On 11 September 2019, the UAE Ministry of Finance issued the Directive for implementation of the provisions of Cabinet Decision No. 31 of 2019 i.e. guidance on the Economic Substance Regulations (ESR) via Ministerial Decision No. 215.
The ESR introduced a legal requirement for all UAE-based entities to locally maintain ‘economic substance’ in line with the level and type of activity they undertake. The ESR applies from 30 April 2019.
The ESR is applicable to all natural and/or juridical persons licensed by the competent authority in the UAE, to carry out a “relevant activity” in the UAE, including free zone and a financial free zone.
The following activities would be considered as relevant activities:
Once a UAE licensee company has been identified as undertaking relevant activities, the ESR requires the company to satisfy the economic substance test which comprises three elements:
There are also regulatory filing requirements that need to be met in order to comply with the ESR.
I. Definition of licensee
The UAE ESR define in scope entities as any natural or juridical person licensed by the competent licensing authority/authorities in the UAE to carry out a relevant activity in the UAE, including free zones. “License” includes a commercial license, a certificate of incorporation or other form of permit required to be procured prior to carrying out relevant activity.
II. Exempt companies
Clarification has also been provided stating that only companies in which the Federal Government, the Government of any Emirate of the UAE or any governmental authority or body of any of them has at least 51% direct or indirect ownership in its shareholding will not be subject to the ESR.
There is no materiality threshold which would exempt companies from the ESR.
III. Economic Substance Test
If a licensee carries out a relevant activity in the UAE and derives income in the UAE out of that relevant activity, then it must review the requirements applicable to such activity under ESR.
Further, if a licensee carries out more than one relevant activity, it is required to satisfy the ESR test for each relevant activity.
Over and above the requirements specified in the ESR, the following has been clarified:
IV. Whether the Economic Substance Test is met
The guidelines specify, for the purpose of ESR determination, the Regulatory Authorities shall adopt a “strict yet pragmatic approach” and may take into account, inter alia, the following possible circumstances/factors:
V. Timelines and filing requirements
It has been re-emphasized in the guidelines that with effect from 1 January 2020, the licensee shall submit a notification to the Regulatory Authority containing the following information
— Licensees that undertake relevant activities are required to submit to the Regulatory Authority a report containing the required information referred to in Articles of the ESR within 12 months from the end of each financial year of the licensee commencing on or after 1 January 2019.
— The guidelines do not yet state the filing mechanism for submitting the notification and report for the ESR, however, it states that, “Each Regulatory Authority shall set out the form of reports to be filed and mechanism for submitting such forms to the Regulatory Authority”.
— The Regulatory Authorities shall not be required to issue its decision immediately in respect of whether a licensee has met the ESR test after end of the relevant financial year. However, it shall reach such a decision within no later than six years after the end of financial year subject to evaluation. But such time limit shall not apply if there has been a gross negligence, fraud, deliberate misrepresentation by the licensee.
VI. Retention of information:
VII. Sector specific guidance
a) Holding company business
Holding company business is one of the relevant activities as per ESR. Such business is defined as a business that has its primary function as acquisition and holding of shares in other companies and derives income from dividend and capital gains.
Further, if a holding company owns other forms of assets (e.g. bonds, interest in real property), it will not be treated as carrying on a holding company business.
b) Headquarters business
It has been clarified that the entities position in a group structure is not relevant. It only depends on the services provided by the entity to other companies in the group, whether parents or subsidiaries.
c) High-risk intellectual property business
It has been clarified that the Regulatory Authority will presume a high-risk IP business licensee has not met the Economic Substance Test and such assumption can be rebutted by the licensee if they submit sufficient information demonstrating the entity does and historically has exercised a high degree of control over the development, exploitation and maintenance.
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