Why is Economic Substance Regulation (ESR) Essential for Your Business?
as of 09 November 2022
Why implement ESR?
On April 30, 2019, the UAE authorities enacted the Economic Substance Regulations (ESR) as a strong commitment to comply with the EU requirements of being removed from the EU’s list of “non-cooperative” tax jurisdictions. The government’s initiative to take this action highlights the nation’s strong efforts to protect companies against unsafe taxation practices that can affect their expansion and advancement in later stages.
What is ESR?
The implementation of ESR requires certain businesses to have substantial activities in the UAE. With it, certain requirements are imposed on businesses that determine their economic activity in a country that is not driven by low or non-tax jurisdiction. Hence, preventing the destructive tax pattern of shifting the profits from a high-tax to a low-tax domain.
To further refine the ESR and reach the highest global standards set by the Organization of Economic Co-operation and Development (OECD), a new Economic Substance Regulation (ESR) was introduced by the Cabinet of Ministerial Resolution no.57 of 2020 with Ministerial Decision no.100 of 2020 which revoked the former regulations and the previous laws connected to it. With this updated law, companies that are conducting business inside the UAE are required to register as licensees.
What is the purpose?
As a result, all UAE businesses that may be subject to these amended regulations must be prepared to take action and ensure compliance. By providing the Notification to the regulatory authorities with complete information associated with the company’s Licensee and their relevant activities in the UAE within a reportable time. The information provided for the Notification is a requirement for filing an Economic Substance Report. This will enable companies to abide by ESR, save on VAT, and also on import/export tax.
*The purpose of the Notification is to provide the Regulatory Authorities with certain initial information in respect of Licensees and their activities in the UAE for the relevant Reportable Period. The information provided as part of the Notification is a prerequisite to filing an Economic Substance Report for the same period (if required).
Who is subject to ESR?
ESR applies to any corporate entity, natural or juridical, incorporated inside of the UAE, that carries out the relevant activity. These companies can be part of a foreign multinational group or owned by a foreign shareholder and include:
- Onshore Companies
- Free Zone Companies
- Limited Liability Companies (LLC),
- Public Joint Stock Companies (PJSC)
- Private Joint Stock Companies (PJSC)
- Non-Profit Organizations
For ESR, different forms of Licensee exist:
- A business that carries out one or more of the relevant activities during the fiscal year is called a Licensee.
- While other businesses that are exempted from certain requirements under the ESR are referred to as Exempted Licensees.
- Both, whether a Licensee or Exempted Licensee, must submit a Notification at a particular time.
- To have more information regarding the exemption and the requirements, businesses can refer to the notice of exemption.
Who is exempted from ESR?
The exempted Licensee does not have to fulfill certain requirements under the ESR, but they still have to file a Notification with documentary evidence to claim the exempt status. For a corporate entity to qualify for an exempted Licensee, it must:
- Have an investment fund/investment holding entities
- Be a tax resident in a jurisdiction outside the UAE.
- Be an entity that is solely owned by UAE residents
o Not part of a multinational group.
o Only business activities in the UAE.
- Be a branch of a foreign entity where the income is subject to tax in the jurisdiction of the foreign entity.
In the previous regulation, corporate entities that are directly or indirectly owned for an extent of 51% by the UAE government are not exempted from the current regulation.
What are the relevant activities?
The company has to file an ESR (Economic Substance Regulation) Notification if it undertakes one or more relevant activities during the Financial Year. The relevant activities include:
- Investment Fund Management
- Lease and Finance
- Holding Company
- Intellectual Property (IP)
- Distribution & Service Center
For more information and an explanation of each activity, companies can refer to the relevant activities Guide in Schedule 1 of Ministerial Decision 100 of 2020 issued by the Ministry of Finance.
How does ESR affect businesses?
Reporting requirements for each Licensee may differ between license types, kinds of activities, and the location of these companies. Certain procedures must be followed for the submission of these forms. Any failure by the Licensee to submit the Notification on time or qualify for the Economic Substance Test may result in the imposition of penalties and sanctions, depending on the nature of that failure.
How to comply with the ESR requirements?
Licensees and exempted Licensees that are operational and acquiring income from one or more relevant activities in the UAE need to submit a Notification with the date of commencement and end of the financial year to the applicable regulatory authority as set out in the ESR.
Within 6 months from the end of the Licensee’s financial year, the Notification must be filed electronically to the Ministry of Finance Portal. The corporate entities that have already submitted their Notification to their Regulatory Authorities for the financial year 2019 are required to re-submit their Notification on the Ministry of Finance portal. The deadline for the submission will be disclosed by the authority in charge.
The corporate entity will need to present an Economic Substance Return report to the regulatory authority to disclose its substance annually and qualify for the “Economic Substance test” within 12 months from the end of each financial year.
For companies that are at least 51% directly or indirectly owned by an Emirate or federal government agency or are a UAE government body or authority itself, an exemption is applied. A proper structure needs to be in place that meets the Economic Substance requirement for companies that go through the process. To meet the Economic Substance Test, corporate entities must satisfy the following criteria
- Manage and direct the company related to their relevant activity.
