than four months to the statutory due date for furnishing the first annual economic substance report for most businesses in UAE, the Ministry, by making a retrospective amendment to the Regulation, has, in a way, pushed the licensees to re-test, re-notify, and re-strategize the existing position.

When most of the businesses were busy in preparing/ collating information for preparing annual ESR report (due in December 2020), this additional exercise of re-assessing the applicability of Regulation will increase the compliance burden

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In response to a review of the UAE’s tax framework by the European Union and the UAE’s commitment to the Organization for Economic Cooperation and Development (OECD) anti-Base Erosion and Profit shifting (BEPS) Action Plan, in 2019 the UAE Cabinet issued: (i) the Cabinet of Ministers Resolution No. 31 of 2019 concerning Economic Substance Regulations in the UAE (the “Original ESR”); and (ii) Ministerial Decision No. 215 of 2019. 

These regulations have been repealed and replaced by: (i) the Cabinet of Ministers Resolution No. 57 of 2020, issued on 10 August 2020 (the “New ESR”); and Ministerial Decision No. 100 of 2020, issued on 19 August 2020 (together with the New ESR, the “Regulations”) respectively. 

The New ESR have overhauled the roles and responsibilities of the relevant authorities by introducing the Federal Tax Authority (FTA) as the National Assessing Authority (NAA) and made some changes in the definitions of some relevant activities. Most importantly, the new law has broadened the scope of exemption by including more categories of licensees to avail the exemption from ESR.

The New ESR require entities (both onshore and free zone) that undertake any of the following activities to maintain an ‘economic’ presence in the UAE: 

• Banking Business;
• Insurance Business;
• Investment Fund Management Business;
• Shipping Business;
• Lease-Finance Business;
• Distribution & Service Centre Business;
• Headquarters Business;
• Intellectual Property Business; and
• Holding Company Business,

(each a “Relevant Activity”). 

Pursuant to the Regulations, several amendments have been introduced and clarifications made, including the following:

1. Definition of Licensee 

The New ESR apply to: (i) juridical persons (a corporate legal entity with separate legal personality from its owners); and (ii) unincorporated partnerships that carry out a Relevant Activity in the UAE (including a free zone) (each a “Licensee”). Natural persons (who fell within the definition of “Licensee” in the Original ESR) are no longer covered, and therefore do not need to file a notification or meet the Economic Substance Test (as detailed in Article 6 of the New ESR). 

The New ESR have overhauled the roles and responsibilities of the relevant authorities by introducing the Federal Tax Authority (FTA) as the National Assessing Authority (NAA) and made some changes in the definitions of some relevant activities. Most importantly, the new law has broadened the scope of exemption by including more categories of licensees to avail the exemption from ESR.

The New ESR require entities (both onshore and free zone) that undertake any of the following activities to maintain an ‘economic’ presence in the UAE: 

• Banking Business;
• Insurance Business;
• Investment Fund Management Business;
• Shipping Business;
• Lease-Finance Business;
• Distribution & Service Centre Business;
• Headquarters Business;
• Intellectual Property Business; and
• Holding Company Business,

2. Widening of the Exemption scope 

Pursuant to the New ESR, the following entities are excluded from the requirement to meet the Economic Substance Test:

1. licensees who are tax resident outside UAE;
2. investment funds and their underlying SPVs and/or investment holding entities;
3. wholly owned businesses of UAE resident which are not a part of a multinational group and only carries on business in the UAE;
4. a branch of a foreign company whose income is subject to tax in a foreign jurisdiction; and
5. any other licensees as directed by the Ministry of Finance (MoF),

(each an “Exempted Licensee”).

Exempt entities are required to: (i) file a notification; and (ii) provide sufficient evidence substantiating its status as an Exempted Licensee for each financial year in which it is claiming to be an Exempted Licensee. 

Previously, the exemption scope was limited to any commercial company in which the Federal government or Government of any Emirate or any Government body had at least 51% direct or indirect ownership. 

Overall, the expansion of exemption scope means that more licensees would be able to claim the exemption which would be a relief for many companies.

