ESG
Introduction
In the cabinet of Ministers, Resolution No. 57 of 2020 concerning Economic Substance Requirements are passed.
The ESR Regulations are issued pursuant to the global standard set by the Organisation for Economic Cooperation and Development (“OECD”) Forum on Harmful Tax Practices, which requires entities undertaking geographically mobile business activities to have substantial activities in a jurisdiction.
In addition to the work of the OECD, the European Union Code of Conduct Group (“EU COCG”) also adopted a resolution on a code of conduct for business taxation which aims to curb harmful tax practices.
The Cabinet of Ministers enacted the ESR Regulations taking into account the relevant standards developed by the OECD and the EU COCG.
Applicability to the following category:
1. Licensee - “an entity that is:
i. a juridical person (incorporated inside or outside the State); or
ii. an Unincorporated Partnership; registered in the State, including a Free Zone and a Financial Free Zone and carries on a Relevant Activity.”
An Unincorporated Partnership is defined under the ESR Regulations to include those forms of partnerships that may operate in the UAE without having separate legal personality and are thereby identified separately under the ESR Regulations.
Branches registered in the UAE are regarded to be an extension of their “parent” or “head office” and therefore are not considered to have separate legal personality. Thus, a branch of a foreign entity registered in the UAE that carries out a Relevant Activity, is required to comply with the ESR Regulations, unless the Relevant Income of such branch is subject to tax in a jurisdiction outside the UAE
Exempted Licensees
The ESR Regulations exclude certain forms of entities from the requirement to meet the Economic Substance Test. For the purpose of the ESR Regulations, an Exempted Licensee includes any of the following entities registered in the UAE and which carry out a Relevant Activity:
(a) an Investment Fund;
(b) an entity that is tax resident in a jurisdiction other than the UAE;
c) an entity wholly owned by UAE residents and meets the following conditions:
(i) the entity is not part of a MNE Group;
(ii) all of the entity's activities are only carried out in the UAE;
(d) a Licensee that is a branch of a foreign entity the Relevant Income of which is subject to tax in a jurisdiction other than the State.
Any entity which claims to be an Exempted Licensee must submit to the relevant Regulatory Authority, along with a Notification, sufficient evidence substantiating its status as an Exempted Licensee for each Financial Year in which it claims to be an Exempted Licensee.
Where an entity fails to provide sufficient evidence to substantiate its status as an Exempted Licensee, the entity will be regarded as a Licensee for the purposes of the ESR Regulations and shall be subject to the requirements of the ESR Regulations as applicable to a Licensee, including the requirement to meet the Economic Substance Test.
Relevant Activity
Article 3 of the ESR Regulations identifies any of the following activities to be a Relevant Activity:
(i) Banking Business
(ii) Insurance Business
(iii) Investment Fund Management Business
(iv) Shipping Business
(v) Lease-Finance Business
(vi) Distribution & Service Centre Business
(vii) Headquarters Business
(viii) Intellectual Property Business
(ix) Holding Company Business
Relevant Income
Key Requirements of Economic Substance Test
(a) The Licensee conducts Core Income-Generating Activities (“CIGA”) in the UAE.
(b) The Relevant Activity is directed and managed in the UAE;
The ‘directed and managed’ test aims to ensure that a Relevant Activity is directed and managed in the UAE and requires that, inter alia, there are an adequate number of board meetings held and attended in the UAE.
The ‘directed and managed’ test further requires that:
(i) meetings are recorded in written minutes and that such minutes are kept in the UAE;
(ii) quorum for such meetings is met and those attendees are physically present in the UAE; and
(iii) directors have the necessary knowledge and expertise to discharge their duties and are not merely giving effect to decisions being taken outside the UAE.
The board members (or equivalent) need not be a resident in UAE rather are required to be physically present in the UAE when taking strategic decisions.
Having regard to the level of Relevant Income earned from a Relevant Activity, (i) has an adequate number of qualified full-time (or equivalent) employees in relation to the activity who are physically present in the UAE (whether or not employed by the Licensee or by another entity and whether on temporary or long-term contracts), (ii) incurs adequate operating expenditure by it in the UAE, and (iii) has adequate physical assets (e.g. premises) in the UAE.
Where an outsourcing arrangement is used, the following conditions must be met:
1. The Outsourcing Provider to whom all or part of the Licensee’s CIGAs is outsourced must have, at all times in the UAE, levels of:
i. employees;
ii. Expenditures; and
iii. Physical assets (e.g. premises),
which are, individually and in the aggregate, adequate in relation to the CIGAs being undertaken.
Notification Filings
Every Licensee and Exempted Licensee is required to submit a Notification to their respective Regulatory Authorities setting out the following for each relevant Financial Year. The Notification must be filled within six months from the Licensee's financial year end:
i. the nature of the Relevant Activity being carried out;
ii. whether it generates Relevant Income;
iii. the date of the end of its Financial Year;
iv. any other information as may be requested by the Regulatory Authority
Economic Substance Report
Every Licensee shall be required to meet the applicable Economic Substance Test requirements and submit an Economic Substance Report containing the requisite information and documentation prescribed under the ESR Regulations within twelve (12) months from the end of the relevant Financial Year. Retention of Information and Records
The ESR Regulations prescribe for a minimum information retention period whereby each Licensee and Exempted Licensee must retain for a period of six (6) years from the end of its Financial Year all relevant documents, records and information required by the Licensee to meet their obligations under the ESR Regulations.
REGULATORY AUTHORITIES AND NATIONAL ASSESSING AUTHORITY
Pursuant to the ESR Regulations, certain authorities are appointed in the capacity of “Regulatory Authorities” and the Federal Tax Authority has been appointed as the “National Assessing Authority”.
Penalty
Failure to file notification – AED 20,000/-
Failure to file report – AED 50,000/- and it is deemed failure to demonstrate Economic Substance in UAE
Failure to provide accurate information – AED 50,000/- and it is deemed failure to demonstrate Economic Substance in UAE
Failure to demonstrate sufficient Economic Substance in the UAE for the relevant period
- First year of failure – AED 50,000/- - Information exchange with foreign competent authority of parent company, ultimate parent company, and ultimate beneficial owner.
- Second consecutive year of failure – AED 400,000/- - Information exchange with foreign competent authority of parent company, ultimate parent company, and ultimate beneficial owner.