What’s new?
On 8th January 2020, the UAE Ministry of Finance (“MoF”) published its comments on Frequently Asked Questions related to the Economic Substance Regulations (“ESR”) and its first guidance (“Guidance”).
See our previous articles on the subject:
UAE Economic Substance Law Briefing
UAE Economic Substance Regulation Update: Guidance Released
Key take-aways
Below are the key takeaways following the MoF clarifications, with M/HQ’s comments where appropriate:
| Information published by the MOF (Q&A) on 8/1/2020 | M/HQ Comments |
|---|---|
| UAE based Distribution Business, Service Centre Business, Headquarter Business or High-Risk IP Business would only be within the scope of the Regulations if the UAE entity transacts with foreign group companies. Distribution, Service Centre, Headquarter and High-Risk IP activities where transactions between UAE entities are not subject to economic substance requirements. | The ESR and initial Guidance were unclear as to whether Headquarter Business or High-Risk IP Business would fall out-of-scope if an entity does only transact domestically (no cross-border). This point has now been clarified, extending the scope of the exemption. |
| A Licensee that undertakes a Relevant Activity but that does not earn income from this activity in a financial period is not required to meet the Economic Substance Test for that period. Whilst the Licensee would still need to submit a notification with its Regulatory Authority, it is not required to file an Economic Substance Return for the relevant financial period. | N/A |
| Employees who perform the CIGAs of a Licensee would in principle need to be resident in the UAE. Non-resident employees or other persons would count towards the economic substance of a Licensee in the UAE only if (i) the relevant activities are performed while the individual is physically present in the UAE, and under the direction of the Licensee and (ii) the Licensee bears the relevant costs of the non-resident individual. | The principle need to be resident in the UAE. Non-resident employees or other persons would count towards the economic substance of a Licensee in the UAE only if (i) the relevant activities are performed while the individual is physically present in the UAE, and under the direction of the Licensee and (ii) the Licensee bears the relevant costs of the non-resident individual.It is permitted to outsource CIGA to both UAE residents and non-UAE residents. The latter is subject to additional conditions (physical presence in the UAE, effective management/control).CIGA outsourced to non-UAE based firms carries a substantial risk of tax requalification by foreign tax authorities. |
| Directors do not need to be UAE residents. They would only need to be physically present in the UAE to attend relevant board meetings of the Licensee. | While retaining UAE resident directors is not mandatory under ESR, it is an effective way of evidencing effective management being carried in the country. Retaining at least 1 UAE resident director – possibly doubling as company secretary – is both best practice and the prudent approach. |
| A Licensee cannot outsource “directed and managed”, as the Licensee is required to demonstrate oversight and control of its Relevant Activity in the UAE. | It is still possible for Licensees to demonstrate oversight and control of Relevant Activity /ies in the UAE by relying on third party input – e.g. Executive director/s, acting on a full- or part-time basis. The level of seniority, competence in the field and time allocated by the relevant individual should be proportionate to the volume of activity deployed. |
| Activities that are not CIGAs (e.g. back-office functions) can be outsourced to related parties or third-party service providers that are located outside the UAE without adversely impacting the economic substance of the Licensee in the UAE. | The MoF has extended the scope of ESR and initial Guidance for non CIGA activities, formally allowing outsourcing of such functions both in and outside the UAE. Activities outsourced to non-UAE based firms carry a risk of tax requalification by foreign tax authorities. |
A UAE entity is considered engaged in a Distribution Business if it:
|
Should the services provided to a Foreign Connected Person not be in connection with the Foreign Connected Person’s business outside the UAE, the Licensee will not be conducting a Relevant Activity. Should the Licensee be providing services to multiple clients [Foreign Connected Persons] and part of the services be connected to the Foreign Connected Person’s business outside the UAE, only this part of the activity will be deemed a Relevant Activity. |
A Holding Company Business (which has light substance requirements) is not required:
|
MoF has confirmed its pragmatic approach towards Holding Company Business. Unless otherwise provided for under the rules and regulations of any Regulatory Authority, a Licensee undertaking Holding Company Business is not required to (i) be directed and managed in the UAE; (ii) have / demonstrate adequate expenditure in the UAE; and (iii) conduct its CIGA from the UAE. However, it is important to note that effective management carried out outside the UAE carries a potential high risk of tax requalification by foreign tax authorities. |
| A UAE entity is considered engaged in a Lease-Finance Business if it provides credit or rents assets, equipment or any other good to another person for consideration. Providing credit includes making loans and entering into other financing arrangements such as hire purchase agreements and finance leases. | The MoF clarified that any Licensee providing a loan to a 3rd party against interest (i.e. income) will be qualified as “Lease-Finance Business”, thereby falling in scope of the ESR. |
| The Regulations do not apply to credit and other financing and leasing arrangements where there is no expectation of consideration in the form of interest, fees, rental payments, capital gains or any other form of compensation. The grant of security in favour of the lender would not constitute consideration. | Where the loan is interest-free, a Licensee undertaking Lease-Finance Business will be considered out of scope of ESR for such specific activity. |
What’s next?
ESR took effect on 30 April 2019. There are a number of actions which relevant Licensees must be undertaking to ensure compliance – from clarifying their entity classification, to the structuring of contractual and delegation arrangements, the review and organization of their internal governance, their employment and premises arrangements and the capturing of relevant business information which will be required for the preparation and filing of reporting information to the Regulatory Authority.
Even entities not deploying a Relevant Activity should implement proper corporate governance mechanisms in order to avoid any risk of failing the Economic Substance Test.
If you operate a business in the UAE or hold shares in a UAE structure, we highly recommend that you take an active role in auditing your corporate arrangements with the view to bring in the necessary level of corporate substance.
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