- The UAE recently enacted the Cabinet Decision No. 31/2019 concerning the economic substance regulations (the “Regulations” or the “Economic Substance Regulations”) on 30 April 2019 in response to the European Union (EU) adding the UAE to the blacklist of non-cooperative jurisdictions for tax purposes in March 2019.
- The Regulations primarily apply to companies carrying out a ‘Relevant Activity’, i.e., banking, insurance, investment find management, lease-finance, headquarters, shipping, holding company, intellectual property, and distribution and service centers. Such companies must satisfy the Economic Substance Test as specified in the Regulations.
- All onshore and freezone companies (including those in the financial freezones, i.e., the DIFC and the ADGM) in the UAE (“UAE Companies”) are required to notify the Regulatory Authority, on an annual basis, as to whether their activities fall within the ambit of a Relevant Activity. Companies which carry on Relevant Activities have additional annual disclosure requirements.
- The Regulatory Authority is not yet established and the format and deadline for the annual notification is not yet known.
- Penalties for non-compliance entails a fine ranging from AED 10,000 to AED 50,000. Subsequent breaches entail additional fines.
Why did the UAE enact the Economic Substance Regulations?
The EU Code of Conduct Group as well as the Organization for Economic Cooperation and Development (OECD) which recently issued a new global standard on Base Erosion and Profit Shifting (BEPS) have been assessing the tax policies of jurisdictions with no or only nominal tax against the criterion of ‘economic substance’. As such, the objective of EU and the OECD is to prevent tax planning strategies used by entities that exploit loopholes in tax rules to avoid paying tax.
In line with the above, the EU has published a list of non-cooperative tax jurisdictions which includes countries or territories that failed make sufficient commitments in response to EU concerns on tax fraud, evasion and avoidance.
In response to the regulatory developments, and to preserve reputation, governments of Bermuda, British Virgin Islands (BVI), Cayman Islands, Isle of Man, Jersey, Guernsey, Mauritius, Bahamas, and Seychelles enacted legislation introducing enhanced economic substance requirements for tax purposes, bringing the rules into force as from 1 January 2019.
Given that the UAE did not enact economic substance regulations, it was included in the EU blacklist in March 2019. With a view to be removed from the EU blacklist, the UAE enacted the Economic Substance Regulations, in line with other international low to no tax jurisdictions.
When did the Economic Substance Regulations Come into Force?
The Economic Substance Regulations came into force on 30 April 2019.
Who does the Economic Substance Regulations apply to?
The Regulations primarily apply to all UAE Companies that conduct “Relevant Activities”.
The following are considered ‘Relevant Activities’ (“Relevant Activities”) under the Regulations:
(iii) Investment Fund management
(vii) Holding company
(viii) Intellectual property
(ix) Distribution and service center
Companies owned directly or indirectly by the government authorities, both federal and state, are excluded from the application of the Regulations.
Note that companies which do not carry out Relevant Activities are still obligated to provide annual notifications to the Regulatory Authority (please see answer to question 8).
What are the key compliance requirements of an entity carrying out Relevant Activities under the Regulations?
An entity carrying out Relevant Activities (the “Relevant Entity”) must (i) comply with the economic substance test (“Economic Substance Test”), and (ii) provide the requisite information to the Regulatory Authority under the Regulations.
How does a Relevant Entity satisfy the Economic Substance Test?
An entity satisfies the Economic Substance Test by demonstrating that:
- it conducts its core income-generating activities (“CIGA”) in the UAE. Note that each of the Relevant Activities has its own CIGA specified in the Regulations, and the relevant CIGAs are set out under the response to question 6;
- the direction and management of the entity is conducted in the UAE with respect to its CIGA;
- the entity has an adequate number of qualified full-time employees, with respect to the CIGA, who are physically present in the UAE or there is an adequate level of expenditure on outsourcing to third-party service providers, whose activities, employees, expenditure, and premises are in the UAE;
- the entity incurs sufficient operating expenses in the UAE or incurs an adequate level of expenditure on outsourcing adequate level of expenditure on outsourcing to third party service providers whose activities, employees, expenditure and premises are in the UAE;
- there are adequate physical assets or adequate level of expenditure on outsourcing to third-party service providers for the company to provide the CIGA within the UAE;
- in the case of CIGA in the UAE is carried out for the relevant entity by another entity, the relevant entity is able to monitor and control the carrying out of that activity by the other entity.
