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Economic Substance Regulations: What They Mean For UAE Businesses

April 10, 2023
Fortius Team
An Arab man holding the UAE flag in the desert illustrates the impact of economic substance regulations in the UAE.

What Are Economic Substance Regulations?

The UAE Government first issued the Economic Substance Regulation or ESR in April 2020, which was later amended in August 2020. The prime objectives of ESR are to ensure the following:

  • All UAE-based companies are economically sufficient to conduct business within the jurisdiction.
  • Mitigate unlawful tax practices and fraudulence within UAE-based companies.

UAE’s ESR applies to the following business sectors operating within the country and in the free zones:

  • Banking
  • Insurance
  • Shipping
  • Headquarters business
  • Lease-finance
  • Intellectual property business
  • Distribution and service centres
  • Holding companies

Implemented as per the needs of the Organisation for Economic Co-operation and Development (OECD), the ESR has set in motion several changes in UAE’s business world. Organisations are modifying their business procedures to ensure they are adequately substantive to conduct operations in the UAE.

Compliance with UAE’s ESR is mandatory. Any non-compliance will likely result in hefty penalties or temporary suspension of business licences, which could be detrimental to the organisation.

What does it take to ensure compliance with ESR?

To ensure compliance with the ESR, you should meet these criteria if your organisation belongs to any of the relevant businesses described above:

  • Maintain a physical presence in the UAE to generate primary income from business activities.
  • Spend sufficient money to ensure all business activities are conducted within the jurisdiction.
  • Employ an adequate number of trained staff to run the business activities.
  • Maintain a well-established system of adequate internal control.

Similarly to any UAE business law, ensuring compliance with the ESR confirms the legitimacy of the business and brings forth several other benefits.

Advantages of ESR Compliance: What UAE-Based Businesses Gain

OECD compliance

ESR compliance demonstrates UAE’s seriousness in complying with OECD’s global standards. In this way, UAE-based businesses are protected from being misused for illegal activities and financial crimes like tax fraud, tax evasion, and money laundering, to name a few.

Healthy business ecosystem

By eliminating illegal business practices, ESR contributes to a healthy and competitive business environment, which generates more income and employment opportunities. Also, since there is no room for unfair advantages, companies can focus on building their business on the merits of their offerings.

Encourages foreign investments

ESR compliance showcases the organisation’s commitment to transparency and trustworthiness- two critical factors that boost the company’s reputation at home and abroad. This compliance can also open opportunities to collaborate with foreign investors, thereby contributing to the nation’s economic development.

All said and done, ESR is also expected to change the course of many business aspects, thanks to its significant impact on organisations. If your company falls within the ESR-relevant activities, you need to know what to expect with these new regulations.

6 Ways ESR Will Impact UAE-Based Businesses

1. Non-compliance attracts penalties.

This should come as no surprise, considering how strict rules and regulations are in the UAE. Non-compliance, like failure to file for ESR or provide accurate information, can result in hefty fines. Sometimes, the organisation may have to pay up to three times their profit or 300% of related fees from customers abroad. Breach of ESR may also result in severe criminal repercussions for the business and those involved in it.

2. Necessity to deliver accurate reports.

Under the ESR, all business-related information must be accurate and up-to-date. Additionally, they should file their reports annually or bi-annually, depending on the company's business activities. While inaccuracies attract significant penalties, they demonstrate the company’s inability to be consistent with the ESR.

3. Tax transparency guarantees UAE tax residency.

Tax transparency is one of the fundamental requisites for ESR, and companies that comply with the same get to secure their UAE tax residency. Maintaining absolute tax transparency demonstrates the company’s:

  • ESR compliance
  • Payment of accurate tax amount
  • Non-diversion of profits to low-tax jurisdictions

4. Maintenance of business-related records.

Under the ESR, all relevant companies should maintain accurate records pertaining to:

  • Operations within the UAE and abroad
  • Business-related documents
  • Business-related contracts

Moreover, all businesses within the ESR radar should keep themselves updated about the latest announcements or modifications related to the rules. Staying on top of what’s happening with the ESR will give you enough time to fulfil the necessary steps and remain compliant.

5. Additional expenses & administrative obligations.

Businesses that fall within the ESR criteria should brace themselves for additional administrative work and expenses for ESR implementation. Since compliance is mandatory, companies will require more staff and systems to regularly review and update business operations. Therefore, businesses must be ready to shell out more money to hire and train staff and expand their administrative capabilities.

6. Company liquidation and deregistration.

The possibilities of liquidation and deregistration are high for companies that repeatedly fail to meet the ESR criteria in terms of:

  • Reporting accurate and updated information
  • Compliance with rules referenced within the regulations

In such cases, the company will be prohibited from renewing its business license, and in the worst-case scenario, the company itself may be liquidated.

It is inevitable for new rules and regulations will cause ripples as businesses make adjustments to comply. ESR is no exception. While it does require a lot of work and expenses, ESR helps you stay protected, operable and thriving in the UAE. It would also make sense to automate the process wherever possible to lessen the administrative burden.

Stay Compliant with Fortius’ ESR Consultation Services

The golden rule for Economic Substance Regulations is Compliance. It is your golden key to remaining operable and open to new regional and global opportunities. ESR will undoubtedly have a positive impact on UAE businesses and the nation's economy as well.

Would you like to know more about ESR and its implementation? Fortius Consulting offers ESR consultation services for UAE-based businesses. Please contact our team for further guidance.

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