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ESR UAE: Demonstrating Substance Under Economic Substance Regulation

ESR UAE: Demonstrating Substance Under Economic Substance Regulation

5 months ago

13 June 2022

KPI

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    Background


    The Economic Substance Regulation of UAE ("ESR" or "the regulation") requires a Licensee to submit a Notification and an Annual Report with the Regulatory Authority within the prescribed timelines. Each financial year a Licensee needs to ascertain whether it had carried out a Relevant Activity and earned Income from such Relevant Activity. If there is no income earned from such Relevant Activity, a Licensee will be required to submit a Notification. However, it is not required to submit the Annual Report and therefore not required to demonstrate Economic Substance for the relevant financial year. If a Licensee carries out Relevant Activity and earned Relevant Income from such Relevant Activity, only then the Annual Report is required to be submitted.

    Submitting the ESR Annual Report


    An annual report is to be filed with the Regulatory Authority within twelve months from the end of the reportable financial year.

    In the Annual report, a licensee would be required to demonstrate that it complies with the regulation and in the event, it has not, it might have to justify why it did not meet the requirements. Apart from the financial information, certain non-financial information is also required to be provided.

    Let us examine some of the non-financial information and its relevance.

    Direct and Managed in the UAE


    A licensee must demonstrate that the business was directed and managed from and within the UAE. Going forward, it will be required to document all the decisions, including strategic business decisions, which are taken in the meeting of directors. It requires at least one meeting of directors in the reportable period and the frequency of such meetings depends on the nature of the business conducted by the licensee. The documentation of the Minutes of the meetings (“MOM”) etc. would be required even if a Licensee is managed by an individual like a CEO or General Manager. 

    Directed and Managed in the UAE Test - How to satisfy the requirement?

    • Register of Directors
    • Review relevant laws and regulations governing the licensee together with the Memorandum and Articles of Association on conducting the meeting of directors 
    • MOM should be prepared and signed by all the directors who attended the meeting
    • MOM and all other records should be maintained in the UAE

    Adequacy Test - How to satisfy the requirement?

    A licensee must employ adequate resources to conduct business activities commensurate with the size of the business with a demonstration of adequacy of physical assets, human resources, and operational spending to conduct the business in the UAE. What a licensee needs to do to meet the adequacy substance requirement: 

    • Prepare a list of all physical assets
    • Prepare a list of all employees including on a contract basis. It needs to evaluate whether it has an adequate number of full-time employees; who are residents of UAE and are adequately qualified or experienced to perform their roles and responsibilities
    • Has adequate operating expenses commensurate to the size of business activities

    A licensee might be outsourcing all or a few of their processes to related/third parties. In such cases, the Regulation requires such related/third-party service providers to be located in the UAE. Moreover, a Licensee should have full supervision and complete control over such a service provider. Non-core processes could still be outsourced outside of UAE and meet the substance requirement 

    A licensee carrying out more than one Relevant Activity may be required to demonstrate substance for each of the Relevant Activity separately.

    Evidence Submission with Annual Report


    A licensee may be required to provide evidence of board meetings held in the UAE, adequacy of full-time employees and their qualification, nature, and type of expenses, details of outsourcing, etc.

    The Licensee should start a review of the documents and processes and be ready with the Annual Report submission.

    Reference from other jurisdictions


    Apart from the ESR in UAE, there are 11 other jurisdictions that have implemented the regulation in 2019. The regulation stems from Action 5 of BEPS

    Let us briefly examine ESR in a few other jurisdictions:

    1. British Virgin Island (BVI) has imposed responsibility on the registered agents to ensure the companies they manage are comply with the regulation

    2. The Isle of Man has introduced the substance requirement as part of its Income Tax Act. In the event of non-compliance, penalties are high for the first year. There is also a risk of being struck off on repeated non-compliance

    3. The regulation in Guernsey and Jersey are like that of the Isle of Man

    4. Bahrain requires an entity to submit an Annual Report within three months from the end of its financial year. The first Annual Report was due on 30 June 2020 (including three months extension). The Annual Report requires an entity to attach certain documentary evidence (non-financial) to demonstrate substance including:
      • agenda for the board meetings
      • copies of board meetings minutes reflecting strategic decisions
      • qualification details of the employees, activity-wise

    The licensee would also need to ensure adequate and appropriate internal policies & controls for its operation, compliance, corporate governance, & risk management. If an entity in Bahrain has not maintained adequate documentation or complied with the regulation, it must provide justification. 

    Mandatory Compliance


    We are entering into an era of enhanced corporate compliances. Authorities in a few jurisdictions view non-compliance strictly. This could ultimately lead to suspension of the license or closure of the business. Moreover, the non-compliance could have a negative impact on the other businesses operated by the Ultimate Beneficial Owner. It is never too late to begin!

    For more on ESR in UAE, check out the following articles:

    • Economic Substance Regulation Annual Report
    • Economic Substance Regulation - Impact on Key business Activities


    ESR - Reminder to submit your ESR Notification


    A reminder to all businesses that concluded their financial year on 31 December 2021, please ensure to submit the Economic Substance Notification with the authorities before the due date to avoid penalties. The due date for the Economic Substance Notification submission is 30 June 2022.  

    You are required to conduct an Economic Substance Test for the financial year ended on 31 December 2021 to assess or verify if you have conducted any of the relevant activity as per the Economic Substance Regulation. Accordingly, you may be required to submit the Economic Substance Notification.

     

    Economic Substance Regulation UAE - Reminder for businesses to submit the notification in time and not miss the ESR notification deadline


    KPI has a dedicated team of experts in the UAE who can assist clients with Economic Substance Regulation compliance, assessment, and reporting.

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