UAE Economic Substance Regulations Guide 2024

The UAE Economic Substance Regulations were introduced in 2019 and subsequently updated to align with global standards. These regulations require certain entities to demonstrate adequate 'economic presence' in the UAE relative to the activities they undertake. The ESR applies to both mainland and free zone entities, including those in financial free zones. Understanding the scope and purpose of these regulations is crucial for businesses operating in the UAE.

The ESR applies to entities conducting one or more 'Relevant Activities'. These include Banking Business, Insurance Business, Investment Fund Management, Lease-Finance Business, Headquarters Business, Shipping Business, Holding Company Business, Intellectual Property Business, and Distribution and Service Centre Business. Entities must accurately identify if they perform any of these activities to determine their obligations under the ESR.

Entities conducting Relevant Activities must meet the Economic Substance Test. This involves demonstrating that the entity is directed and managed in the UAE, has adequate employees, expenses, and physical assets in the UAE, and conducts Core Income Generating Activities (CIGA) in the UAE. The specifics of these requirements can vary depending on the type of Relevant Activity being conducted.

All entities subject to ESR must submit an annual notification to their Regulatory Authority, declaring whether they have carried out a Relevant Activity. Entities conducting Relevant Activities must also submit a detailed ESR Report. The notification must be filed within six months from the end of the financial year, while the ESR Report is due within twelve months. Adhering to these deadlines is crucial to avoid penalties.

To meet the economic substance requirements, entities must demonstrate that they have an adequate level of qualified employees, physical assets, and operating expenditure in the UAE. This often involves maintaining a physical office, employing staff, and incurring operational costs in the UAE. The level of substance required can vary depending on the nature and extent of the Relevant Activity being conducted.

Each Relevant Activity has specific Core Income Generating Activities (CIGA) that must be conducted in the UAE to meet the economic substance requirements. For example, a Distribution Business must conduct activities such as transporting and storing goods, managing stocks, and taking orders in the UAE. Entities must ensure they are performing the appropriate CIGA for their Relevant Activities within the UAE.

The ESR places additional requirements on entities engaged in 'High-Risk IP' activities. These are typically scenarios where an entity holds intellectual property that it did not develop and licenses to foreign related parties or generates income from foreign related parties. Such entities face a rebuttable presumption that they have not met the Economic Substance Test and must provide additional evidence to demonstrate substance.

The ESR allows for certain activities to be outsourced, provided they are conducted in the UAE and the entity can demonstrate adequate supervision. However, there are limitations on outsourcing, particularly for Core Income Generating Activities. Entities relying on outsourcing must carefully document these arrangements and ensure they meet the specific requirements outlined in the regulations.

Non-compliance with the ESR can result in significant penalties. These include financial penalties for failure to submit notifications or reports, providing inaccurate information, and failure to meet the Economic Substance Test. Repeated non-compliance can lead to higher penalties and potential suspension, revocation or non-renewal of licenses. Understanding and adhering to the regulations is crucial to avoid these consequences.

The ESR framework includes provisions for the exchange of information with foreign authorities. This is particularly relevant for entities that are part of multinational groups or have foreign ownership. Information submitted under the ESR may be shared with tax authorities in other jurisdictions, particularly the jurisdiction of the ultimate parent entity, the ultimate beneficial owner, and where the entity claims to conduct its CIGA.