To ensure that companies doing business in the UAE actually have an economic impact and are contributing to the local economy, the UAE has implemented the Economic Substance Regulations (ESR). All enterprises operating in the UAE, whether onshore or in a free zone, are subject to the restrictions if they engage in specific tasks referred to as Relevant Activities. This article aims to provide essential information on the Economic Substance Test and its implications for Licensees.
Requirements of the Economic Substance Test
A company must show it has economic substance in the country where it operates by fulfilling all requirements in order to pass the economic substance test. The following items must be met:
1. Directed and Managed in the UAE
Entities must show that they are directed and managed in the UAE in connection to any relevant operations in order to pass the economic substance test. In this part, we’ll take a closer look at this prerequisite.[1]
Board Meetings
If the entity wants to avoid being “directed and managed” by a court in the United Arab Emirates, its board of directors needs to hold regular meetings there that are proportional to the number of decisions that need to be made.
Management Presence
The appropriate managerial presence and staff in the UAE are required to direct and oversee the pertinent operations. This includes top executives who possess the necessary expertise and background.
From the United Arab Emirates, management should be carrying out CIGAs, putting board decisions into action, and creating management accounts and reports.
Primary Decision Making
Decisions about the related activities’ strategy and operations must be made in the UAE. Financial, organizational, managerial, and risk management choices all fall under this category.
Record Keeping
The United Arab Emirates should be the site of the preparation and storage of all essential documents and papers, including contracts, management accounts, and minutes.
Entities can prove there are actual connections between their operations and UAE-based material by meeting the “directed and managed” criterion. To pass the economic substance test, this must be present.
2. Core Income Generating Activities
Entities must also engage in core income generating activities (CIGA) related to any relevant activities, which is a crucial requirement. The CIGAs requirement is examined in this section.
What are CIGAs?
CIGAs are those that make a substantial financial contribution to the relevant activity. The following are examples of what these activities entail:[2]
- Taking reasonable risks
- Taking on the costs associated with utilizing assets and personnel
- Making strategic and operational decisions on the go
Examples of CIGAs
For different relevant activities, examples of CIGAs include:
- Banking: obtaining capital, overseeing risk, and approving loans.
- Insurance: setting rates, making reservations, and handling claims
- Fund management: investment choices and overseeing a portfolio.
The specific CIGAs will vary according to the type of activity and the industry in which it falls.
Conducting CIGAs
The test requires CIGAs to be performed either in the UAE or overseas. Any business operations carried out outside of the country must have good financial reasons and be liable to foreign taxes. In addition, CIGAs should have a sufficient number of skilled workers and budgets that are proportional to the scope and requirements of the activity. As long as the entity is in charge and willing to take risks, outsourcing is legal. Entities can prove that their relevant activities have a real economic effect by engaging in substantial CIGAs. A passing score on the economic substance exam requires this.
3. Adequate Physical Presence
Finally, the economic substance test states that you must have adequate workers, space, and funding to operate in the UAE. [3]
Employees
Full-time employees in the UAE should be sufficient in quantity and appropriately qualified considering the amount of work done. Directors might be considered employees.
Staff members who work part-time or are outsourced are acceptable as long as they provide substantial work for the company.
Premises
In order to carry out its operations and CIGAs, the firm is required to have a real workplace in the UAE. There needs to be more than just a virtual workplace.
The number of staff and the volume of operations should determine if the location is adequate. Ownership is not necessary, but rental agreements should show that there is economic substance.
Expenditure
Operating expenses in the United Arab Emirates (UAE) should be proportional to the amount of activity, including expenditure on personnel, buildings, and other operational expenditures.
Salaries, rent, utilities, and professional services are all examples of expenditures that should be included since they constitute a significant portion of total expenditures.
By meeting the requirement for a sufficient physical presence, entities establish tangible economic connections between their operations and the UAE by establishing a local working space. The examination for economic substance is now complete.
Penalties for Non-Compliance
The UAE Ministry of Finance has the authority to impose fines for any relevant activity that does not meet the economic content test. The possible fines are detailed in this section.
- Warning Notice: Typically, the non-compliant firm will get a warning notice from the Ministry of Finance as the initial step. You have 30 days to fix the problems and show that you’re compliant.
- Administrative Fine: The administrative penalty for each relevant action that fails the test is AED 400,000 for the second consecutive violation and AED 50,000 for the first offense if non-compliance persists beyond the warning period.
- License Cancellation: The Ministry has the authority to revoke or suspend a company’s business license in extreme circumstances or when the offender commits the same offense more than once, thereby compelling the company to discontinue its activities in the United Arab Emirates.
In summary, complying with UAE’s economic substance regulations in order to avoid fines and keep their reputations intact. Obtaining advice from seasoned economic substance advisors may be quite helpful due to the intricacy of the legislation. Professionals in this field may advise businesses on their legal responsibilities, evaluate their current level of compliance, and devise plans to ensure they are meeting all regulations.
