In April 2019, the UAE published its first Economic Substance Regulations (ESR) through Cabinet Decision No. 31 of 2019. Until June 30, 2020 all companies registered in the UAE have fulfilled one of their obligations, i.e. submitting a notification to the relevant authority of whether or not a Relevant Activity has been carried in the financial year 2019. As the companies are now awaiting the second phase of submission which is the Economic Substance Report itself – the Ministry of Finance has now announced a new set of laws and guidelines on ESR. These newly enacted changes will have a profound effect on the companies registered in the UAE as they will have to re-submit the ESR Notifications for the financial year 2019.
I. WHAT IS THE CURRENT SITUATION?
In April 2019, the UAE published its first ESR which have then been constantly updated by subsequent decisions and guidelines (please click here for our legal briefing on the initial ESR).
Until June 30, 2019 all companies registered in the UAE and holding a license were obliged to submit a notification of whether or not a Relevant Activity has been carried out in the financial year 2019.
Until the December 31, 2020, the second phase of reporting should have been implemented – the actual submission of the Economic Substance Report indicating whether or not the Economic Substance Test has been met and why.
II. THE NEW ESR FRAMEWORK
In August 2020, the UAE government has issued a new set of laws and guidelines forming a new ESR framework. The following table provides a brief overview of the current ESR framework after the newly enacted changes:
|OId Regulation||New Regulation|
|Cabinet of Ministers Resolution No. 31 of 2019 concerning Economic Substance Regulations||Cabinet of Minister Resolution No. 57 of 2020 concerning Economic Substance Requirements (Revised ESR)|
|Ministerial Decision No. 215 of 2019 on the Issuance of Directives for the Implementation of the Provisions of the Cabinet Decision No. 31 of 2019 concerning Economic Substance Requirements||Ministerial Decision No. 100 of 2020 on the Issuance of Directives for the Implementation of the Provisions of the Cabinet Decision No. 57 of 2020 concerning Economic Substance Requirements (IR)|
|Cabinet Resolution No. 58 of 2019 Determining the Regulatory Authorities Concerned with the Business mentioned in Cabinet Resolution No. 31 of 2019 Concerning Economic Substance Regulations||Abolished|
|UAE Economic Substance Regulations – Relevant Activities Guide||Schedule 1 to the IR (Guide)|
The Revised ESR came into effect on August 10, 2020 and the IR came into effect on August 19, 2020.
Below are the most notable changes made to the ESR framework pursuant to the enactment of the Revised ESR and IR:
1. Exempted Licensee
The Revised ESR have introduced the category of "Exempted Licensee" who do not have to pass the Economic Substance Test, but still have to submit the ESR Notification.
The following entities will be considered as an Exempted Licensee:
- an investment fund;
- an entity which is tax resident in a jurisdiction other than the UAE;
- an entity wholly owned by UAE residents (nationals or expats) that is not part of a multi-national group and only carries out activities in the UAE; and
- branch of a foreign entity if the relevant income (in terms of ESR) is subject to tax in a jurisdiction other than the UAE.
Such Exempted Licensees would still have to submit the annual notification to the relevant authority in which they would have to state that they are an Exempted Licensee. The notification has to be accompanied with supporting documents showing the grounds for the sought exemption.
2. UAE Branches
Branches of UAE companies within the UAE will not be considered as separate legal entities in terms of ESR but rather as extension of the parent company. This means that no separate ESR Notification and/or ESR Report has to be submitted for the UAE branches.
Such branches will now be consolidated in the ESR Notification and/or ESR Report of their parent companies.
3. Definition of Distribution and Service Center Business
Although the Revised ESR have slightly changed the definition of the Distribution and Service Center Business, the result will have a big impact.
The old ESR defined a Distribution Business Center as purchasing goods and materials from a foreign connected person, importing and storing them in the UAE and reselling such goods and materials outside the UAE. The Revised ESR does not require that the goods and materials shall be imported into and/or stored in the UAE as well as sold "outside the UAE". This means that as long as the UAE entity is part of its headquarter's supply chain, it will be considered as carrying out a Distribution Center Business.
4. National Assessing Authority
Maybe one of the most significant changes is the introduction of a National Assessing Authority ("NAA") which resulted in an additional administrative layer for the whole process of submitting and assessing ESR Notifications and Reports.
The role of the NAA is being performed by the Federal Tax Authority. The following tasks have been assigned to the NAA:
- assessing and determining whether or not an Economic Substance Test has been met;
- imposing administrative penalties;
- hearing and deciding on appeals against administrative penalties; and
- reporting to the Ministry of Finance.
With the introduction of the NAA, the relevant authorities are now only collecting the notifications, reports and any other data and forwarding them to the NAA for further assessment.
It is also now the responsibility of the NAA to decide on any administrative penalty.
The relevant authority will only apply and implement the penalties decided by the NAA without having any right to object and/or discuss the imposed penalties on their licensees.
It is not along ago when the first ESR Notification in May/June 2020 raised multiple questions with regard to various topics as well as the further procedure related to the ESR Report. Although the Revised ESR do not resolve the aforementioned problems, they are nevertheless providing clarifications on a few of contentious topics.
However, the introduction of the NAA also resulted in the obligation of re-assessing the entities' activities – especially of branches of foreign companies – and re-submitting the ESR Notification. Neither the Revised ESR nor the IR provide for any deadline and/or format for the re-submission of the ESR Notification. Furthermore, it should be noted that the ESR Report will still be due by end of the year 2020 without any clarity on the submission channel and/or the format for such a report.
It is now on the Ministry of Finance to provide clear information and instructions on the further procedures with regard to the ESR Notification and Report.
SCHLÜTER GRAF will monitor the developments and inform you on any new development and/or information.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.