3. Amendment to the definitions of some relevant activities

Distribution and Service Centre Business:

The old definition of a ‘Distribution and Service Centre Business’ required the purchase of goods from a Foreign Connected Person (as defined in the Old ESR), importing goods into UAE and subsequently reselling them outside UAE. This has now been amended to exclude the requirement to import and export the goods from UAE.

This means that businesses which are engaged in purchasing goods from a Foreign Connected Person (as defined in the New ESR) for the purpose of selling them in within UAE or sells the goods offshore (i.e. high sea sales) should qualify as a Distribution and Service Centre Business under the New ESR. 

The definition of a Distribution and Service Centre Business has also been amended to exclude the requirement of the services to be in connection with a business outside UAE. Therefore, licensees providing any services to a Foreign Connected Person will now qualify as service center business. 

These changes would likely result in a significant amount of MNCs in UAE having to reassess whether the Relevant Activity of ‘Distribution and Service Center Business’ would apply to them in their respective financial year.

High Risk IP Business:

Pursuant to the New ESR, the definition of a High Risk IP Licensee has been narrowed – the condition relating to a licensee not carrying out any research and development, or branding, marketing and distribution as part of its core income-generating activity in the UAE has been removed as part of the update. 

IP related businesses should reassess wither they fall within the remit of the three limbs outlined in the New ESR.

4. Roles and responsibilities of various authorities in ensuring ESR compliance:

The Ministry of Finance remains the ultimate authority to ensure overall ESR compliance and remains responsible for exchange of information with foreign tax authorities. 

The New ESR law has introduced Federal Tax Authority as the National Assessing Authority, who shall:

• Conduct assessments to determine whether a Licensee has met the Economic Substance Test. 
• Impose administrative penalties. 
• Hear and decide on appeals. 
• Carry out reporting requirements and exchange of information with the Ministry of Finance. 
• In executing the above-mentioned functions, the FTA will draw support from the Regulatory Authorities (as detailed in Article 4 of the New ESR). 
• Regulatory Authorities will remain the first point of contact for collection of information and documents from Licensees, and shall:
• Collect and review of ESR notifications and reports. 
• Identify and validate Licensees claiming exemption status. 
• Support the FTA during audits. 
• Implement cancellation/suspension/non-renewal of a Licensee’s trade license for instances of consecutive non-compliance. 

5. First Reportable Period

All Licensees and Exempted Licensees are subject to the New ESR from the earlier of: (i) their financial year commencing on 1 January 2019; or (ii) the date on which they commence carrying out a Relevant Activity (in the case of a financial year commencing after 1 January 2019). 

6. ESR Notifications – Electronic Filing

It is anticipated that the Ministry of Finance will launch an electronic portal to collect notification forms, substance reports and other relevant information. The rules and procedures will be published in due course. Where a notification has already been previously submitted to a regulatory authority, such notification will have to be re-submitted on the new portal once available. Licensees will need to submit their ESR notification within 6 months of the end of the financial year. 

7. Board Members

It has been clarified that the ‘directed and managed’ requirement does not require board members (or equivalent) to be resident in the UAE. The board members (or equivalent) are required to be physically present in the UAE when taking strategic decisions. 

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The UAE’s Economic Substance Regulations (ESR) have gained momentum again. While not a tax, the rules aim to determine that entities undertaking ‘relevant activities have adequate ‘economic substance’ in the UAE, are directed and supervised, and have adequate assets, resources and qualified people in the UAE.

 Recently, significant changes were made to the ESR through Cabinet resolution No. 57 of 2020 and ministerial decision 100 of 2020. The amended ESR is a positive development. UAE businesses should take note of the amendments to reassess the implications and where they stand on compliance.

 Extends the scope

The amended ESR covers juridical persons or unincorporated partnerships, while ‘natural persons’ possibly including sole proprietors, trusts and foundations are now excluded. Four categories of licensees have been specifically exempted from the ESR covering (a) investment funds, (b) a licensee that is tax resident in a foreign jurisdiction, and (c) a UAE branch of a foreign entity if the branch’s income is taxed in a foreign jurisdiction. The exempt category also includes entities wholly-owned by UAE residents/ nationals and are not part of a multinational group provided it carries out business in UAE. This is a big relief for local businesses. All exempted licensees are required to submit only the ESR notification along with prescribed documents on an annual basis.

