Earlier in April 2019, Ministry of Finance of United Arab Emirates (UAE) released Cabinet Resolution No 31 of 2019 (Resolution) on Economic Substance Regulations (ESR or the Regulation). The regulation is a part of UAE's commitment to the OECD inclusive framework. Our publication summarizing key highlights of the regulations can be found here.
The regulations require UAE onshore and free zone companies and other UAE business forms (collectively referred to as Licensee) that carry out any of the Relevant Activities to maintain an adequate economic presence in the UAE related to the activities.
In furtherance to the above, recently, the Finance Ministry of UAE released a list of 41 Frequently Asked Questions (FAQs) to address the concerns of impacted entities in relation to ESR. Most importantly, in addition to listing down the FAQs, the Ministry has also provided useful guidance on the steps a Licensee needs to take before the end of the financial year in order to meet the compliance requirements of the regulations. Basis the said guidance, a Licensee shall –
- Assess what Relevant Activities have been/likely to be performed during the financial period (applying a 'substance over form' approach);
- Assess amount and type of income earned from the Relevant Activity during the financial period;
- Conduct board meetings with a quorum of directors' present in the UAE; document minutes of these meetings;
- Analyze all the expenses incurred;
- Analyze and document key UAE based assets (including premises) which is connected to the Relevant Activity;
- Maintain relevant documents such as agreements and financial records supporting the assets and expenses;
- Analyze roles and responsibilities of employees towards the Relevant Activity;
- Examine relevant outsourcing agreements;
- Any other aspects that may help Licensee to demonstrate sufficient Economic Substance in the UAE for a relevant financial period.
Key highlights of the FAQs are summarized below:
|What is the first reportable financial year?||Regulations apply to financial year starting on or after 1 January 2019. For a UAE company following January to December as financial year, first assessable period would be 1 January 2019 to 31 December 2019. However, for a UAE company following April-March financial year, first assessable period would be 1 April 2019 to 31 March 2020.|
|Do the regulations only apply to UAE entities that are part of a foreign multinational group?||No. The regulations impose Economic Substance requirements on any UAE entity which carries on a Relevant Activity, regardless of whether the UAE entity belongs to a foreign multinational group. However, a UAE based Distribution Business, Service Centre Business, Headquarter Business or High-Risk IP Business would only be within the scope of the regulations if the UAE entity transacts with foreign group companies.|
|Is a company registered under an 'offshore' free zone company regime subject to the regulations?||Yes. Regulation shall apply to 'offshore' company provided it undertakes a Relevant Activity.|
|Do the activities listed on the commercial license determine whether a Licensee undertakes a Relevant Activity?||No. Whilst the commercial license may indeed describe the Relevant Activity, a 'substance over form' approach must be used to determine whether a Licensee undertakes a Relevant Activity and is within the scope of the regulations.|
|What if a Licensee does not undertake a Relevant Activity during a financial period?||The Licensee would not be required to notify its Regulatory Authority nor submit an Economic Substance return for the relevant financial period.|
|What if a Licensee undertakes a Relevant Activity, but does not earn any income from that activity during a financial period?||The Licensee would only need to submit a notification with its Regulatory Authority, however, not required to file an Economic Substance return for the relevant financial period.|
|If all income from the Relevant Activity is earned from outside UAE, is the Licensee exempt from the Regulations?||No, this Licensee is not exempt from the regulations. Income from a Relevant Activity for which the Licensee needs to demonstrate Economic Substance in the UAE includes all income, including income that is generated by the Licensee outside of the UAE.|
|What is an 'adequate' or 'appropriate' economic substance?||The regulations and guidance do not provide a minimum standard for what is considered adequate or appropriate. The Regulatory Authorities are expected to take a pragmatic approach when assessing whether a Licensee has met the Economic Substance test, recognizing that the type and level of activity of a Licensee may fluctuate during the course of a financial period and from year to year.|
|Will Economic Substance be assessed on a Licensee by Licensee basis, or can Licensees that are part of the same group elect to be assessed on a 'consolidated' basis?||No. The regulations do not allow Licensees that are part of the same group to be aggregated for Economic Substance purposes. Each Licensee will need to comply with the regulations, and demonstrate Economic Substance on an individual basis.|
|Condition for directed and managed apply to Holding company business?||A Holding Company Business is not required to be directed and managed in the UAE, except where this is a requirement for the relevant licensing authority.|
|Do employees who perform Core Income Generating Activities (CIGAs) need to be residents in the UAE?||Yes, employees who perform the CIGAs of a Licensee
would, in principle, need to be resident in the UAE. Non-resident
employees or other persons would count towards the Economic
Substance of a Licensee in the UAE only if:
|Do the directors of the Licensee need to be resident in the UAE?||No. Directors only need to be physically present in the UAE to attend relevant board meetings of the Licensee.|
|Whether CIGAs or any other activities can be outsourced by Licensee?||A Licensee can outsource any or all of its CIGAs
so long as the outsourced activities are performed in the UAE.
However, A Licensee cannot outsource activity of being directed and
managed, as the Licensee itself is required to demonstrate
oversight and control of its Relevant Activity in the UAE.
Activities that are not CIGAs (such as back office functions) can be outsourced to person located outside UAE without adversely impacting the Economic Substance of the Licensee in the UAE.
|Are investment funds subject to the Regulations as a Holding Company Business?||No, an investment fund is not considered a Holding Company Business.|
|Is lending to another group entity considered a Lease-Finance Business?||Yes, a UAE entity that makes a loan or provides any other form of credit to a UAE or foreign group company for consideration (e.g. interest) will be considered engaged in a Lease-Finance Business.|
|Is investing and trading in debt securities considered undertaking a Lease-Finance Business?||No, UAE entities that invest and hold bonds and other debt securities that are traded on a regulated exchange are not considered engaged in a Lease-Finance Business.|
|What if there is no consideration payable for the credit provided?||The Regulations do not apply to credit and other financing and leasing arrangements where there is no expectation of consideration in the form of interest, fees, rental payments, capital gains or any other form of compensation. The grant of security in favor of the lender would not constitute consideration.|
The substance and transparency related requirements are becoming a norm of almost all developing nations, especially those who are part of OECD inclusive framework.
The FAQ's are a welcome step to provide much needed clarity to the impacted Licensees. Now, the Licensees may look to –
- Conduct a health-check on their operations in UAE keeping in mind requirements of the regulation
- Take corrective steps, basis the risk areas identified during the health check
- Accurate/ appropriate disclosures in the prescribed manner to meet the compliance requirement of the regulations.
Important note: For the companies located in DIFC, first compliance due date is 31 March 2020, wherein, the covered Licensees will have to furnish a notification with the authority (i.e DIFC's Registrar of Companies) with information prescribed in the regulations.
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.