Ensure Your Business Abides by the New UAE ESR Rules

In response to global efforts to combat harmful tax practices, the United Arab Emirates (UAE) has implemented Economic Substance Regulations (ESR). These regulations, introduced for financial years commencing on or after January 1, 2019, signify a crucial compliance requirement for businesses operating in the region, particularly amidst the economic challenges brought about by the COVID-19 pandemic. This guide aims to provide a thorough understanding of the ESR, its implications, and the essential steps for businesses to ensure compliance.

What are Economic Substance Regulations?

Economic Substance Regulations (ESR) were introduced by the UAE in alignment with international standards set by the Organization for Economic Co-operation and Development (OECD). These regulations aim to curb harmful tax practices and closely adhere to the global framework established by the OECD. As part of its commitment to international tax standards, the UAE, being an OECD member, enacted the ESR on April 30, 2019.

The UAE is not considered a tax haven, having implemented value-added tax (VAT) in 2018 and specific excise taxes. The Ministry of Economy has also indicated considerations for broader corporate taxation. With global emphasis on financial transparency and regulation, international bodies like the OECD advocate for better coordination on tax regulations to prevent profit shifting and tax evasion across jurisdictions.

Alignment with Global Standards:

The UAE is among several low-tax or tax-neutral jurisdictions that have adopted similar regulations. Notable examples include the Bahamas, Cayman Islands, British Virgin Islands, Mauritius, and others. As the UAE seeks to position itself as a leading global business hub, compliance with international standards becomes imperative to maintain its attractiveness for investors and businesses worldwide.

Applicability and Scope:

ESR applies to all businesses established in the UAE, except those entities with at least 51% direct or indirect government ownership. Businesses generating income from specified activities within the UAE must adhere to economic substance requirements for accounting periods beginning on or after January 1, 2019. However, certain allowances are made for holding companies and additional provisions exist for activities involving high-risk intellectual property.

Key Economic Substance Tests:

Businesses engaged in specified activities and generating income in relevant sectors during the specified accounting period are subject to economic substance tests. These tests serve as prerequisites for determining compliance with the regulations. The following are the essential tests that businesses must undergo:

Core Income-Generating Activities (CIGAs):

• Identifying and conducting core income-generating activities within the UAE is a fundamental requirement. These activities vary based on the nature of the business but typically include activities such as manufacturing, distribution, and service provision.

Adequate Substance:

• Demonstrating adequate substance in the UAE is crucial. This entails having appropriate physical presence, qualified personnel, and operational facilities necessary to conduct core business activities effectively.

Management and Control:

• Ensuring that strategic decision-making and management control are exercised within the UAE is essential. Businesses must have a sufficient level of decision-making authority and board meetings held locally.

Compliance Measures and Deadlines:

To ensure compliance with ESR, businesses must undertake comprehensive measures, including:

Assessing Applicability:

• Determine whether your business falls within the scope of specified activities subject to ESR.

Conducting Substance Tests:

• Conduct thorough assessments to ensure adherence to economic substance requirements, including CIGAs, substance presence, and management control.

Documentation and Reporting:

• Maintain accurate records and documentation to substantiate compliance with ESR. Prepare and submit relevant reports to regulatory authorities within stipulated deadlines.

Conclusion:

In conclusion, adherence to UAE's Economic Substance Regulations is a critical requirement for businesses operating in the region. By aligning with international standards and demonstrating economic substance, businesses can ensure compliance and mitigate risks associated with non-compliance. As regulatory scrutiny intensifies, it is imperative for businesses to proactively assess their obligations and take necessary measures to meet ESR requirements effectively.