The UAE introduced the Economic Substance Regulations (ESR) on April 30, 2019, requiring companies engaged in defined “Relevant Activities” to demonstrate adequate economic presence in the UAE. The ESR promotes transparency and adherence to global tax standards, combating tax evasion and profit shifting.
This article briefly explains the ESR, identifies who needs to comply, and relevant activities, and outlines the reporting mechanisms, exemptions, and potential penalties associated with non-compliance. The experts at Now Consultant help you file the ESR In UAE to protect your business from hefty penalties.
What Are Economic Substance Regulations?
ESR is designed to ensure that businesses conducting specific activities within the UAE have a substantial economic presence. The core principle of ESR is that businesses doing certain activities must show that their operations are real and not just in name only.
This includes showing that they have sufficient physical presence, resources, and operations in the UAE to justify their income. It ensures that profits are taxed in the country where the business is actually operating, rather than in places with lower tax rates.
Who Needs to File ESR in the UAE?
Entities required to comply with ESR are those engaged in any of the relevant activities as defined by the regulations. These include companies involved in banking, insurance, fund management, finance, leasing, and intellectual property management, which must file under ESR if they are generating income from these activities within the UAE.
Article 4 of the Economic Substance Regulations:
Article 4 of the Economic Substance Regulations clarifies that the law does not apply to businesses where the Emirati Government or the Federal Government holds a direct or indirect ownership of more than 51%.
The article specifies that for a business to meet the economic substance requirements in the UAE, must adhere to several key conditions. Furthermore, the article states that entities must conduct their core income-generating activities within the UAE, employ a sufficient number of qualified staff, and maintain an adequate physical presence in the country.
Economic Substance Regulations Relevant Activities:
ESR specifically applies to a range of activities that are often associated with profit shifting. These activities include:
- Banking: Activities related to accepting deposits or similar financial services.
- Insurance: Engagement in insurance or reinsurance services.
- Fund Management: Managing funds or investments for others.
- Finance and Leasing: Providing financial services or leasing arrangements.
- Headquarters: Entities providing central management functions for other businesses.
- Intellectual Property: Managing or holding intellectual property assets.
Each of these activities must be carried out with genuine economic substance in the UAE to comply with ESR.
ESR Exemptions In UAE:
Certain entities are exempt from ESR requirements. These exemptions are designed to ease compliance for specific types of businesses that are less likely to engage in tax erosion or profit shifting. These exemptions generally apply to:
- Government entities: Full government or public authority-owned entities are typically exempt.
- Non-profit organizations: Entities that operate on a non-profit basis and do not conduct commercial activities are excluded.
- Local activities: Businesses that operate exclusively within the UAE and do not engage in international transactions may be exempt.
These exemptions help focus the ESR enforcement on entities most likely to impact the UAE’s tax base.
ESR Reporting Mechanism:
Entities that fall under the ESR must adhere to a reporting mechanism to demonstrate compliance. This process involves:
Filing Reports
Entities must submit detailed reports to the UAE tax authorities outlining their business activities, economic presence, and compliance with ESR requirements.
Annual Reporting
Reports are typically filed on an annual basis, detailing the income and activities related to ESR-relevant sectors.
Disclose Information
Businesses are required to present information about their operations and economic presence in the UAE to ensure transparency.
Timely and accurate reporting is significant for demonstrating compliance and avoiding potential issues with the regulatory authorities.
Penalties for Non-Compliance with Economic Substance Regulations:
The penalties for failing to comply with the Economic Substance Regulations in the UAE are specified in Cabinet Resolution No. 57 of 2020.
The penalties include the following:
1. Failure to Submit Notification
Under Article 13, a fine of AED 20,000 will be imposed on any licensee or exempted licensee who does not submit the required ESR notification or relevant documents within six months of the financial year’s end unless the competent authority grants an extension.
2. Failure to Meet the Economic Substance Test
Article 14 sets out penalties for businesses that do not meet the Economic Substance Test:
- Not submitting the Economic Substance Report or related documents within 12 months of the financial year’s end or submitting a report that does not meet UAE’s ESR requirements
In this case, they will face a penalty of AED 50,000.
- Repeat violations in the following financial year will incur an AED 400,000 penalty.
3. Providing Inaccurate Information
According to Article 15, a fine of AED 50,000 will be imposed on any licensee or exempted licensee who knowingly submits inaccurate ESR information. If the inaccuracy is discovered after submission and the entity fails to notify the relevant authorities, the same penalty applies.
FAQs:
Why Was ESR Introduced In The UAE?
ESR was introduced in the UAE to prevent companies from shifting profits to low-tax countries without real business activities. It ensures businesses can not exploit tax laws unfairly.
Is There A Difference Between ESR For Mainland And Free Zone Companies?
ESR applies equally to both mainland and free zone companies in the UAE that are involved in “Relevant Activities.” If your business is involved in any of these, you must follow the ESR rules.
Are Free Zone Companies Subject To ESR?
Yes, Free Zone companies in the UAE must follow the Economic Substance Regulations (ESR) if involved in any defined “relevant activities.” The ESR applies to all companies in the UAE, including those in free zones.
What Is The ESR Reporting Deadline In The UAE?
The deadline for submitting the ESR notification in the UAE is 30th June for every financial year.
How Can We Help You?
The Economic Substance Regulations in the UAE make sure that businesses operate with genuine economic substance and adhere to international tax standards. Businesses may face penalties for not complying with the Economic Substance Regulations in the UAE.
At Now Consultant, we help businesses understand and meet ESR requirements. Our team of experts will guide you through the process to ensure compliance and avoid expensive penalties.
