Main ESR legislation
The ESR includes, in particular: (i) Cabinet Resolution No. 31 of 2019 on the Specification of the Requirements of the Real Economic Activities, (ii) Ministerial Decision No. 215 of 2019 on the Issuance of Directives for the Implementation of the Provisions of Cabinet Decision No. 31 of 2019, (iii) Cabinet of Ministers Resolution No. 57 of 2020 Determining the Economic Substance Requirements, and (iv) Ministerial Decision No. 100 of 2020 on the Issuance of Directives for the Implementation of the Provisions of Cabinet Decision No. 57 of 2020 Concerning Economic Substance Requirements.
What does the ESR require?
The ESR requires Licensees to demonstrate that they have a genuine economic presence in the UAE and that the activities they carry on are not solely tax-driven. Licensees may be required to prepare and submit an economic substance notification (Notification) and an economic substance report (Report) from 1 January 2020 onwards, on an annual basis (if applicable).
Economic Substance Test
Pursuant to the ESR, Licensees that carry on a Relevant Activity in the UAE that generates revenue/income (either a profit or a loss) must maintain an adequate presence in the UAE such as through having an adequate level of assets or number of qualified employees. In addition, the strategic management decisions of the Licensee must be conducted in the UAE. In other words, they must meet what is known as an “Economic Substance Test”. The level of economic substance a Licensee is required to demonstrate under the Economic Substance Test may depend on the type of Relevant Activity conducted by it in the UAE.
What are the Relevant Activities?
The Relevant Activities are as follows:
(i) Banking business
(ii) Insurance business
(iii) Investment fund management business
(iv) Lease-finance business
(v) Headquarter business
(vi) Shipping business
(vii) Holding company business
(viii) Intellectual property business
(ix) Distribution and service centre business
Any Licensee carrying on any of the above activities may be required to prepare and submit a Notification and potentially a Report to the Ministry of Finance.
Economic substance notification
The Ministry of Finance requires that a Notification is filed by the Licensee on an annual basis if it has conducted one or more Relevant Activities. The purpose of the Notification is for the Licensee to confirm whether it carried on one or more Regulated Activities and whether it generated an income from such activity (or activities) during the reportable period. The Notification must be filed annually, within six months from the Licensee’s financial year end.
Licensees that undertake one or more Relevant Activities must submit a Notification even if their business falls within the scope of one of the exemptions under the ESR.
Economic substance report
The main aim of the Report is for Licensees conducting Relevant Activities in the UAE to provide the Ministry of Finance with information on their income, expenditure, assets, employees and governance as they relate to the Relevant Activities. The Report must be filed annually, within 12 months from the Licensee’s financial year end.
Licensees that conduct any Relevant Activity in the UAE that generates revenue, must submit an annual Report demonstrating that they meet the requirements of the Economic Substance Test, unless they benefit from an exemption. As an exception, an entity which carries on a Relevant Activity but does not earn any income from that activity within the reportable period, is not required to meet the Economic Substance Test and file a Report in that period.
The Report requires disclosure of information similar to that required to be disclosed in the Notification. However, the Licensee must provide further information regarding its financial performance, including total revenue in the reportable period, the accounting profit or loss, and a breakdown of its financial statements. The Licensee is also required to file a copy of its audited accounts for the reportable period.
Are you exempt?
The following categories of entity are exempt from filing a Report, but still need to file a Notification:
(i) Entities wholly owned by UAE nationals or UAE resident individuals which are not part of a multinational enterprise group and operate solely within the UAE
(ii) Investment funds
(iii) Special purpose vehicles or an investment holding company of investment funds
(iv) Entities that are tax resident in a jurisdiction other than the UAE
(v) Branches of a foreign company where the income of the branch is subject to tax in the jurisdiction of the parent company
Failure to comply with the ESR may lead to financial penalties and/or the suspension of a Licensee’s business licence. For instance, a failure to submit or late submission of a Notification may incur a fine of AED 20,000 while failure to submit a Report may give rise to a fine of AED 50,000. Failure to provide accurate or complete information may also result in a fine of AED 50,000 being imposed.
Entities that fail to demonstrate sufficient economic substance in the UAE in the relevant reportable period, may be subject to a fine of AED 50,000, which could rise to AED 400,000 if this failure is repeated in subsequent reportable periods and lead to the suspension or withdrawal of the entity’s business licence.
Notifications must be filed within six months from the end of the relevant reportable period, while Reports must be filed within 12 months from the end of the relevant reportable period.
A reportable period is a Licensee’s accounting reference period or financial year for which a Notification must be filed. Therefore, the end of the reportable period should correspond to the financial year end date.
Licensees with a financial year ending on 31 March are required to file:
(a) A Notification by 30 September
(b) A Report by 31 March
Licensees with a financial year ending on 30 June are required to file:
(a) A Notification by 31 December
(b) A Report by 30 June
Licensees with a financial year ending on 30 September are required to file:
(a) A Notification by 31 March
(b) A Report by 30 September
Licensees with a financial year ending on 31 December are required to file:
(a) A Notification by 30 June
(b) A Report by 31 December
It is important for legal entities to determine whether they are required to file a Notification and a Report based on the Relevant Activities they perform and the income generated. To avoid the risk of fines, legal entities should also begin to prepare the evidence that may be required to supplement the Notifications and Reports required under the ESR. If you have any questions regarding the ESR or its application to your business, please get in touch you’re your usual contact at Reed Smith or one of the authors, and we would be happy to assist you in determining whether the ESR applies to your business and what the next steps are to ensure compliance.
Client Alert 2023-110