 Clarity has also been provided on businesses with multiple branches within the UAE, for foreign branches of a UAE entity, and for entities that undertook the ‘relevant activities’ but did not earn any income.

 Among other changes, ESR now covers purchasing of goods from a foreign-connected person as well as the reselling of such goods. Under the original ESR, coverage under the D & SC business required (a) purchasing of goods from a foreign-connected person; (b) importing and storing those goods in the UAE; and (c) reselling the outside the country. With the removal of conditions (b) and c), purchasing of goods from foreign group companies for international distribution typically referred to as “bill to-ship to” transactions, or for local distribution within UAE, would trigger ESR compliance. Mother welcome change is the introduction of a concept of ‘group’ to identify foreign-connected person and link it with the requirements to prepare consolidated financial statements.

Resubmission necessary

A landmark change is the appointment of the Federal Tax Authority (FTA) as the ‘National Assessing Authority’. In addition to VAT and excise tax, the FTA will undertake assessments to determine compliance with economic substance tests by the entities. The FTA will also be responsible for administrative penalties, appeal processes and other prescribed functions. An online portal will be launched by the Ministry of Finance for submission of ESR notification/reports and other documents. Businesses will have to resubmit ESR notifications submitted earlier. The new deadlines for the resubmissions are yet to be announced by the authorities as on date.

 ESR notifications and reports should be submitted within six-and 12 months respectively, calculated from the end of the financial year of the company, which is typically December, March or June. It has been clarified that the board members (or equivalent) of the business need not be UAE residents, but must be physically present in UAE when taking strategic decisions. Increased and stringent penalties for non-compliance could range from Dh20,000 to Dh50,000, further increasing to Dh400,000 and possible cancellation/suspension of trade license. Considering that limited time is available to prepare a detailed ESR report and submit/resubmit ESR notification, it is strongly recommended that businesses reassess the implications under the amended ESR.

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News Courtesy : Gulfnews

Background

The UAE introduced economic substance requirements for certain businesses on 30 April 2019 by way of Cabinet of Ministers Resolution No.31 of 2019 concerning Economic Substance Regulations (“the original ES Regulations”). Guidance on the application of the original ES Regulations was issued on 11 September 2019 pursuant to Ministerial Decision No. 215 of 2019 (“Guidance”).

On 10 August 2020, the UAE Cabinet of Ministers issued Cabinet Resolution No. 57 of 2020 (the “amended ES Regulations”) which repeals and replaces the original ES Regulations, along with updated Guidance clarifying the amended ES Regulations (Ministerial Decision 100 of 2020 dated 19 August 2020). In addition, the UAE MoF has updated the information on its dedicated economic substance website (link here).

The amended ES Regulations apply from 1 January 2019 and introduce important changes to the scope and administration of the economic substance regime in the UAE, which are discussed below. 

Critical changes in the amended ES Regulations

The amended ES Regulations introduce a number of important changes:

Definition of a “Licensee”

• The amended ES Regulations only apply to (i) juridical persons (persons with separate legal personality) and (ii) unincorporated partnerships that carry on a relevant activity in the UAE. 
• Natural persons, sole proprietors, trusts and foundations (that were considered as “Licensees” under the original ES Regulations) are no longer in scope of the ES regulations, and therefore do not need to file a notification or meet the Economic Substance Test.
• The amended ES Regulations also clarify the treatment of UAE and foreign branches (see page 4). 

Applicable exemptions

• The amended ES Regulations introduce the following exemptions:
• Entities that are tax resident outside the UAE
• Investment Funds
• Entities that are wholly owned by UAE residents and that (i) are not part of a multinational group, and (ii) only carry out business activities in the UAE
• UAE branches of a foreign head office / parent whose relevant income is subject to tax in the jurisdiction of the foreign head office / parent
• Exempt entities must (i) file a notification and (ii) provide sufficient documentary evidence to substantiate and benefit from their exempt status.

Ad 1) The UAE entity will need to submit a tax residence certificate or other documentation issued by the tax authority in the foreign jurisdiction in which it claims to be a tax resident, evidencing that it is treated as a locally tax resident entity in that foreign jurisdiction.

