How does my business comply with UAE Economic Substance Rules?

In April 2019 UAE enacted rules to require certain legal entities set up in the UAE to demonstrate that they carry out substantial economic activities in the UAE (the Economic Substance Rules). You can find out more in our guide to the Economic Substance Rules.

If businesses are within scope of the Economic Substance Rules they must implement strategies for compliance and prepare for the notification and reporting requirements.

The Economic Substance Rules require UAE-based entities within the scope of the Economic Substance Rules to comply with annual notification requirements from January 2020 onwards; the Economic Substance Test, and annual reporting requirements to demonstrate compliance with the Economic Substance Test.

Failure to notify the regulatory authority, submit annual reports or provide information on request or the provision of inaccurate information will attract a penalty of between AED10,000 and AED50,000 ($2,700-$13,600).

Failure to meet the Economic Substance Test will result in penalties of between AED10,000 and AED50,000 in the first instance and the relevant regulatory authority will issue a notice specifying the actions to be taken. If the regulatory authority determines that an entity is not meeting the Economic Substance Test for the company's financial year following the year in which the above notice was issued, a penalty between AED50,000 and AED300,000 ($13,600-$81,600) will be imposed and the company's licence may be suspended or revoked or renewal denied. Information may also be shared with the business's foreign regulators.

Annual notifications to the relevant regulatory authority

From January 2020 entities will be required to notify the relevant regulatory authority on an annual basis whether they are carrying on a 'relevant activity'; whether any income is subject to tax outside the UAE; and the entity's financial year dates.

If an entity is established in a free zone the relevant regulatory authority will be the competent authority in the relevant free zone. Otherwise, the relevant regulatory authorities will be:

• for banking and finance leasing businesses, the Central Bank;
• for insurance businesses, the Insurance Authority;
• for investment fund management businesses, the Securities and Commodities Authority; and
• for all other entities, the Ministry of Economy.

As each regulatory authority is tasked with receiving notifications, there may be a differing approach as to how such notifications are to be received and the timing and form of such notifications.

The Economic Substance Test

The general Economic Substance Test assesses whether a business:

• conducts 'core income-generating activities' within the UAE;
• directs and manages business from within the UAE;
• employs full-time staff in the UAE, or outsources to a UAE-based provider;
• incurs operating expenditure in the UAE;
• retains adequate physical assets in the UAE.

As each regulatory authority is tasked with making a determination of whether an entity is in compliance with the Economic Substance Test, this has the potential to result in differing approaches across sectors.

Conduct 'core income-generating activities' within the UAE

For each Relevant Activity, there are various tasks (called core income generating activities) specified in the Economic Substance Rules that must be undertaken in the UAE. For example, in relation to a company headquarters, the tasks of taking relevant management decisions, incurring operating expenditures and coordinating group activities must be actually carried out in the UAE by staff present in the UAE.

The recently-published guidance clarifies that the list in the Economic Substance Rules is not exhaustive and therefore its possible that other tasks will also be deemed to be core income generating activities. The general principle is that the most important activities relevant for each Relevant Activity should be carried out in the UAE.

Direct and manage your business from within the UAE

The "'directed and managed' test ensures that there are an adequate number of board meetings held and attended in the UAE. The quorum must be met by directors physically present in the UAE. If there is no board, the chief executive or general manager must be physically present in the UAE for key decision making. Whether or not a regulatory authority will permit management to fly in and fly out will no doubt depend on the size and nature of the business as well as an assessment of what other arrangements have been put in place for a physical presence in the UAE.

A board or manager present in the UAE must have the necessary knowledge or expertise for the role and must not be merely giving effect to decisions taken outside the UAE.

Employ full-time staff in the UAE

There must be an "adequate" number of qualified full-time employees working on the Relevant Activity who are physically present in the UAE. Alternatively, there must be an adequate level of expenditure on outsourcing to third party service providers whose activities, employees, expenditure, and premises are in the UAE and these activities, employees, expenditures and premises are adequate for carrying out the Relevant Activity.

Outsourcing to a third party service provider may be attractive to entities seeking compliance with the Economic Substance Rules.  However, there must be no double counting if a third party service provider provides outsourced services to more than one entity carrying out a Relevant Activity. In addition, the entity must be able to demonstrate its ability to supervise the carrying out of the core income generating activities by the outsourced provider and that the outsourcing to third party service providers is not being done to circumvent compliance with the Economic Substance Rules.

