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Economic Substance Regime

On 30th April 2019 the United Arab Emirates (UAE) issued the Cabinet of Ministers Resolution No. 31 of 2019 concerning Economic Substance Regulations ("ESR") in the UAE (the "New Law"). Other guidances and amendments have been and will be published by the Ministry of Finance and/or the "Relevant Authorities".

The New Law creates the basis for the UAE to meet the requirements of the European Union Code of Conduct Group (Business Taxation) (COCG) in respect of economic substance, and specially to ensure that the jurisdiction does "not facilitate structures or arrangements aimed at attracting profits which do not reflect real economic activity in the jurisdiction" and "avoids that profits registered in a jurisdiction are not commensurate with economic activities and substantial economic presence". The introduction of the New Law follows the decision of the European Union (EU) to include the UAE on a list of non-cooperative jurisdictions for tax purposes.

The UAE has been firmly committed to its long-standing policy of meeting the highest international standards on taxation, including the OECD’s requirements. The introduction of the New Law is a strong sign that the country is keen to continuously update its domestic legislative framework in this regard.


What is the New Law about?

The Regulations apply to all UAE onshore and free zone companies that carry on a "Relevant Activity". The licensees meet this economic substance test if:
They conduct core income generating activities (or “CIGA”) in the country
Are directed and managed in the UAE in relation to that activity
Have adequate number of qualified full-time employees in relation to that activity who are physically present in the UAE
Have premises and adequate level of expenditure in the country.

Who is subject to this New Law?

The substance requirements apply to licensees carrying out and deriving incomes from one of the activities listed below (the “Relevant activities”): Banking business
Finance and leasing business
Fund management business
Headquarters business
Holding company business
Insurance business
Intellectual property holding business
Shipping business
Distribution and service centre business.
A licensee is not required to pass the economic substance test if it does not generate income in relation to a Relevant activity that it carries.

What does it mean in practice?

Each company needs to notify their Relevant Authorities whether they are not subject to submit the full Economic Substance Test by end of 2020. Failure to submit the notification, sanctions are already stated in the law.

Sanctions
If the company registered in the UAE does not provide required information or submit inaccurate information to the regulatory authority knowing that it is inaccurate, it will be sanctioned by an administrative fine not less than AED 10,000 but not exceeding AED 50,000 in the first year, increased to an amount not less than AED 50,000 but not exceeding AED 300,000 in the subsequent year, and ultimately, deregistration in case of continuous non- compliance.

Exchange of information
Besides the fines, the Law stipulates that the tax authorities may exchange information on the non- compliant UAE-registered companies with the tax authorities in the State where their holding companies and UBOs are resident. Presumably, a group would then run the greater risk of attribution of the UAE allocated profits to the foreign jurisdictions although whether this would be included in or additional to the country-by-country reporting regime remains to be seen. For all core requirements introduced by the law, outsourcing is permitted providing this outsourcing is not used to circumvent the economic substance test. The company may satisfy the economic substance test if it retains a UAE-based service provider and outsources all or part of the requirements to it – e.g. occupy non- executive functions and/or coordinate the handling of meetings, maintenance of records, undertaking all or part of CIGA.

Who will assist you?

Zoran Marinkovic, Managing and Founding Partner: zoran@bmdubai.com and corpservices2@bmdubai.com. www.bmdubai.com.

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