Ad 2) The Investment Fund exemption applies to the Investment Fund as well as any UAE entities used by the Investment Fund to make or hold investments but does not extend to the entity(is) in which the Investment Fund ultimately invests. 

Ad 3) The term UAE residents refers to either (i) UAE citizens or (ii) individuals holding a UAE residency visa who reside in the UAE.

Ad 4) Subject to further guidance, we would expect that the “subject to tax” test is met where the income of the UAE branch is included in the taxable income of the foreign head office / parent, irrespective of whether the foreign head office / parent can claim a branch profit exemption under a double tax treaty with the UAE or under the domestic tax law of the jurisdiction of the foreign head office / parent.  

• Entities directly or indirectly owned at least 51% by the UAE government are no longer specifically exempted under the amended ES Regulations. Such entities may (where applicable), however, benefit from any of the newly introduced exemptions set out above.

Changes to the definition of certain “Relevant Activities”

Distribution and Service Centre Business

• The scope of the “Distribution and Service Centre Business” has been expanded such that:
  • There is no longer a requirement for the goods to be imported and stored in the UAE for an entity to be considered a “Distribution and Service Centre Business”.
  • There is no longer a requirement for services to be provided “in connection with a business outside the State”, resulting in any service provided to a foreign related party to be considered a “Distribution and Service Centre Business”.

High Risk Intellectual Property Licensee

• The definition of a High-Risk Intellectual Property Licensee has been limited to an intellectual property business that meets all of the following conditions:
• The business did not create the intellectual property asset.
• The business acquired the intellectual property asset from either:
  • a Connected Person, or
  • in consideration for funding research and development by another person situated in a foreign jurisdiction; and
• The business licenses or has sold the intellectual property asset to a Connected Person or earns separately identifiable income from a Foreign Connected Person in respect of the use or exploitation of the intellectual property asset.

Changes to the definition of a “Connected Person” and introduction of a definition of a “Group”

• The amended ES Regulations define a Connected Person as an entity that is a part of the same Group as the Licensee or the Exempted Licensee. 
• A Group is defined as “two or more entities related through ownership or control such that they are required to prepare consolidated financial statements for financial reporting purposes under the accounting standards applicable thereto”.

Administration 

• The UAE Federal Tax Authority has been appointed as the Assessing Authority for the ES Regulations. In this capacity, the FTA will be responsible for assessing and enforcing compliance of UAE businesses with the Economic Substance Test.
• The Regulatory Authorities’ primary responsibility is the collection and verification of information regarding their Licensees and assisting the FTA in carrying out its role as National Assessing Authority. 

Exchange of information

• The amended ES Regulations provide that the Ministry of Finance (as Competent Authority) will exchange information with Foreign Competent Authorities on Licensee that claim to be exempt from the ES Regulations on the basis of: 
  • being tax resident outside the UAE; or
  • being a UAE branch of a foreign entity, whose income is subject to tax outside of the UAE.

Critical areas clarified in the updated guidance

The updated Guidance provides further clarifications on the application of the amended ES Regulations. Included below is a summary of critical clarifications that were not addressed in the previous guidance and/or Relevant Activities Guide.

Treatment of branches

• As branches do not have separate legal personalities from their “parent” or “head office”, they are not regarded as “Licensees”. 
• The Guidance clarifies how branches and their “parent” or “head office” are required to comply with the ES Regulations:
  • UAE branch of a UAE business: The UAE business must file a single notification and (if applicable) an Economic Substance Report to report the relevant activities of itself and all its UAE branches.
  • UAE branches of a foreign business: The UAE branch is not subject to the ES Regulations if its relevant income is reported in the tax return of the foreign parent / head office.
  • Foreign branch of a UAE business: The UAE business does not need to report (and demonstrate economic substance in the UAE related to) the relevant activities of its foreign branch, provided that the foreign branch is subject to tax on its relevant income in the foreign jurisdiction.

Notification filings

• The amended ES Regulations confirm that notifications must be filed electronically on the Ministry of Finance Portal within six months of the Licensees financial year end. 
• Similarly, businesses that already submitted a notification to their Regulatory Authorities will be required to re-submit their notification on the Ministry of Finance portal after it goes live. The guidance does not confirm a deadline for this resubmission. 
• For businesses that are required to file a notification before the portal is available it may be reasonable to anticipate that the deadline for such filings is postponed until the portal goes live. 

