The UAE recently enacted the Cabinet Decision No. 31/2019 concerning the economic substance regulations (the “Regulations” or the “Economic Substance Regulations”) on 30 April 2019 in response to the European Union (EU) adding the UAE to the blacklist of non-cooperative jurisdictions for tax purposes in March 2019.
The regulations apply to all UAE onshore and free zone companies that carry on a "Relevant Activity". It is yet to be confirmed whether the Regulations will also apply to sole proprietorships and branches, but it is expected that entities incorporated under offshore (free zone) companies regulations that carry on a “Relevant Activity” to be within the scope of the Regulations.
Entities that are directly or indirectly owned by the UAE government (both federal and local) are specifically excluded from the Regulations. On this basis, UAE sovereign investment funds and other UAE government-related entities would not need to meet the UAE economic substance requirements.
The following are considered as “Relevant Activities” under the Regulations:
- Banking
- Insurance
- Fund management
- Lease-finance
- Headquarters
- Shipping
- Holding company
- Intellectual property (IP)
- Distribution and service center.
To satisfy the economic substance requirements in relation to a Relevant Activity, a Relevant Entity must:
- Conduct the relevant “core income-generating activities” in the UAE;
- Be “directed and managed” in the UAE; and
- With reference to the level of activities performed in the UAE:
- Have an adequate number of qualified full-time employees in the UAE
- Incur an adequate amount of operating expenditure in the UAE
- Have adequate physical assets in the UAE.
A Relevant Entity that only undertakes a Holding Company Business will be subject to less stringent economic substance requirements. Additional requirements apply if a Relevant Entity carries out “high-risk IP related activities”. If a Relevant Entity carries out more than one Relevant Activity, the economic substance requirements must be met for each of the Relevant Activities.
Reporting requirements
A Relevant Entity will be required to report certain information on its Relevant Activities on an annual basis to the relevant regulatory authority (being the authority that issued the trade license to the Relevant Entity).
Failure to comply would result in administrative penalties (not less than AED 10,000 but not exceeding AED 50,000 in the first year, increased to an amount not less than AED 50,000 but not exceeding AED 300,000 in the subsequent year), subject to a six-year limitation period. Additional penalties such as suspending, revoking or not renewing the UAE Relevant Entity’s trade license could also apply.
Summary
The introduction of the Regulations in the UAE brings the UAE in line with other jurisdictions that have recently issued economic substance legislation (e.g. Cayman Islands, Bermuda, Mauritius), and affirms the UAE’s commitment to addressing concerns around the shifting of profits derived from certain mobile business activities to “no or nominal tax jurisdictions” without corresponding local economic activities.
This should also be seen as the UAE making positive progress towards meeting the EU’s requirements to be removed from the EU list of non-cooperative jurisdictions for tax purposes (the EU blacklist). The Regulations should have a limited impact on UAE-headquartered businesses and foreign multinationals that have genuine commercial operations and management in the UAE (aside from complying with additional disclosure requirements going forward).
For multinationals that undertake Relevant Activities in the UAE but are managed remotely, the governance structure and operating model should be reassessed in light of the UAE economic substance requirements, and any necessary adjustments should be made to ensure compliance with the Regulations.
