Discontinuation of UAE Economic Substance Regulations

The UAE’s Economic Substance Regulations (ESR) were initially introduced in 2019 to comply with international tax standards, especially as part of its commitment to the OECD’s Inclusive Framework on Base Erosion and Profit Shifting (BEPS). However, recent amendments under Cabinet Decision No. 98 of 2024, published in the Official Gazette on 16 September 2024, have brought substantial changes to these regulations.

Here’s a detailed breakdown of the key updates and what they mean for businesses subject to ESR in the UAE.

Key Amendments to the UAE ESR

1. ESR No Longer Applies for Periods After 31 December 2022

The most notable change is that the Economic Substance Regulations are now only applicable for financial periods ending on or before 31 December 2022. Businesses with financial years starting from 1 January 2023 onward are no longer required to file ESR notifications or reports. This change streamlines the regulatory environment, reducing the compliance burden on entities operating in the UAE.

This amendment effectively ends the ESR obligations for businesses in the UAE, as the reporting and filing requirements are no longer relevant for periods after 31 December 2022.

2. Abolition of ESR Penalties

Alongside the cessation of ESR filings, all administrative penalties related to non-compliance for financial periods ending after 31 December 2022 have been abolished. Previously, businesses faced penalties of up to AED 20,000 for failure to file ESR notifications and up to AED 50,000 for not submitting the required ESR report.

With the new Cabinet Decision, any penalties paid for non-compliance during periods starting after 31 December 2022 will be refunded by the Federal Tax Authority (FTA). However, the actual mechanism for the refund process is still awaiting further clarification, which is expected to come through future legislation issued by the Ministry of Finance.

3.Substance Requirements for Qualifying Free Zone Entities

While the ESR no longer applies for financial periods after December 2022, this does not mean that the need to demonstrate economic substance is entirely removed. Businesses that seek to benefit from the UAE’s 0% corporate tax rate, specifically Qualifying Free Zone Persons (QFZP), are still required to demonstrate adequate substance in the UAE.

Qualifying Free Zone Entities will need to continue maintaining adequate substance, including having employees, premises, and core income generating activities located in the UAE, to remain eligible for the corporate tax benefits.

Implications for UAE Businesses?

If your business was previously required to comply with the Economic Substance Regulations, here are the key takeaways from the recent changes:

• No ESR Filing Obligations Post-2022: You no longer need to submit ESR notifications or reports for financial periods ending after 31 December 2022.
• Refund of Paid Penalties: If your business paid ESR-related penalties for financial periods after December 2022, the Federal Tax Authority will refund these amounts. The exact refund procedure will be outlined in future legislation.
• Ongoing Substance Requirements for Free Zone Entities: If your business is looking to benefit from the 0% corporate tax rate as a Qualifying Free Zone Person, you must still demonstrate adequate substance in the UAE.

These amendments reduce the compliance burden on businesses previously subject to the ESR, which had required filing an annual notification, submitting an annual ESR report, and meeting the substance requirements. Many businesses had faced penalties for non-compliance under the earlier regulations, but with this amendment, they may now be eligible for refunds of previously imposed penalties, providing a welcome relief from past obligations.