Other clarifications

• Gross income means all income from whatever source derived, without deducting any type of costs or expenditure.
• A Licensee is not required to perform all the Core Income Generating Activities (“CIGAs”) listed in the ES regulations for a particular relevant activity. However, any of the CIGAs that generate relevant income must be performed in the UAE.
• The board members (or equivalent) are not required to be resident in the UAE. However, the board members (or equivalent) are required to be physically present in the UAE when taking strategic decisions.
• A Licensee may outsource activities which are not CIGAs to parties outside the UAE, such as back office functions, IT, payroll, legal services, or other expert professional advice or specialist services provided.

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Companies in the UAE are expected to ensure their compliance with the new Economic Substance Regulations (ESR), and failure to do so will invite hefty penalties. Amid a number of financial challenges came with the Covid-19 pandemic, adhering to the UAE’s new ESR is now a mandatory and another reality for businesses to operate in the country.

Aimed at facilitating build business transparency, the UAE introduced ESR on April 30, 2019, and issued the guidance on the application of the regulations on 11 September 2019. The regulations require companies and other business forms registered in the UAE that carry on one or more “Relevant Activities” (together, “Relevant Activities”), to have economic substance in the UAE in relation to these activities, and to comply with notification and return filing obligations.

The ESR has been introduced to facilitate and cooperate with governments of high tax jurisdictions. The ESR is not a source of income and there will be no monetary or financial implications like VAT and excise tax as introduced in the UAE on January 1, 2018.

The objective for introducing ESR is to avoid shifting of profits from high tax jurisdictions to low or no tax jurisdictions. ESR has been implemented to tax heaven countries such as BVI, Cayman Islands, Jersey, Bermuda, Bahrain etc. to cooperate with high tax jurisdictions countries where corporate taxes should have been paid for transactions where economic substance would not be present in the UAE. ESR shall ensure that profits are taxed where economic activities are performed and where actual value is created.

ESR is applicable to NINE relevant activities and substance over form approach shall be applicable while assessing and identifying the applicability of relevant activities. The nine listed activities are Insurance, Banking, Investment Fund Management, Lease-Finance, Headquarters, Holding Company, Shipping, Intellectual Property Business, and Distribution & Service Centre Business.

ESR Compliance shall be performed in 3 phases: Phase 1: Identification and assessment of Relevant Activity & submission of Notification; Phase 2: Action Plan to meet Economic Substance Test (Assess whether business meet; compliance requirements and Substance Test); and Phase 3: Reporting to Relevant Authority.

Distribution & Service Centre, one of the relevant activities of ESR shall cater to plethora of Companies in UAE. Since UAE is strategically located globally, which provides access to companies to trade in or outside the UAE and procuring the goods from the manufacturing plant outside UAE which is mainly foreign connected companies of the UAE based Entity. Such kind of transactions would tantamount to applicability of Distribution & Service Centre 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.

The biggest challenge in ESR Compliance is to identify income from core income generating activities. Core Income Generating Activity must be conducted in UAE to substantiate the economic substance test in UAE. Other challenge is to prove that the Entity is being managed and directed in the UAE which is also required to substantiate the economic substance test.

Companies must assess all the transactions cautiously and vigilantly to identify the relevant activities and must follow substance over form approach while making the assessment of relevant activities. Understanding of Corporate structure, Business Model and then finally identify the applicability of Relevant Activity are the pre-requisites to file the ESR Notification. The deadline for filing ESR Notification was June 30, 2020 for most of the Free Zones and Mainland Companies for the reportable period January 01 to December 31, 2019. There are few free zones which has extended the deadline to July 31, 2020.

All the licensees need to comply with return filing obligations if income from the relevant activity is earned during the reportable period. It is imperative for the licensees to calculate the income and prepare the financial statements to compute the operating expenditure, net profits, assets held by the Licensee with respect to relevant activity only.

The compliance is indispensable and records and details to be maintained for each reportable period. Non-compliance of Economic Substance Regulations shall not only result in monetary penalties but could also lead to suspension, revocation of the license which can lead to major disruptions.

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