02/06/2020 by Amanda Paiva
Economic Substance Regulations In The UAE
The UAE government has recently introduced economic substance regulations, and as a result, all UAE businesses that may be subject to these regulations should be prepared to take action and ensure compliance. Read on to learn more.
On 30 April 2019, the UAE Cabinet issued the Cabinet of Ministers Resolution No.31 of 2019 (concerning economic substance regulations in the UAE, “the Regulations”), requiring all in-scope UAE entities that carry on certain activities to have demonstrable economic substance in the UAE from 30 April 2019.
The Economic Substance Test requires a Licensee to demonstrate that the Licensee and Relevant Activity are being directed and managed in the UAE; the relevant Core Income Generating Activities (CIGAs) are being conducted in the UAE and the Licensee has adequate employees, premises and expenditure in the UAE.
The Regulations apply to all UAE onshore and free zone companies that carry on a Relevant Activity. It is yet to be confirmed whether the Regulations will also apply to sole proprietorships and branches, but we expect entities incorporated under offshore (free zone) companies’ regulations that carry on a Relevant Activity to be within the scope of the Regulations. Entities that are directly or indirectly owned by the UAE government (both federal and local) are specifically excluded from the Regulations. On this basis, UAE sovereign investment funds and other UAE government related entities would not need to meet the UAE economic substance requirements.
The following are considered as “Relevant Activities” under the Regulations:
· Fund management
· Holding company
· Intellectual property (IP)
· Distribution and service center
To satisfy the economic substance requirements in relation to a Relevant Activity, a Relevant Entity must:
- Conduct the relevant ‘core income generating activities’ in the UAE
- Be ‘directed and managed’ in the UAE; and
- With reference to the level of activities performed in the UAE;
Have adequate number of qualified full-time employees in the UAE
Incur an adequate amount of operating expense in the UAE
Have adequate physical assets in the UAE
In the case of state core Income Generating Activities carried out for the relevant licensee by another entity, it should be able to monitor and control the carrying out of that activity by the other entit
A Relevant Entity that only undertakes a Holding Company Business (a company that owns other companies and usually does not produce goods and services on its own) will be subject to less stringent economic substance requirements. Additional requirements apply if a Relevant Entity carries out “high risk IP (Intellectual Property) related activities”. If a Relevant Entity carries out more than one Relevant Activity, the economic substance requirements must be met for each of the Relevant Activities.
Further Definition On Relevant Activities
Insurance, Banking, Lease Financing, Investment Fund Management. If an entity is licensed by the relevant UAE licensing authority to carry out any of these activities in the UAE, they will be required to comply with the Economic Substance Rules.
Shipping. Shipping is defined in the Economic Substance Rules as being the operation of a ship anywhere in the world other than within the territorial waters of the UAE and includes any of the following activities:
- transporting persons, animals, goods or mail by sea or chartering ships for such purpose;
- selling travel tickets and ancillary (support/help) services;
- using, maintaining or renting shipping containers including trailers and other vehicles or equipment for the transport of shipping containers; or
- ship crew management.
Holding Companies. Holding companies which hold shares or equitable interests in other companies, earn dividends and capital gains from such shares and do not carry on any other commercial activity are within the scope of the Economic Substance Rules but have much lower compliance requirements.
Holding companies that generate income from activities other than capital gains and dividends or hold assets such as real estate or other investments will not fall within this category. Such a company will need to examine whether they fall under one of the other categories, such as a company headquarters or service centers, and whether they are required to comply with the usual Economic Substance Rules requirements. If not, they will fall outside the scope of the Rules.
Intellectual Property. A business which is licensed in the UAE to hold, exploit or receive income from intellectual property assets, defined as being any intellectual property right in intangible assets including, but not limited to, copyright, trademarks, patents, brand and technical know-how, are within scope of the Economic Substance Rules.
Headquarters Business. Whether or not an entity is deemed to be a company headquarters will not depend on its position in the group but rather on the services it provides to other entities within the group.
Entities providing any of the following services to one or more overseas related entities will fall within the definition:
- the provision of senior management;
- the assumption or control of material risk for activities carried out by, or assets owned by, any overseas related entity; or
- the provision of substantive advice in connection with the assumption or control of such risk.
The above definition appears to be quite broad and reflects the wording of similar legislation in other jurisdictions.
Arguably, if a UAE entity establishes a subsidiary overseas and manages that subsidiary from the UAE, it may be operating a headquarters business and be caught by the legislation. Any company which operates as part of a group should therefore review their arrangements to ascertain whether they are required to comply with the Economic Substance Rules.
Distribution and Service Centers. Although the definitions of distribution centers and service centers have been clumped together in the Economic Substance Rules, they are quite different businesses and the definition of service center has the potential to bring a lot of companies within the scope of the Economic Substance Rules.
A service center is a business providing services to a "connected person" resident outside the UAE in connection with a business outside the UAE. A "connected person" is an entity related through direct or indirect ownership or control, or common control. This definition could potentially capture companies forming part of a group not otherwise captured by the holding company or headquarters definitions. As neither the Economic Substance Rules nor the Ministry of Finance guidance provide any definition or guidance for what sort of "services" are included in this definition it could potentially capture a company who provides services to a related overseas company such as the secondment of staff, technology services, payroll, HR or general business advice.
A distribution center business on the other hand, is a business involved in the acquisition of goods, components or materials from a foreign "connected person" and importing/storing in the state & the sale of such goods, components or materials overseas.
Further Info On ‘Core Income Generating Activities’
Within a Banking Business
- Raising funds, managing risk including credit, currency and interest risk.
- Taking hedging positions.
- Providing loans, credit or other financial services to customers.
Managing capital and preparing reports to investors or any government authority with functions relating to the supervision or regulation of such business
Within an Insurance Business
- Predicting and calculating risk.
