Navigating the UAE’s New Economic Substance Regulations

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The UAE has updated its Economic Substance regulations and firms need to act now to understand how this will affect them and what actions they need  to take to remain compliant.

The UAE Cabinet of Ministers issued Cabinet Resolution No. 57 of 2020 on August 10 2020, which included important changes to the scope and application of the Economic Substance requirements. Firms need to make sure that they understand the updated regulations and act accordingly to remain compliant. These changes have now replaced the original regulations passed in April 2019.

 

Background

 

The UAE is committed to the OECD’s Inclusive Framework on Base Erosion of Profit Shifting, an international collaborative initiative to address tax avoidance strategies that exploit gaps and mismatches in international tax rules.

 

Following a review by the EU Code of Conduct Group for Business Taxation, the UAE introduced, in April 2019, a Resolution on Economic Substance (Cabinet of Ministers Resolution No.31 of 2019 Regulations). This regulation states that UAE onshore and free zone companies that carry out a “Relevant Activity” need to meet certain thresholds for “Economic Substance” in order to continue to carry on these activities without any additional taxation or reporting obligations. The revised regulations completely replace the original regulations.

 

Entities governed by this regulation are required to submit a notification to their Regulatory Authority from January 1, 2020 onwards, an economic substance declaration within 12 months from the end of their financial year, and annually thereafter. It is still unclear whether the existing filed notifications will be accepted. It is advisable that all entities which are in scope resubmit their notification through the Ministry of Finance portal, once it becomes available.

 

How is ‘Economic Substance’ defined?

 

Economic Substance is a broad term and encompasses multiple business activities including operations, controls, procedures and physical presence in a jurisdiction. The level at which substance is required for any particular company will vary depending on the nature of the activities and any other jurisdictions in which the organisation is registered or operating through. A business may demonstrate sufficient economic substance by:

 

  • conducting “core” income generating activities in UAE
  • incurring functioning expenses in UAE
  • hiring and retaining staff in UAE
  • retaining physical assets in UAE
  • ensuring important management decisions concerning the entity are made in UAE.

 

What are ‘Relevant Activities’?

 

Activities that fall within the scope of the regulations include:

 

  • banking business
  • insurance business
  • investment fund management
  • lease – finance
  • headquarters business
  • shipping
  • holding company business
  • intellectual property (“IP”)
  • distribution and service centre business.

What types of entity fall within scope?

 

Entities that fall within the scope of this regulation include incorporated businesses, government agencies, NGOs, unincorporated partnerships that conduct relevant activities in the UAE and, importantly, entities with majority ownership (greater than 51%) by the UAE government are now included.

 

The update to the regulation includes some notable exemptions. Exempted entities will still need to file a notification and provide sufficient evidence to prove they meet the definition of the exemptions. Natural persons, sole proprietors, trusts and foundations are out of scope and do not need to file notification or meet the Economic Substance Test.

 

  • Non-UAE resident entities are excluded and the related UAE entity will need to submit a tax residence certificate or other such documentation to prove it is tax resident in another jurisdiction.
  • Investment Funds and Special Purpose Vehicles, but the exemption does not extend to entities in which it ultimately invests.
  • Entities wholly owned by UAE residents which are either not part of a multinational group or carry out business activities only in UAE.
  • UAE branches of a foreign head office or parent whose income or capital is subject to tax in the head office jurisdiction. The “subject to tax” test is met where the foreign head office (or parent) entity includes the UAE branch as part of any reportable income or capital gain, irrespective of any double taxation treaties between the foreign head office and UAE branch.

 

What are the penalties for non-compliance?

 

The Federal Tax Authority is responsible for assessing the applications for licensees or exempted licensees. The Ministry of Finance is responsible for exchange of information with any foreign tax authorities it deems necessary.

 

Penalties range from AED 20,000 for failure to file a notification to AED 400,000, plus withdrawal of a relevant trade / commercial licence for the entity in question, for repeat offences of not filing notifications and not satisfying sufficient economic substance in UAE.

 

Talk to Apex

 

Our local team in UAE has considerable experience and is able to support clients in gaining a full understanding of the Substance requirements under local law.

 

Our single-source service model enables our team to support clients at every stage of the process from Substance analysis all the way through to the implementation of additional measures, ongoing monitoring and assisting with the relevant filing with the regulatory authority; with a range of services tailored to the individual needs of each company.

 

Apex is well placed to provide the following services which form the core of the Economic Substance requirements demonstrating physical presence in UAE.

 

  • Company Incorporation
  • Registered Office
  • Provision of Resident Directors
  • Company Secretarial Services
  • Opening and Managing Principal Bank Account in UAE
  • Business Services
  • Fund Administration Services.

 

Contact us now to learn more about what Apex Group can offer you.

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