Introduction

On 11 September 2019, the UAE issued Ministerial Decision No. 215 of 2019 on the Directives

for the implementation of the Economic Substance Regulations (ESR). The ESR was earlier

published in April 2019 as the Cabinet of Ministers Resolution No. 31 of 2019.

The Ministerial Decision of September 2019 (the “Guidance”) is served as a ‘preliminary’

advice on how the Economic Substance Test (“EST”), could be met for the purposes of

complying, in accordance, with the provisions of the ESR. The Guidance provides various

procedures and functions as to how the Regulatory Authorities wish to enforce and asses the test.

The Guidance may be amended from time to time, revised or expanded

by the appropriate Regulatory Authorities.

Exemption

At the outset, the Guidance confirms that the ESR is not applicable

towards companies where any of the following governmental bodies have at least 51% direct or indirect ownership

in its shareholding. These bodies include:

How will the Economic Substance Test be determined?

Each Regulatory Authority will have its

own substance and reporting guidelines that the Licensee will need to adhere to in

order to satisfy the EST as per the ESR. The licensees will need to provide a

a notification containing the appropriate information for the Relevant Authority

to determine if the ECT criteria have been satisfied.

For example, for a company registered in DIFC, it is the DIFC

Authority (as Regulatory Authority) who issues the reporting

requirements and who needs to receive the notifications for the EST. Likewise,

for a company registered for instance in mainland Dubai or in DMCC, it will be

the Dubai Department of Economic Development, respectively the DMCC Authority (as

Regulatory Authorities) that will issue requirements and receive

notifications from the companies registered under them. As such, it is the Regulatory

Authorities that determine in each case whether the Economic Substance Test

(EST) is met.

As a first clarification, the ECT requirements apply only to

specific areas of business, which are: Banking, Insurance, Investment Fund

Management, Lease-Finance, Shipping, Headquarters Business, Holding Companies,

Intellectual Property, Distribution, and Service Center Businesses. In the

conditions set forth by the ESR, such businesses are considered to undertake

income-generating Relevant Activities, therefore their activities need to be

notified to the Regulatory Authority.

Secondly, the Guidance mentions that

the Regulatory Authority will collect information from the Licensee in two

ways:

Regulatory Authority.

The manner as to how these forms are

to be written and laid out is yet to be given. However, it would seem to be

determined as per each Regulatory Authority.

Thirdly, the

information that needs to be supplied to the Regulatory Authority generally

refers to:

Licensee's gross income in relation to a Relevant Activity is subject to tax in

a jurisdiction outside of the UAE;

Year;

income and operational expenses of the company, its employees, management,

board meetings, intellectual property assets and activities, location and place

of business, outsourced business, as determined in detail by Article 8(4) of

the ESR. The Regulatory Authorities may require additional documents, in order

to evaluate whether a company and its activities meet the EST.

Time Frame

The requirements above are in effect from

1 January 2020, meaning that all licensees commenced on or after 1 January 2019

and carrying a Relevant Activitywill need to submit an annual notification

concerning these requirements at the end of their Financial year, which would

be (12) months from the date of commencement.

In the opinion of certain Regulatory Authorities in UAE, the end of

March 2020 would be the first reporting deadline. In this time frame, a

simplified form of reporting will be required, followed by a more comprehensive

report to be notified to the Regulatory Authorities by December 31 2020. The

Regulatory Authorities are expected to issue guidance to their licensees in the

close future.

Article 4.2.3 of the Guidance has clarified that it is not mandatory for the Regulatory

Authority to issue their decision of whether the Licensee has met the prescribed

EST requirements at the end of the relevant financial year instantly. However,

if a decision needs to take place, then as per the ESR, the decision should be executed

no later than six (6) years after the end of that relevant financial year. However,

this time period will not be applicable if the Regulatory Authority cannot

reach a decision due to the Licensee's or any other person's action, deemed as gross

negligence, fraud or misrepresentation.

