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Get Your Business ESR-Ready: Vital Requirements for UAE's Economic Substance Test

February 20, 2023
Fortius Team
Buildings in Abu Dhabi, the capital city of the United Arab Emirates.

The UAE Economic Substance Regulations are the most recent in a series of regulations to modernise the economy under international best practices. To demonstrate their seriousness about meeting the conditions set by the EU for being removed from the list of "non-cooperative" tax jurisdictions, the UAE enacted the Economic ESR on April 30, 2019.

This action on the part of the government exemplifies the country's commitment to safeguarding businesses from harmful taxation practices that may impede their development and growth. And first-rate ESR consultation services such as Fortius help ensure your compliance with the regulations!

According to the ESR, all UAE-based businesses must provide evidence of the economic substance of their operations within the country. Before fulfilling the requirements for the UAE economic substance test and filing an ESR report, companies are required to notify regulators of their decision to engage in the relevant activities outlined in the ESR.

Essentials for ESR Compliance- As Advised by ESR Consultation Services in the UAE

To demonstrate sufficient substance in the UAE within a fiscal year, a Licensee must meet the following requirements, as outlined in the Economic Substance Regulation granted in Ministerial Decision no. 100.

Maintain primary revenue generators in the UAE.

To pass the Economic Substance Test, you need to have some reliable source of income. As part of their ESR guidelines, the UAE has compiled a comprehensive list of the core revenue-generating activities and the specific tasks related to each (CIGA). Organisations are not required to carry out every one of the activities deemed appropriate under this Article, but they must perform at least one. Typical components of a distribution company's CIGA are as follows:

  • Managing the risks involved in transporting and storing goods, components, raw materials, or completed products.
  • Setting minimum inventory levels, managing stock count frequency, making efficient use of storage space, taking into account perishable items, and implementing security measures are all part of effective inventory management that can boost profits.

It's worth noting that only UAE-based employees should handle the company's CIGAs.

Run operations from within the UAE

A company's ability to pass the Economic Substance Test depends on the frequency its board of directors holds meetings within the United Arab Emirates. Their primary place of business should be in the United Arab Emirates, and their operations must be conducted under the purpose for which the company was formed. This prerequisite applies regardless of the size of your company. To be taken into account are the following:

  • Durations of all relevant activity meetings should be recorded in hours and minutes. The records/ data must be kept in the UAE.
  • You must attend the meeting in person in the United Arab Emirates.
  • All decisions made during a meeting must be documented in the minutes.

For the ESR Regulations and clarification, the "directed and managed" aspect does not require board members to be based in the UAE. Instead, the board members must be physically present in the UAE when making strategic decisions.

Hire UAE nationals full-time

Companies must have a sufficient number of full-time, locally qualified employees who are physically located in the UAE and responsible for carrying out the CIGA to pass the Economic Substance Test. Because of differences in size, organisations' staffing needs range widely. The optimal workforce size for a small company may be too few for a large corporation. It guarantees that enough people are working on the relevant projects at any given time.

If directors perform CIGAs apart from their fiduciary duties, the ESR may treat them as employees for the Economic Substance Test. However, the regulations provide that the directors should be within the geographical boundaries of UAE and to participate in the board meetings.

Spend money on daily operations in the UAE

To satisfy the UAE Economic Substance Test, the companies must ensure sufficient operating expenses are incurred in the UAE on the Relevant Activity. As with many regulations, it’s hard to gauge precisely how much or to put an exact figure.

Your business may have customers from another country but the United Arab Emirates must serve as your primary place of business. Nonetheless, the UAE Ministry of Finance has clearly stated that the ESR is not meant to compel companies to spend more money than they have to to operate legally and conduct legitimate business in the UAE and CIGA.

Ensure majority of physical assets are in the UAE

The ESR guidelines state that companies must have sufficient funds to outsource the Relevant Activity or sufficient assets in the UAE to carry out the CIGA. The Ministry of Finance clarifies that the definition of “adequate” is contingent upon the level and nature of the Relevant Activity being performed.

A Licensee must have adequate physical assets to operate a Relevant Activity in the United Arab Emirates. The Licensee may own or lease the appropriate facilities to conduct the Relevant Activity (e.g. lease agreement). Offices and other types of company real estate may be considered physical assets in some contexts.

Administrative Penalties for Not Meeting the Economic Substance Test

An organisation can expect to pay a fine of between AED 10,000 and AED 50,000 from the regulatory body if it fails to pass the Economic Substance Test. Businesses failing to pass the test the following year will be subject to a fine between AED 50,000 and AED 300,000. Once the Regulatory Authority issues a notice, it will specify the exact amount of the penalty, and that amount, plus interest, must be paid within 30 days.

Parting Thoughts

It is recommended that all organisations operating in the UAE determine whether or not their operations fall under the Economic Substance Regulations, and if so, which of their operations do, and how they will ensure that they can pass the Economic Substance Test concerning each Relevant Activity.

Various factors will be evaluated quantitatively and qualitatively, including operations, finances, taxes/transfer pricing, law and governance. The recommendation is to consult with professionals to assess the ESR position of any relevant Licensee and meet the ESR requirements within the given deadlines. Our experts at Fortius- one of the most well-known ESR consultation services in the UAE ensure optimum compliances with the ESR. Give us a call today!

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