Economic Substance Regulations (ESR) require companies registered in the UAE that carry on one or more “Related Activities” to have economic substance in the UAE in relation to these activities and to comply with notification and return filing obligations. If you cannot prove Economic Substance or adhere to the filing requirements, your company’s information will be shared/disclosed to your home country or country of residence.
These regulations apply equally to mainland or Free Zone companies which provides the following Related Activities:
- a) Banking
- b) Insurance
- c) Investment Fund Management
- d) Lease-finance
- e) Headquarter company
- f) Shipping business
- g) Holding company
- h) Intellectual property
- i) Distribution and service center
The first step is to determine whether your company falls in the ambit of providing a Related Activity. If your business is providing a relevant activity, you have to determine whether the company is exempt from these requirements or not, whether it earns income from such Related Activity or not, whether the Related Activity is a Holding Company Business, or whether the Related Activity is a High-Risk IP Licensee. If any of these requirements apply, one must move to the next step which is to prove that you comply with the ESR in the UAE.
ESR is cumbersome and requires detailed attention. Addressing each of these Related Activities in detail does not form part of this article and therefore a general overview is provided. In most instances your business would fall in the category “distribution and service center” and therefore this Related Activity will be addressed in more detail.
The evaluation of Related Activities should take a substance over form approach requiring not only to consider the activity as per your license but any supporting or ancillary services. Similarly, passive income from a lease would also classify as a Related Activity as it is not required to only be actively
trading. It is also required that the Core Income Generating Activity (CIGA) which relates to the relevant activity be situated in the UAE.
In relation to the Related Activity and whether your company has economic substance in the UAE, one should consider the following when evaluating the ESR:
- Whether the entity is directed and managed in the UAE;
- Whether adequate number of staff involved in the CIGA are physically present in the UAE;
- Whether adequate operating expenditure is incurred in the UAE; and/or
- Whether there are adequate physical assets in the UAE.
In making such an evaluation the entity may outsource some of these requirements. If this is the case the entity must ensure that the service provider is complying with the ESR.
The requirement relating to whether an entity is directed and managed in the UAE must consider the following:
- The board of directors should meet frequently in the UAE;
- The board of directors should have the relevant qualifications and experience to act as board members;
- The board of directors meeting should have a quorum and minuting of meetings should be done properly;
- The company manager should ideally be situated in the UAE.
In complying with the ESR a company should therefore be able to objectively prove the requirements stated before, in that:
- a) The company is directed and managed from the UAE having conducted the board meetings and direction of the company, minuting the meetings, and archiving such in the UAE as well as (preferably) having a resident manager in the UAE.
- b) Ensure the company has an adequate number of qualified staff, physical presence, and expenses proportional to the level of activity exercised in the UAE.
With specific relation to “Distribution and Service Center Business,” if the business performs a Related Activity where products or services are procured from foreign connected persons (refer to an extract of the definition below):
“Distribution Business” if the Licensee purchases raw materials or finished products from a foreign group company, and distributes those raw materials or finished goods.
“Service Centre Business” if it provides consulting, administrative or other services to a foreign group company, and those services are in connection with the foreign group company’s business outside the UAE.
In the event that licensees only purchase goods from or distribute goods to third parties which is not connected persons, they are not considered engaged in a Distribution Business. Likewise, licensees that are engaged in the business of providing services to third parties are not considered as carrying on a “Service Centre Business”. If this is the case and all other ESR are in place, you will ensure that your business complies with local ESR legislation.