Economic Substance Regulations (ESR) – Overview
What is the ESR
The ESR regulations require certain businesses in the UAE to maintain and demonstrate adequate economic presence in the UAE in respect of the activities carried out.
The goal is to ensure that UAE’s businesses report income that are proportionate with their economic activities in the UAE.
The ESR is introduced by the UAE as part of its commitment as a member of the Organization for Economic Co-operation and Development (OECD) Inclusive Framework, and in response to an assessment of the UAE’s tax framework by the European Union Code of Conduct Group on Business Taxation.
Who is subject to ESR?
The ESR is applicable to Licensees that carry out any of 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 (LLC, shareholding company) that carry out a Relevant Activity and registered in the UAE’s mainland or free zones.
What are the distribution and service center businesses?
Most of small businesses, if they are part of a foreign group, will probably perform either distribution or service center business activities. For this reason, and as an example, here is a brief explanation of these Relevant Activities.
A UAE entity is considered engaged in a Distribution Business if it:
- Purchases goods or materials from a foreign group company; and
- Distributes or sell those goods inside or outside the UAE (even if the goods are directly dispatched to the customer by the foreign group company)
A UAE entity is considered engaged in a Service Centre Business if it:
- Provides consulting, administrative, or other services to a foreign group company
For Example, if a subsidiary in the UAE provides services for its parent company in Germany, it would be considered as a service center business (a Relevant Activity). Hence, the subsidiary is subject to the Economic Substance Regulations.
Who is NOT subject to ESR?
- Natural persons
- Sole proprietorship licenses
- Any other business that does not carry out any of the above Relevant Activities
What are the Licensee’s obligations if it is subject to ESR?
Licensees that carry out a Relevant Activity are required to file an annual notification. And if they earn income for the Relevant Activity, they should demonstrate sufficient economic substance in the UAE and file an annual Economic Substance Report.
How to demonstrate sufficient economic substance in the UAE?
- Conduct Core Income Generating Activities in the UAE. Those are the important activities that generate income from Relevant Activities.
- Those activities must be directed and managed in the UAE (board meeting to be held in the UAE)
- The Licensee must have adequate level of employees, expenditure, and physical assets in the UAE.
What are the important things for a Licensee to consider each financial year?
- Assess whether the business has carried out any Relevant Activity
- Assess the income generated from a Relevant Activity
- Assess the adequacy of resources to carry out the Relevant Activities
- Hold board meetings in the UAE
- Submit the annual notification and file the annual ESR report
What are the 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
- Failure to provide accurate or complete information: AED 50k and deemed failure to demonstrate economic substance
- Failure to demonstrate sufficient economic substance in the UAE: AED 50k. Second consecutive instance of failure: AED 400k. License suspended, withdrawn, or not renewed.
For a detailed discussion on how to determine whether you conduct a Relevant Activity, or how to meet the ESR requirements, please contact us.