What are the relevant CIGAs for each of the Relevant Activities?
(a) predicting and calculating risk;
(b) insuring or re-insuring against risk and providing insurance business services to clients;
(c) underwriting insurance and reinsurance.
(a) raising funds, managing risk, including credit, currency and interest risk;
(b) taking hedging positions;
(c) providing loans, credit or other financial services to customers;
(d) managing capital and preparing reports to investors or any government authority with functions;
(e) supervision or regulation of such businesses.
|Investment Fund Management Business||
(a) taking decisions on the holding and selling of investments;
(b) calculating risk and reserves;
(c) taking decisions on currency or interest fluctuations and hedging positions;
(d) preparing reports to investors or any government authority with functions relating to the supervision or regulation of such business.
(a) agreeing funding terms;
(b) identifying and acquiring assets to be leased (in the case of leasing);
(c) setting the terms and duration of any financing or leasing;
(d) monitoring and revising any agreements;
(e) managing any risks.
(a) taking relevant management decisions;
(b) incurring operating expenditures on behalf of group entities;
(c) coordinating group activities.
(a) managing crew (including hiring, paying and overseeing crew members);
(b) overhauling and maintaining ships;
(c) overseeing and tracking shipping;
(d) determining what goods to order and when to deliver them, organising and overseeing voyages.
(a) all activities related to that business;
(b) in respect of business that derives income from other sources other than dividends and capital gains from its equity interest, the CIGA will be those activities associated with the income generated.
(a) where the Intellectual Property Asset is a:
A. patent or an asset that is similar to a patent, research and development.
B. non-trade intangible (including a trademark), branding, marketing and distribution.
(b) if the Relevant entity is regarded as a high-risk IP licensee (as defined under the Regulations), the CIGA must include any of the following additional activities:
A. taking strategic decisions and managing (as well as bearing) the principal risks related to development and subsequent exploitation of the intangible asset generating income.
B. taking the strategic decisions and managing (as well as bearing) the principal risks relating to acquisition by third parties and subsequent exploitation and protection of the intangible asset.
C. carrying on ancillary trading activities through which the intangible assets are exploited leading to the generation of income from third parties.
|Distribution and service center||
(a) transporting and storing component parts, materials or goods ready for sale;
(b) managing inventories;
(c) taking orders;
(d) providing consulting or other administrative services.
Who is the Regulatory Authority in the UAE?
The Regulations has not specified the Regulatory Authority yet. The Regulatory Authority is likely to be indicated by the UAE Cabinet in it a later resolution.
What Information must be provided to the Regulatory Authority?
Under Article 8 of the Regulations, UAE Companies are required to provide the Regulatory Authority with the following information on an annual basis:
(i) whether the company is engaged in a Relevant Activity;
(ii) If the entity is carrying out a Relevant Activity, whether or not its gross income from the Related Activity is subject to tax outside the UAE;
(iii) the date of the end of its financial year.
The format and the deadline for such notification will be specified by the Regulatory Authority.
Additionally, UAE Companies that are engaged in the Relevant Activities have to provide the following additional information in an annual report which has to be filed no later than 12 months from the financial year end of the company:
(i) the type of Relevant Activity the company is engaged in;
(ii) the value and type of income related to that Relevant Activity;
(iii) the value and type of operating expenses and assets of the Relevant Activity;
(iv) the location of the place of business and, if applicable, plant, property or equipment used for the Relevant Activity;
(v) the number of full-time employees, including their qualifications, and the number of those responsible for the exercise of the Relevant Activity;
(vi) information showing the CIGA in respect of the Relevant Activity;
(vii) declaration of whether the company has met the requirements of the Economic Substance Test.
Additional information must be provided for those entities carrying out a high-risk intellectual property business or outsourcing their Relevant Activity.
What are the Penalties for not Complying with the Regulations?
Fines ranging from AED 10,000 to AED 50,000 may be imposed on UAE companies for failure to comply with the Regulations including not providing the Regulatory Authority with the information specified under Article 8, not providing the Regulatory Authority with accurate information about their economic substance, and not meeting the requirements of the Real Economic Activities.
Subsequent breaches entail greater penalties ranging from AED 50,000 to AED 300,000.
(i) All UAE Companies must assess whether their activities fall under the ambit of Relevant Activities and be prepared to take action soon as the details of the Regulatory Authority is notified.
(ii) Relevant Entities must ensure compliance with the Economic Substance Test.