Worldwide: Monthly Insight: The Updated EU Blacklist And What It Means For The UAE

Background of Economic Substance Regulations (ESR)

The European Union Code of Conduct Group, a few years ago, conducted an assessment of the UAE's tax framework. As a participating member of the Organization for Economic Development and Cooperation (OECD), the UAE Government committed to implementing the recommended international standards. In 2019, they introduced legislation in all UAE jurisdictions which, in essence, requires all UAE onshore and free zone companies conducting related activities to demonstrate an adequate ‘economic presence' in the country and implement best practices to tackle Base Erosion and Profit Shifting (BEPS). BEPS is a tactic followed by many multinationals to ‘shift' profits from higher-tax jurisdictions to lower tax jurisdictions, purely for the purpose of reducing or avoiding tax.

Recent International Developments

In an effort to keep the EU member states up to date with international tax compliance and help them better deal with countries that encourage abusive tax practices, the EU keeps a list of non-cooperative jurisdictions for tax purposes, the so-called EU tax haven blacklist. In line with this, they have recently updated the list to include the Cayman Islands, making it the first British territory to be added to the blacklist. It is used by the Member States to tackle external risks of tax abuse and unfair tax competition.

The major concerns are that the Cayman Islands have not addressed several concerns of putting appropriate measures in place to prevent tax abuse. They have done this by allowing firms to register there despite having minimal presence in the territory and not showing any real proof of economic activity, in contravention to OECD regulations. This situation emphasizes and highlights the direct relationship between tax non-cooperation and economic substance regulation (this is an important point to keep in mind).

The blacklisting is predicted to have an adverse impact on Cayman based and linked entities, fund managers and investment vehicles. Negative consequences include, among others, an increased cost due to higher compliance checks, added reporting requirements and increased substance thresholds as well as an increase in reputational risk, an impaired confidentiality and a risk of tax leakage should also not be ignored. Further to this, blacklisted countries will not have access to certain EU funds, and along with the more stringent compliance measures the Cayman-based companies are facing, business is expected to be made a lot more difficult.

Important to note is that, in the recent blacklist update, in addition to Cayman Islands, Seychelles, Panama and Palau were also added bringing the total number to 12 countries. The same repercussions are expected for all non-cooperative jurisdictions.

Defining ESR

The UAE has enacted regulations (Cabinet of Ministers Resolution No.31 of 2019) to guide the application of ESR. UAE authorities and jurisdictions have already issued guidance for companies to understand the criteria used to determine if a company is required to have economic substance and, if so, how to determine what is adequate economic substance.

The first step is to see whether the concerned company falls under the list of relevant activities. The relevant activities are the activities that are required to adhere to ESR, all other activities are unaffected. These activities include Banking, Insurance, Investment Fund management, Lease – Finance, Headquarters, Shipping, Holding Company, Intellectual property (“IP”), Distribution and Service Centre Businesses.

Each company must demonstrate how it satisfies ESR. This is done by providing information on core income generating activities (CIGA) in the UAE and showing that the company is directed and managed in the country, as well as confirmation that the company has an adequate number of qualified employees. In considering the adequacy of employees there can be no double counting. In addition, companies are expected to incur operational expenses in UAE and have physical assets in UAE. In the case of a company conducting more than one relevant activity, each activity must be individually satisfied.

In the related activities outlined, only the holding company's definition can vary from case to case. Some require substance while others do not, and this is looked at in more detail further below.

Redomiciliation

There are some Cayman companies (and Seychelles or Panama companies for that matter) that rely on EU business and funds and whose operations may be negatively affected as a direct result of the blacklist. Even if not directly affected, the dent made in their reputation should be seen as a strong enough reason for them to want to ‘disassociate' themselves from the list of non-cooperative countries. With no end in sight to this blacklist many firms, fairly so, are opting to move (or redomicile or migrate) to cooperative jurisdictions as a way to regularize their operations with the EU and adhere to the global Economic Substance Regulations (ESR).

The UAE, a real business economy and a trading country, is a preferred jurisdiction for redomiciliation. Advantages are many. It is a fully fledged and functioning economy, very profitable to operate in due to the favorable tax regime, even outside of the context of ESR challenges. It therefore offers a real capacity for substance all the while adhering to the global guidelines. What is more, the UAE authorities have now streamlined the process of redomiciliation making it fairly easy for companies to move across.

UAE Holding Company

The Holding Company activity is the only related activity where the threshold for economic substance varies depending on the case. Some holding companies require no substance while others do. What is a Holding Company Business? In this context, it is a business whose primary function is the acquisition and holding of equity interests (e.g. shares) in other entities from which it derives income as dividends and capital gains. It does not carry out any other commercial activity. This type of holding company is subject to reduced Economic Substance Test.

Compliance can be satisfied by acquiring an adequate number of employees (of which directors may be counted as full time employees) and premises, including offices and flexi desk. These two requirements may also be satisfied through outsourcing the functions to your preferred registered Corporate Service Provider. Important to note is that, these type of holding companies do not need to be ‘directed and managed' in the UAE. They are however subject to the relevant regulatory approval and proof of adequate expenditure being incurred in the UAE.All in all, a UAE holding company provides a very good alternative solution to jurisdictions facing ESR challenges and to those corporates and entrepreneurs who would otherwise find it difficult to operate in a traditional tax haven jurisdiction.

Tying it all together

The UAE is perfectly positioned to address all the challenges faced in the full value chain of operating ‘offshore' and the perfect candidate to redomicile your company. The country is committed to adhering to international best practice in international business, all the while maintaining its most compelling characteristics of doing business there namely, the 0% corporate and income tax.

Equally important, operating in the UAE offers additional benefits such as confidentiality, a place to meet economic substance requirements and a stable, well-established economy to operate in. The UAE also allows for more relaxed regulations for certain types of holding companies, as well as giving the option to outsource some of the required criteria to meet ESR.

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.