On 30 April 2019, the UAE Cabinet issued the Cabinet of Ministers Resolution No.31 of 2019 (concerning economic substance regulations in the UAE, “the Regulations”), requiring all in-scope UAE “Relevant Entities” that carry on certain “Relevant Activities” to have demonstrable economic substance in the UAE from 30 April 2019.

The enactment of the substance requirements is a result of the recent work by the Organisation for Economic Co-operation and Development (OECD) under Action 5 of the Base Erosion and Profit Shifting (BEPS) project and investigation by the European Union (EU) Code of Conduct Group (COCG) into certain low or no corporate income tax regimes. The ratification should be viewed as the UAE working towards being removed from the EU list of non-cooperative jurisdictions for tax purposes (the EU blacklist).

The introduction of the Regulations in the UAE brings the UAE in line with other jurisdictions that have recently issued legislation (e.g. Cayman Islands, Bermuda, Mauritius), concerning shifting of profits derived from certain mobile business activities to “no or nominal tax jurisdictions” without corresponding local economic activities.

Who is affected?

The Regulations apply to all UAE onshore and free zone companies that carry on a “Relevant Activity”. It is yet to be confirmed whether the Regulations will also apply to sole proprietorships and branches, but entities incorporated under the offshore (free zone) companies regulations that carry on a “Relevant Activity” are expected to be within the scope of the Regulations.

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Entities that are directly or indirectly owned by the UAE government (both federal and local) are specifically excluded from the Regulations. Against this definition, UAE sovereign investment funds and other UAE government-related entities would not need to meet the UAE economic substance requirements.

The following are considered as “Relevant Activities” under the Regulations:

Banking, Insurance, Fund management, Lease-finance, Headquarters, Shipping, Holding company, Intellectual property (IP), Distribution and service center.

What are the substance requirements?

To satisfy the economic substance requirements in relation to a Relevant Activity, a Relevant Entity must:

  1. · Conduct the relevant “core income-generating activities” in the UAE
  2. Be “directed and managed” in the UAE; and
  3. With reference to the level of activities performed in the UAE:
  • Have an adequate number of qualified full-time employees in the UAE
  • Incur an adequate amount of operating expenditure in the UAE
  • Have adequate physical assets in the UAE.

A Relevant Entity that only undertakes a Holding Company Business will be subject to less stringent economic substance requirements. Additional reporting requirements apply if a Relevant Entity carries out “high-risk IP related activities”.

If a Relevant Entity carries out more than one Relevant Activity, the economic substance requirements must be met for each of the Relevant Activities.

Outsourcing to Third-party Providers

The Regulations allow a company to outsource some or all of its activity to third-party service providers; however, these service providers must in their own right have adequate presence in the UAE and the company must be able to demonstrate that it has adequate supervision of the outsourced activities.

Support from service providers cannot be ‘double-counted’ if the services are provided to more than one Relevant Entity.

What are the reporting requirements

A Relevant Entity will be required to report certain information on its Relevant Activities on an annual basis to the relevant regulatory authority (being the authority that issued the trade license to the Relevant Entity).

It is expected that further executive regulations will be issued to provide more clarifications with respect to the provisions of the new economic substance regulations, including the implementation details.

Considerations

Businesses with any relevant activities should assess whether the economic substance laws impact their current and planned UAE operations.

Non-compliance could result in administrative penalties for failure to meet economic substance test (up to AED50,000 in the first financial period, and up to AED300,000 in subsequent financial periods), administrative penalties for failure to provide information (up to AED50,000), spontaneous exchange of information, and potentially deregistration.

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