- Conduct income-generating activities.
- Supervise the appropriate number of qualified full-time employees.
- Handle a sufficient amount of operating expenditure.
- Hold adequate physical assets for the function of the company.
The new ESR regulations permit corporate entities to outsource certain functions to third-party service providers. The companies should ensure that they can regulate and oversee outsourced activities.
Specific regulations are in place for holding companies whose profits and income are garnered from equity investments. A holding company in the UAE is subject to less rigorous Economic Substance requirements. For high-risk IP-related activities in the UAE, additional requirements are put in place.
What needs to be reported?
Specified information on the ‘Relevant Activities’ must be reported annually to the appropriate authority who has issued the company’s trade license to determine that the report is in line with the Economic Substance requirements which include:
- Information on the relevant activities
- Nature of business
- Amount of revenue
- Company expenditure
- Location of company
- Number of employees
What are the Notification dates for ESR?
The corporate entities that have fulfilled the Economic Substance requirements can report to the Ministry of Finance. For the company to comply with the ESR:
- Existing corporate entities will have to submit the Notification from April 20, 2019, onwards, with the first return due in 2020.
- New corporate entities need to submit the requirements upon the receipt of their trade licenses, with the first return due in 2022.
How to send the Notification?
The Notification must be submitted electronically to the Ministry of Finance (MOF) and all the fields in the Notification are mandatory to fill unless stated as optional.
How many Notifications can be sent?
The submission of Notification is dependent on the type of company, the form of business, the economic activity, and the kind of Licensee.
- If the business carried out a relevant activity for part of the year, then it is still required to file for Notification and report all relevant activities undertaken during the Financial Year.
- If a business has multiple Licensees, then each Licensee must file a Notification on a stand-alone basis, whether the Licensee is part of a consolidated group for accounting or not.
- If the business has a branch in the country and must file a Notification, then the UAE head office or parent company can file a single consolidated Notification that incorporates all the details of the branches that carry out the relevant activity.
What is the deadline to file for ESR?
The ESR Notification must be filed within 6 months from the end of the Licensee’s financial year.
What happens if the Licensee has failed to comply?
If a business had failed to fulfill the requirements of ESR on time, then significant amount of fines are imposed by the Federal Tax Authority which include:
- Failure to file Notification on time – AED 20,000
- Providing inaccurate information – AED 50,000
- Failure to submit substance report – AED 50,000
- Failure to fulfill Economic Substance test – AED 50,000
- Suspension, revocation, or non-renewal of the license: AED 300,000
- Failure to comply for the second consecutive year: AED 400,000
- The penalty amount is increased every year which entities and activities are within the scope of the revised Economic Substance rules and/or
What are the authorities under the ESR?
- National Assessing Authority
- The UAE Federal Tax Authority is appointed as the National Assessing Authority that is responsible for:
- The assessment of Licensees and Economic Substance tests
- The injunction of administrative penalties for non-compliance
- Evaluate and conclude on the appeals filed by Licensees.
- The UAE Federal Tax Authority is appointed as the National Assessing Authority that is responsible for:
- Regulatory Authority
- The Regulatory Authorities have the main responsibility to gather, organize, and verify the information of the Licensees and help the FTA in performing its role as the National Assessing Authority.
- Competent Authority
- The Ministry of Finance is the competent authority to disclose the necessary information to foreign competent authorities.
How can EZONE assist you?
EZONE has created exceptional partnerships that can provide a complete array of services connected to bookkeeping, accountancy, auditing, payroll, VAT, banking facilities, ERP selection, business planning, and cash flow forecast to a diverse range of clientele from personal entities, and SMEs to MNCs. Our expert team of affiliates is ready to assist you with the following:
A. Initial Assistance
- Recognizing if the business is within the scope of ESR
B. Comprehensive Assessment and Gap Analysis
- Analyzing if the business is subject to the Economic Substance Test.
- If they are subject then an assessment will be done which will determine if the business operations across all emirates, onshore/ free zones, are currently expected to meet the requirements of the regulations.
C. Compliance Assistance
- Evaluate if the company is a Licensee conducting relevant activity during the reportable period.
- Classifying the compliance requirements for the company.
D. Implementation to meet Economic Substance Test
- Recommending solutions to comply with the Regulations
- Ensuring the implementation of the corrective or preventive corporate measures to fulfill the requirements of the Economic Substance Test
- Preparing submitting the Notification and the report for submission with the Ministry of Finance.
From the preparation of any documentation, and the review of information to the submission to the significant authorities, we can help you with the filing and refiling of the Notification and Economic Substance Return with the Ministry of Finance. We can provide you with continuous assistance and assessment services to ensure that there is ongoing compliance with the ESR.
With EZONE, you don’t have to worry about any unwarranted risks. ESR Assessment is essential for your business. Save your time and money. Call us at 800-EZONEUAE or message us at email@example.com and book a FREE consultation with us.