Economic Substance Regulations (ESR)

The UAE introduced Economic Substance Regulations (ESR) in response to concerns from the European Commission about the country being used as a tax haven, leading to its inclusion on the EU’s list of non-cooperative tax jurisdictions. Effective from January 1, 2019, through Cabinet Decision No. 57 of 2020, ESR requires all UAE entities— including offshore companies and branches of local and foreign companies—to demonstrate a real economic presence in the UAE for certain activities. This involves having adequate employees, office space, and operations in the country. Entities must also file annual reports to show compliance with ESR; failure to do so can result in penalties. Challenges with ESR include understanding the specific requirements, preparing accurate reports, and maintaining ongoing compliance. Meeting ESR requirements is essential for businesses to avoid fines and remain in good standing. If you need assistance with ESR compliance, we can help with understanding the regulations and managing your filings.

When figuring out if a company is involved in any of the Relevant Activities, you need to focus on the real substance of the activities, not just how they’re presented. Each UAE entity must be assessed individually, and there is no minimum income requirement for this assessment.

1. Notification:
   • Who Needs to Notify: If your UAE entity is involved in any Relevant Activities, you must file a notification.
   • When to Notify: This must be done within six months after the end of your financial year.
   • Where to Notify: Use the Ministry of Finance’s (MoF) online ESR portal.
   • What to Include: Report which activities you were involved in, whether you earned income from these activities, and if this income was taxed outside the UAE.
   • Multiple Branches: If you have several branches in the UAE, submit just one consolidated notification for all branches.
2. Economic Substance Tests:
   • Core Income Generating Activities (CIGA) Test: You must show that the main activities that generate income are carried out in the UAE.
   • Directed and Managed Test: The business activities must be directed and managed from the UAE.
   • Adequacy Test: You need to have sufficient resources (employees, expenses, and assets) in the UAE to support these activities.

ESR requires companies to prove they have a real presence in the UAE by meeting these tests and submitting necessary notifications.

3. Exemptions:

Certain entities are exempt from the requirement to maintain economic substance in the UAE, provided they meet specific conditions:

• Investment Funds: They are generally exempt.
• UAE National-Owned Entities: Entities owned by UAE nationals, not part of a multinational group, and operating solely within the UAE.
• Tax Residents Outside UAE: Entities that are tax residents in another country.
• Branches of Foreign Entities: These are exempt from maintaining economic substance in the UAE.

Exempt entities need only file a notification with supporting documents. If an exemption claim is denied, the entity must meet the ESR tests and file a report.

4. Administration:

• Regulatory Authorities: Free zone authorities, mainland licensing authorities, and the Federal Tax Authority (FTA) oversee ESR compliance. They handle filing requirements, verify notifications, assess exemption claims, and determine whether entities meet ESR tests.
• Penalties: The FTA can impose penalties for non-compliance. If there’s misrepresentation or fraud, the six-year review period does not apply.

5. Recent Developments and Practical Issues:

• Information Exchange: The UAE is sharing information with foreign authorities about entities that fail ESR tests.
• Filing Challenges: Entities face issues such as calculating employee numbers and expenditures, conducting board meetings, and maintaining adequate documentation. Documents must be in English, and some may not have the necessary documentation for exemption claims.

To ensure compliance, entities should maintain thorough records and prepare for possible audits extending up to six years

FM offers comprehensive support for navigating Economic Substance Regulations (ESR) through its experienced international tax team. We can help assess whether your business activities fall under any Relevant Activities and determine if you qualify for any exemptions. Our team assists with filing the necessary notifications and evaluates whether your business meets the Economic Substance Tests, advising on the required documentation to support any future inquiries from authorities. Additionally, we help with filing reports and providing necessary supporting documents.FM also identifies any gaps between your current level of substance and what is required under ESR, offering guidance on how to address these issues effectively.