UAE Companies – How Your Business May Be Affected
If you are operating an onshore or offshore entity in a "no or only nominal tax jurisdiction" (referred to hereinafter as a "noon"), which amongst others, holds shares or licenses intellectual property and receives operational income from other jurisdictions this article should be important to you and you should make yourself aware of the content as your business may be materially affected by the newly introduced economic substance rules formulated by the European Union Code of Conduct Group on Business Taxation.
What are "Economic Substance Rules"
The European Union (EU), has implemented criteria with which jurisdictions with no or only nominal tax policies need to comply as part of the EU's efforts to promote economic inter-jurisdictional transparency and to restrict so-called "harmful tax competition" practices. Noons are required to eliminate the facilitation of structures or arrangements aimed at attracting profits that do not reflect real economic activity within that jurisdiction. Noons are required to promulgate appropriate legislation to ensure compliance with the EU's economic substance rules to avoid sanction by the EU.
To date the British Virgin Islands (BVI), Cayman Islands, Isle of Man, Jersey, Guernsey, Mauritius, Bahamas, Seychelles, Bermuda and now also the UAE have promulgated laws incorporating the EU's economic substance rules. As a result, entities incorporated in noons, conducting identified business activities need to show actual economic activity in the noon or face fines, penalties, possible de-registration and even liquidation of the entity by the noon's authorities.
Failure of a noon to comply with the EU's economic substance rules will and have resulted in the "blacklisting" of these non-compliant jurisdictions.
What is Economic Substance
For an entity to have economic substance an entity must display that it is directed and managed in the noon by directors with adequate experience and qualifications, and has, taking into account the level of income generated, the necessary premises, qualified staff, sufficient annual expenditure within the noon, and lastly, that the entity conducts certain defined core income generating activities (dependent on the business sector and activities of the entity) either by the entity itself within the noon or by appropriate service providers, either inside or outside the noon.
Economic Substance Rules vs Noons
The EU's criteria on economic substance were to be introduced by all noons by 1 January 2019. Noons that had not implemented required laws but that showed commitment to the implementation of economic substance laws were placed on a "grey-list" by the EU. Noons that did not show commitment and those that have subsequently not finalized their commitments have been placed on a "blacklist". The listing followed a screening processes by the EU relating to tax transparency, fair taxation and the implementation of anti-Base Erosion and Profit Shifting (BEPS) measures.
Inclusion on the EU "blacklist" would have negative repercussions for entities operating from non-compliant noons. Subject to the internal laws of the EU country in which the entity that is incorporated in a non-compliant noon is operating, the result of non-compliance by the noon may include the audit by the tax authorities in the EU countries in which the said entity has assets and/or operations of such as well as of payments being made to the noon; EU countries may impose higher withholding or other taxes on dividends, interest payment, royalty payments or service fees on these entities; certain tax exemptions on withholding taxes may be increased; and direct tax consequences may also be encountered such as the refusal of deductions against income of certain expenses by the entity in the said EU country. The EU may further impose restrictions or prohibitions on investment or financing into the "blacklisted" jurisdictions which may affect noon entities in non-compliant noons.
Economic Substance Rules in the UAE
As the UAE falls within the definition of a noon as a no or only nominal tax jurisdiction, the UAE has been obliged to promulgate the necessary laws to comply with the EU's economic substance rules. The UAE introduced its economic substance regulations by Cabinet of Ministers Resolution No. 31 of 2019, which was effective as of 30 April 2019 (the "Resolution"). These regulations regulating economic substance do not affect UAE entities that are owned and conduct their operations and receive income solely in and from the UAE.
UAE entities that are owned by entities incorporated in other noons would be affected by the economic substance laws of that noon, or if incorporated in a non-compliant noon, the UAE entity may be affected by such non-compliance as indicated hereinabove.
UAE entities operating outside or receive income from outside the UAE (including but not limited to dividends, royalties, license fees and management fees) are the target of the EU's economic substance rules and accordingly that of the Resolution. These UAE entities must in terms of the Resolution provide the UAE authorities proof of compliance with the EU's economic substance rules. UAE entities must show that they have economic substance in the UAE by (i) being managed and directed in the UAE, (ii) conduct core income generating activities within the UAE as may be required by the entity's particular business sector or activity, and (iii) have an adequacy of qualified staff, premises, expenditure and equipment in order to conduct the activity and that justifies the income received.
Each UAE entity shall, from a date to be determined by the relevant authority that will oversee this process (which is still to be determined), submit a report that will be used to confirm compliance with the aforementioned economic substance rules contained in the Resolution.
Failure to Comply with the Resolution
Disclosure to Foreign Authorities
Failure by a UAE entity to comply with the Resolution will result in the disclosure of such non-compliance to the relevant authorities of the foreign jurisdiction either where the parent company or the ultimate beneficial owner of the UAE entity is resident.
Penalties for Non-Compliance with Economic Substance Rules
In the event that a UAE entity is found to be non-compliant with the requirements of the provisions mentioned in (i), (ii) and (iii) in the third paragraph above, the relevant UAE authority may impose an administrative penalty of between AED10,000 and AED50,000 for the first year of default with these penalties for repeated failure reaching up to AED300,000.
Failure to Submit Return or Give Accurate Information
In the event that a UAE entity fails to submit a return in compliance with the Resolution or gives inaccurate information therein, the relevant UAE authority may impose an administrative penalty of up to AED50,000.
Do you need Assistance
Should you not be sure of what to do next in order to comply with the economic substance laws for the UAE or that of a noon in which you have an entity, we are able to assist you in providing a "health check" and advise on corrective measure in order to ensure compliance and avoid painful and unnecessary administrative penalties or worse.
Head of Indirect Tax and Real Estate Conveyancing
+971 55 115 9228
John has been a qualified Attorney who has been practicing for over twenty-five years. He has been a managing partner in a law practice where he was responsible for all tax and accounting matters in the practice for over 20 years. John has advised and represented numerous tax payers in tax and VAT disputes across various industries. He also has extensive experience in tax obligations, tax management, tax accounting and tax litigation, especially relating to value added tax and other indirect and direct taxes, company governance and administration as well as corporate governance and commercial transactions in the UAE and Gulf Cooperation Council member states ("GCC"). John is a regular contributor to local publications, including Emirates Law and Lexis Nexis and has his own column on real estate in the Gulf News. John is a regular contributor to VAT related discussions on the radio and in the press and has conducted numerous presentations including on the request of the Dubai Chamber of Commerce.
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.