The ESR doesn't set out a time frame regarding the retention of records. In

this respect, the Guidance advises that a Licensee should retain any relevant

information evidencing compliance with the ESR for a period of six (6) years

after the end of each relevant financial year. Therefore, upon questioning from

the Regulatory Authority, the licensee may be able to address those requests.

Key factors concerning the Economic substance test

To get the full transparency as to what comprises the EST, the Guidance has provided additional clarity regarding the information below, as to how the Regulatory Authority would assess the submission. This involves:

pointed out what activities are considered ‘Core Activities', under Article 5

ESR. However, the guidance mentions that this not an exhaustive list. Meaning,

the licensee may use that list, but are not limited towards them. Therefore, a Licensee should analyze the

nature of their Relevant Activity(ies), rather than focusing only on Core Income-

Generating Activities ("CIGA") list

under the ESR.

test appropriately, by elaborating that at least one (1) meeting should be held

per financial year which should be signed by all attendees physically present

in the UAE. Furthermore, the applicable law under which that entity is governed

by should be considered regarding meeting requirements.

business activity', whilst carrying out the relevant CIGA in the UAE with the

employees, expenditure and premises. The guidance mentions that the EST has no

intentions to compare a smaller firm's requirements to the same level of a

medium-large firm. Each EST will be individually assed as per the firm's nature

and level of the relevant activity, income earned and the firm's size.

to evade compliance with the EST, if brought up. Furthermore, within an agreement

between the Licensee and the outsourced, the Licensee should consider

mentioning ECR compliance terms, such as disclosing information to the

Regulatory Authority, for conformity purposes. The Guidance also notes that

double counting is not allowed if the services are provided to more than one

Licensee carrying out a Relevant Activity in the UAE.

Additional Guidance for Holding

Companies and Intellectual Property Business

As per the Guidance, a holding

company business that derives its income from dividends and capital gains only

are subjected to a reduced ECT. However, a Licensee that owns other forms of

assets besides dividends and capital gains (e.g. bonds, government securities,

interest in real property) will not be deemed as a ‘pure equity holding entity',

(even if it also owns equity participation). Therefore, the entity will not be

treated as carrying on holding business and therefore will not be exempted from

the EST requirements.

The Guidance mentions that income which

is derived from Intellectual Property "IP" assets, pose a greater risk due to artificial

profit shifting. Similarly, the ESR notes that certain activities relating to

IP Business are to be considered as ‘High Risk', therefore, more conditions are

needed to be satisfied by a Licensee undertaking these activities as mentioned under

Article 5(8)(e) ESR. The Guidance further mentions that periodic decisions made

by non-resident directors or board members would not qualify to satisfy the EST

due to considered high risk IP Licensee.

Why is the EST a necessity and how

do the Regulatory Bodies use the information provided by companies?

The ESR are issued pursuant to

certain international standards set by OECD and the EU, aimed at curbing

harmful tax practices.

The information collected by the

Regulatory Authorities will be supplied to the Ministry of Finance and, for the

companies that do not meet the EST requirements, such information will be

notified to the Regulatory Body of each company at issue. Similarly, for

companies that do not meet the EST or are High Risk IP businesses, the Ministry

of Finance will disclose such information overseas, to Foreign Competent

Authorities.

Finally, the Regulatory Authorities may impose administrative penalties for licensees who fail to notify their activities or do not otherwise comply with the ESR and the Regulatory Authorities rules in this respect. Conversely, the licensees will have the right to appeal the Regulatory Authority decisions.

Conclusion

The UAE entities will need to analyse carefully whether their business is in line with the ESR. The Regulatory Authority will adopt a "strict yet pragmatic approach" when assessing the SCT. The Guidance acts as a supporting guide

towards the regulations by providing further insight as to what is required.

However, further guidance is expected to be issued for further support and this is expected from the Regulatory Authorities in the close future.

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