- Insuring or re-insuring against risk and providing Insurance Business services to clients.
- Underwriting insurance and reinsurance.
- Within a Fund Management Business.
- Taking decisions on the holding and selling of investments.
- Calculating risk and reserves.
- Taking decisions on currency or interest fluctuations and hedging positions.
Preparing reports to investors or any government authority with functions relating to the supervision or regulation of such business.
Within a Lease-Finance Business
- Agreeing funding terms.
- Identifying and acquiring assets to be leased (in the case of leasing).
- Setting the terms and duration of any financing or leasing.
- Monitoring and revising any agreements.
Managing any risks
Within a Headquarters Business
- Taking relevant management decisions.
- Incurring operating expenditures on behalf of group entities.
- Coordinating group activities
Within a Shipping Business
- Managing crew (including hiring, paying and overseeing crew members).
- Overhauling and maintaining ships.
- Overseeing and tracking shipping.
- Determining what goods to order and when to deliver them, organising and overseeing voyages.
Within a Holding Company
All activities related to that business; and in respect of Holding Company Business that derives income from other sources other than dividends and capital gains from its equity interest, the state Core Income-Generating Activities shall be those activities associated with the income generated.
Within an Intellectual Property Business
- Where the Intellectual Property Asset is a -
patent or an asset that is similar to a patent, research and development.
non-trade intangible asset (including a trademark), branding, marketing and distribution.
- If the Relevant Activity is conducted by a Licensee that is regarded as a High Risk IP Licensee, the State Core Income-Generating Activity must include any of the following additional activities:
- taking strategic decisions and managing (as well as bearing) the principal risks related to development and subsequent exploitation of the intangible asset generating income.
- 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.
- carrying on the ancillary trading activities through which the intangible assets are exploited leading to the generation of income from third parties.
Within a Distribution & Service Center Business
- Transporting and storing component parts, materials or goods ready for sale.
- Managing inventories.
- Taking orders.
- Providing consulting or other administrative services.
Requirement To Provide Information
A Licensee shall notify the Regulatory Authority annually of the following and shall be made at the time specified by the Regulatory Authority and in the form and the manner approved by the Regulatory Authority
- Whether or not it is carrying on a Relevant Activity.
- If the Licensee is carrying on a Relevant Activity; whether or not all or any part of the Licensee’s gross income in relation to the Relevant Activity is subject to tax in a jurisdiction outside of the State, in all cases such Licensee shall provide the Regulatory Authority with all information and documentation required to be submitted by it pursuant to this Resolution or any further guidance or decision issued pursuant to this Resolution.
- The date of the end of its financial year.
Offences & Penalties Where The Economic Substance Is Not Met
· An amount of administrative penalty of not less than dirhams ten thousand (AED 10,000) and not exceeding dirhams fifty thousand (AED 50,000) shall be imposed for failure to meet the Economic Substance Test
· If the Regulatory Authority determines that a Licensee has failed to meet the Economic Substance Test for a Financial Year, the Regulatory Authority must issue a notice to the Licensee notifying it if their findings.
· An amount of administrative penalty of not less than dirhams fifty thousand (AED 50,000) and not exceeding dirhams three hundred thousand (AED 300,000) shall be imposed for failure to meet the Economic Substance Test if the Regulatory Authority has determined that, for the Financial year following a Financial Year in which a notice was issued (Further Financial Year), the Licensee has failed to meet the Economic Substance Test, the Regulatory Authority must issue a further notice with the same advice as mentioned above including any other administrative action the Regulatory authority may impose, including the suspension, revocation or non-renewal of the license of a licensee.
Offences & Penalties Where Information Is Either Inaccurately Provided Or Not Provided At All
· An amount of an administrative penalty of not less than dirhams ten thousand (AED 10,000) and not exceeding dirhams fifty thousand (AED 50,000) if it fails to provide information that the licensee is required to provide or the information provided is inaccurate and knows of the inaccuracy at the time it is being provided and no disclosure of the same is being made right away.
· A Licensee upon whom a penalty is imposed by the Regulatory Authority may appeal against it on any of the following grounds:
- That liability to that penalty does not arise.
- Appeal against its amount.
· The Regulatory Authority shall issue a resolution setting out the procedures for an appeal, including the mechanism for filing an appeal and other procedures relating to the review and decision in relation to an appeal by the Regulatory Authority on receipt of an appeal and means for notifying its decisions to a Licensee.
· An administrative penalty under this Resolution must be paid on or before the date mentioned in 2 any of the following dates whichever is taking place first:
- The date upon which the administrative penalty is due pursuant to a notice issued by Regulatory Authority.
- If notice of appeal is given, the date on which the appeal is finally determined or withdrawn
Power To Examine Business Documents
- The authorized personnel of the Regulatory Authority may examine and take copies of any Business Document that is located on Business Premises.
- The power may be exercised only for the purpose of investigating any issue relating to compliance with any provision of this Resolution.
- The authorized personnel of the Regulatory Authority may at any reasonable hour enter Business Premises for the purpose of exercising the power.
- The Regulatory Authority may by notice require any person to produce any specified Business Document at the Business Premises where the Business Document is located for the purpose of enabling the Regulatory Authority to exercise the power in relation to that document.
Each Relevant Entity must report specified information on its ‘Relevant Activities’ annually to the authority which has issued its trade license to demonstrate that it satisfies the economic substance requirements (this includes, for example, information on the relevant activities such as nature and amount of revenue, expenses, place of business and number of employees with qualifications).
Existing entities will have to comply from 30 April 2019 onwards, with the first return due in 2020. New entities must comply with the Regulations upon receipt of their trade license, with the first return due in 2020 (or later).
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