UAE Businesses Should Focus on Catching up With International Economic Practices

UAE business practices differ slightly from International economic standards. While this hasn’t been a problem for UAE on a domestic level, they have begun facing challenges on the international stage. The UAE is expected to catch up with Economic Substance Regulations as soon as possible or face consequences. In fact, UAE businesses have until June 30 to verify their compliance.

The UAE issued the Economic Substance Regulations (ESR) with the aim of eliminating harmful taxation. The ESR shall also be responsible for tracking international standards established by the Organization for Economic Cooperation and Development (OECD).

Why are UAE businesses being put under the microscope now? This is due to the fact that back in 2017, the COCG, European Union’s Code of Conduct Group decided that UAE business taxation practices weren’t on par with economic substance. The COCG claimed that the creation of off-shore activities for profit attraction cannot reflect “actual” economic activity taking place within the UAE. This resulted in the issuance of “non-cooperative jurisdictions for tax purposes”. Under this issuance, several nominally taxed and not at all taxed jurisdictions were placed on the grey list. Once on the grey list, they have a limited amount of time (12 months) before they become blacklisted.

In 2018, the OECD followed their 2017 actions by forming an international standard on “Base Erosion and Profit Shifting”. This standard prevented business activities from shifting to jurisdictions with no or nominal taxing.

Who Will the ESR Affect?

Currently, any UAE business that is free-zone, off-shore, or on-shore that generates income from the following activities will be affected by the ESR:

• Insurance
• Lease-finance
• Distribution and service centres
• Banking
• Investment fund management
• Headquarters
• Shipping
• Intellectual property
• Holding company

Basically, any UAE established company that has a considerable amount of income from relevant sectors (in accounting periods that started on or after the 1st of January 2019) is subject to the ESR. Companies that have at least 51% investment (direct or indirect) from government authorities shall be exempted.

Economic Substance Tests

Companies that are affected by the ESR shall be required to provide proof of adequate substance in the UAE. The criteria for this proof consist of certain tests:

• Directed and Managed Test:ESR shall introduce specific requirements that shall provide guidance on the management and direction of companies in the UAE.
• Adequate Test:companies in the UAE must have a satisfactory number of full-time, qualified employees in the UAE. They must also have a satisfactory operating expenditure in the UAE and need to hold physical assets over here as well.
• Core Income Generating Activities Test:UAE companies must ensure that their core income-generating activities must take place within jurisdiction. They must also be related to the income level being generated from relevant activities.

Penalties for Non-Compliance

• In case of failing to file a notification, a fine of Dh10,000-Dh50,000 shall be incurred.
• In case of failing to provide complete information, a fine of Dh10,000-Dh50,000 shall be incurred.
• In case of failing to prove sufficient economic substance in the UAE:
• Multinationals based in the UAE that fall under the ESR must scrutinize their corporate structure.
• Entities must take action to ensure that their substance level meets compliance.
• Off-shore and on-shore companies must notify their regulator before the deadline.