Changes to UAE Economic Substance Regulations

Background

In Cabinet Resolution No. 57 of 2020 of 10 August 2020 and the updated Guidance in Ministerial Decision 100/2020 of 19 August 2020 (Amended ESRs), the UAE Ministry of Finance (MoF) has amended its original Economic Substance Regulations of 30 April 2019 and the related Guidance of 11 September 2019. The amendments introduce a number of substantive and clarificatory changes which should be taken into account by market participants in the assessment of their filing requirements. The updated requirements have been published on the MoF website available here.

This note should be read in conjunction with our previous client updates accessible here and here.

Scope of application

The Amended ESRs narrow the definition of a Licensee to whom the regulations apply. The scope of application of the Amended ESRs is limited to (i) persons with separate legal personality and (ii) unincorporated partnerships that carry on a relevant activity in the UAE. Natural persons, sole proprietors, trusts and foundations are not in scope.

There have also been changes to the definitions of Relevant Activities. For example, the concept of Distribution and Service Centre Business, which was already previously a potentially broad category, has been further expanded. Under the Amended ESRs, a UAE entity is considered to be engaged in a Service Centre Business if it provides consulting, administrative or other services to a foreign connected person. It is now no longer a requirement for services to be provided "in connection with a business outside the State", resulting in any such service provided to a foreign related party to be in scope. The amendment arguably broadens the already wide application of this category of Relevant Activity even further and could bring additional businesses within scope which previously made an assessment that they did not require to submit an economic substance notification.

Furthermore, there have also been changes to the definition of a High Risk Intellectual Property Licensee so businesses which are active in this space should review the previous assessment of their filing requirements.

Exemptions

The Amended ESRs introduce four new exemptions from filing an economic substance report and the requirement to demonstrate substance in the UAE, namely (i) entities that are tax resident outside the UAE; (ii) investment funds and their underlying SPVs or investment holding entities (but this does not extend to the entities in which the investment fund ultimately invests); (iii) entities that are wholly owned by UAE residents and that are not part of a multinational group that only carries on business activities in the UAE and (iv) a UAE branch of a foreign entity that is subject to tax on all of its relevant income in a foreign jurisdiction.

Licensees have to provide documentary evidence to substantiate their exempt status.

Branches

Branches do not have separate legal personality and are therefore not Licensees by themselves but merely an extension of their parent. Therefore, the Amended ESRs have clarified the treatment of branches in three scenarios:

1. If the parent is registered in the UAE, it must file as a single Licensee, reporting the Relevant Activities of itself and all its UAE branches in one composite notification and/or economic substance report.

2. In the case of UAE branches of a foreign entity, such a branch would have to comply with the regulations as if it was a separate legal person. However, the UAE branch might be able to benefit from the exemption which applies where the relevant income of the branch is reported in the tax return of the foreign parent.

3. A UAE entity is not required to consolidate the activities and income of a foreign branch for the purposes of the regulations, provided that the relevant income of the foreign branch is subject to tax in the foreign jurisdiction where the branch is located.

Demonstrating economic substance

The Amended ESRs also provide some useful additional guidance on the substantive test for demonstrating economic substance and on the treatment of outsourcing in this regard. It should, for instance, be noted that the directors of the Licensee do not need to be resident in the UAE. However, a Licensee's board of directors must meet in the UAE at an adequate frequency having regard to the amount of decision-making required at that level. At such board meetings, there must be a quorum of directors physically present in the UAE and the board meetings must be recorded in written minutes and signed by the directors attending.

Notifications and competent authority

The Federal Tax Authority was appointed as the National Assessing Authority. The assessment and determination on whether a Licensee has economic substance in the UAE will therefore be made by the Federal Tax Authority. The role of the other regulatory authorities is to collect and verify information provided by Licensees and assist the Federal Tax Authority in its duties. Therefore, the role of the other regulatory authorities is now more limited under the Amended ESRs.

Notifications must now be filed electronically with the MoF rather than submitted to the Licensee's competent regulatory authority. Businesses that already submitted a notification to their regulatory authorities will be required to re-submit their notification on the MoF portal after it goes live. The guidance does not confirm a deadline for this resubmission

The Amended ESRs have increased applicable penalties for non-compliance. The penalty for failure to submit a notification is now set at AED 20k and AED 50k for failing to show economic substance.

If you require any assistance with the assessment of your filing and economic substance obligations under the Amended ESRs, please contact Muneer Khan, Nina Fischer or Adam Wolstenholme.