What is the ESR

Economic Substance Regulations (ESR) in the UAE mandate that certain businesses maintain and demonstrate adequate economic presence within the country based on their activities. The primary objective is to ensure that UAE businesses report income proportionate to their economic activities in the UAE.

ESR was introduced by the UAE as part of its commitment to the Organization for Economic Co-operation and Development (OECD) Inclusive Framework and in response to the European Union Code of Conduct Group on Business Taxation’s assessment of the UAE’s tax framework.

Who is Subject to ESR?

The ESR applies to Licensees engaging in the following Relevant Activities:

• Banking Businesses
• Insurance Businesses
• Investment Fund Management Businesses
• Lease-Finance Businesses
• Headquarter Businesses
• Shipping Businesses
• Holding Company Businesses
• Intellectual Property Businesses
• Distribution and Service Center Businesses

A Licensee is a juridical person, such as an LLC or a shareholding company, conducting Relevant Activities and registered in the UAE mainland or free zones.

Distribution and Service Center Businesses

Many small businesses, particularly those that are part of a foreign group, may perform distribution or service center business activities. Here’s a brief explanation of these Relevant Activities:

• Distribution Business: A UAE entity is engaged in a Distribution Business if it:
  • Purchases goods or materials from a foreign group company
  • Distributes or sells those goods inside or outside the UAE (even if directly dispatched to the customer by the foreign group company)
• Service Center Business: A UAE entity is engaged in a Service Center Business if it:
  • Provides consulting, administrative, or other services to a foreign group company
  • For example, a UAE subsidiary providing services to its parent company in Germany is considered a service center business and is thus subject to the ESR.

For the other activities check this article about Relevant Activities Assessment here.

Who is NOT Subject to ESR?

• Natural persons
• Sole proprietorship licenses
• Businesses not conducting any of the Relevant Activities

Licensee Obligations Under ESR

Licensees performing Relevant Activities must:

• File an annual notification
• If earning income from Relevant Activities, demonstrate sufficient economic substance in the UAE and file an annual Economic Substance Report

How to Demonstrate Sufficient Economic Substance in the UAE

To demonstrate sufficient economic substance, a Licensee must:

• Conduct Core Income Generating Activities (CIGAs) in the UAE
• Ensure these activities are directed and managed in the UAE (e.g., holding board meetings in the UAE)
• Maintain an adequate level of employees, expenditure, and physical assets in the UAE

Important Considerations Each Financial Year

Licensees should:

• Assess whether they have conducted any Relevant Activity
• Evaluate the income generated from Relevant Activities
• Ensure adequate resources to carry out Relevant Activities
• Hold board meetings in the UAE
• Submit the annual notification and file the annual ESR report

Penalties for Non-Compliance

• Failure to submit a Notification: AED 20k
• Failure to submit an Economic Substance Report: AED 50k and deemed failure to demonstrate economic substance
• Providing inaccurate or incomplete information: AED 50k and deemed failure to demonstrate economic substance
• Failure to demonstrate sufficient economic substance: AED 50k. Second consecutive failure: AED 400k. License may be suspended, withdrawn, or not renewed.

Let’s Talk

For a detailed discussion on determining whether you conduct a Relevant Activity or how to meet ESR requirements, please contact us: tax@audiix.com