Incur operating expenditure in the UAE

The business must ensure there is adequate operating expenditure incurred within the UAE on the Relevant Activity (which will include expenditure on outsourced services based in the UAE). The Ministry of Finance guidance states that it is not the intention of the Economic Substance Rules to force companies to incur expenditures beyond their needs provided they are engaged in genuine business activity and carrying out core income generating activities in the UAE.

Adequate physical assets in the UAE

Either the entity has adequate levels of physical assets in the UAE used for conducting the Relevant Activity or has an adequate level of expenditure on outsourcing for the Relevant Activity. Again the Ministry's guidance assures us that what is "adequate" is dependent on the nature and level of the Relevant Activity being undertaken.

Submit annual reports

If an entity is carrying on a Relevant Activity, then, within 12 months of the end of its financial year, the entity must submit an annual report to the relevant regulatory authority providing details relating to the activity, income, expenses and assets and declaring whether the Economic Substance Test has been met.

The form of such annual report will be determined by the Ministry of Finance which should enable a consistent approach is taken across all sectors. Each UAE entity must submit a separate report even if part of a corporate group.

Annual reports must include:

• a description of the type of each Relevant Activity and the amount and type of income relevant to such Relevant Activities;
• the amount and type of operating expenses and assets in relation to each Relevant Activity;
• the location of the place of business and, if applicable, the plant, property or equipment used for the Relevant Activity;
• the number of full-time employees with qualifications and the number of personnel responsible for carrying out the Relevant Activity;
• information showing the Core Income Generating Activity for the Relevant Activity;
• a declaration stating whether or not the Economic Substance Test has been satisfied; and
• where the Relevant Activity has been outsourced, the entity must demonstrate that they had adequate supervision of the outsourced activity and they must submit a report detailing the adequacy of the outsourced services provider's activities, employees, operating expenditures and premises in the UAE.

Document retention and further requests for information

A regulatory authority may request any such additional information, documents or other records as is reasonably required to make a determination on whether an entity is compliant with the Economic Substance Rules. Such information could include board meeting minutes signed by directors physically present; employee and management qualifications and experience; employee time sheets; time sheets for outsourced service providers, and any other documents the regulatory authority considers necessary. The regulatory authority may request that the information be translated into English.

As some of the information requested by a regulatory authority may be held by an outsourced service provider, outsourcing contracts must ensure that the outsourced service provider creates, maintains and discloses such records in accordance with the Economic Substance Rules.

A regulatory authority may determine that an entity isn't compliant with the Economic Substance Rules at any time up to six years after the end of the relevant financial year. Therefore, it is advisable that businesses should keep records evidencing compliance with the Economic Substance Rules for at least six years after the end of the relevant financial year in order to comply with any information requests from a regulatory authority.

Should a regulatory authority decide to investigate non-compliance, it has the power to enter the business premises and take copies of documents relating to the carrying on of the Relevant Activity. In addition, it may impose a fine of up to 50,000 AED should an information request not be complied with.

Requirements for Holding Company Businesses

If your entity is a Holding Company Business that derives its income purely from equity capital gains and dividends, the general Economic Substance Test will not apply and a much lower test is applied. However, holding companies that generate income from activities other than capital gains and dividends or hold assets such as real estate or other investments will be required to comply with the usual Economic Substance Test.

All holding companies, including UAE nominee and trust structures set up for foreign ownership of UAE entities, must ensure that all income sources coming into such holding structures are strictly dividends and capital gains in order to avoid the more stringent Economic Substance Rules requirements.

Despite the fact that the usual Economic Substance Test will not apply, the entity will still be required to comply with certain Economic Substance Rules including the notification, reporting and document retention requirements.

Requirements for high risk IP licensees

Income derived from intellectual property assets is at a higher risk of artificial profit shifting and therefore more stringent rules have been imposed on entities deemed to be 'high risk IP licensees'.

Your entity may be considered to be a High Risk IP Licensee if it holds, exploits or receives income from intellectual property assets and falls within one of the following two categories:

• the entity doesn’t carry out any branding, marketing, distribution or research and development activities; or
• the entity didn’t create the intellectual property but acquired it from another related entity or acquired the intellectual property in consideration for funding research and development from a foreign entity. The entity then licences the intellectual property to a related entity or generates income as a result of activities conducted by a related entity situated outside the UAE.