The UAE Economic Substance Regulations (the "Regulations") are now in force (for more information, please see our previous update here). From January 1, 2020 onwards, relevant entities within the scope of the Regulations are required to prepare and submit economic substance declarations to their relevant regulatory authority, and may be required to meet an Economic Substance Test.
What has changed?
The UAE Ministry of Finance ("MoF") has published further guidance related to the UAE Economic Substance Regulations, in the form of answers to Frequently Asked Questions. These can be accessed here.
We explore some of the key themes of the MoF’s guidance below.
Does this apply to me?
The Regulations apply to UAE onshore and free zone companies, branches, partnerships, and other UAE business forms (referred to as "Licensees") that carry out any of the following activities ("Relevant Activities"):
- Banking businesses
- Insurance businesses
- Investment fund management businesses
- Lease-finance businesses
- Headquarter businesses
- Shipping businesses
- Holding company businesses
- Intellectual property businesses
- Distribution and service centre businesses
A “substance over form” approach is used to determine whether a Licensee undertakes a Relevant Activity and is within the scope of the Regulations. This means looking beyond what is stated on its commercial licence to the activities actually undertaken by the Licensee.
It is important to note that free zone (“offshore”) companies are not exempted from the Regulations. However, Licensees that are directly or indirectly at least 51 per cent owned by the Federal or an Emirate Government, or a UAE Government body or authority, are exempt.
What does it mean to be within the scope of the Regulations?
For each financial period in which a Licensee earns income from a Relevant Activity, it will need to meet an Economic Substance Test in relation to that activity. The Economic Substance Test requires a Licensee to demonstrate that:
- the Licensee and Relevant Activity are being directed and managed in the UAE;
- the relevant Core Income Generating Activities ("CIGAs") are being conducted in the UAE; and
- the Licensee has adequate employees, premises and expenditure in the UAE.
Licensees that undertake and earn income from a Relevant Activity are also required to file an economic substance return within 12 months from the end of the relevant financial period.
It should be noted that a Holding Company Business is not required to be directed and managed in the UAE, except where this is a requirement of the relevant licensing authority. Further specific detail on certain of the Relevant Activities is available on the MoF website.
What financial periods does this apply to?
The Regulations apply to financial years commencing on or from January 1, 2019.
Declarations must be submitted within 12 months from the end of the relevant financial year. For Licensees with a financial year ending on December 31, 2019, a declaration must be made by December 31, 2020.
I am part of a foreign multinational group. What impact does this have?
The Regulations apply regardless of whether the Licensee belongs to a foreign multinational group.
However, a UAE-based distribution, Service centre, Headquarter or High-Risk intellectual property business would only be within the scope of the Regulations if it transacts with foreign group companies. Licensees carrying out these specific activities and who transact only between UAE entities would not be subject to the Economic Substance Test.
Where Licensees are part of the same group, each Licensee will need to comply with the Regulations, and demonstrate economic substance on an individual basis. However, relevant substance (staff, functions, assets, etc.) maintained in the UAE by other group companies can be taken into account if that economic substance is made available to the Licensee under a service/outsourcing type arrangement.
What if I only earn income from a Relevant Activity outside of the UAE?
In such instance the Licensee is not exempt from the Regulations. Income from a Relevant Activity for which the Licensee needs to demonstrate economic substance in the UAE includes all income, including income that is generated by the Licensee outside of the UAE.
What is meant by “adequate” or “appropriate” economic substance?
Businesses vary in size and nature, and what is adequate and appropriate will depend on the nature and level of activities carried out, and the level of income earned by the Licensee.
The Regulations and guidance released to date do not provide a “minimum” standard for what is considered “adequate” or “appropriate”. The regulatory authorities are expected to take a pragmatic approach when assessing whether a Licensee has met the Economic Substance Test, recognising that the type and level of activity of a Licensee may fluctuate during the course of a financial period and from year to year.
Does this mean I need to hold board meetings in the UAE?
If you need to meet the Economic Substance Test, yes. An adequate number of board meetings should be held in the UAE. What is considered to be an adequate number of board meetings will depend on the nature and extent of the Relevant Activity being undertaken by the Licensee. For each board meeting held in the UAE:
- a quorum of directors must be physically present in the UAE;
- meeting minutes must be maintained and signed in the UAE; and
- directors attending the board meeting must have the necessary skills and expertise to discharge their fiduciary duties.
Do directors, or employees who perform the CIGAs, need to be present in the UAE?
Directors only need to be physically present in the UAE to attend relevant board meetings.
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.
Can I outsource any of these requirements?
A Licensee can outsource, contract or delegate any or all of its CIGAs to related parties or to third party service providers, as long as: (i) the Licensee monitors and retains the ability to control the outsourced activities, and (ii) the outsourced activities are performed in the UAE.
Effectively, this means that a Licensee can use UAE based employees and physical assets (including premises) of third parties or related entities to satisfy the Economic Substance Test.
A Licensee cannot outsource the requirement to be “directed and managed”, as the Licensee is required to demonstrate oversight and control of its Relevant Activity in the UAE.
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.
What should I do now?
The MoF has provided the following non-exhaustive list of matters a Licensee should consider (and action, where relevant) before the end of a financial period:
- assess what (if any) Relevant Activities it has performed during the financial period (applying a “substance over form” approach);
- assess the amount and type of income earned (if any) from the Relevant Activity during the financial period;
- hold board meetings with a quorum of directors physically present in the UAE;
- ensure board meeting minutes are signed and maintained in the UAE;
- identify the amount and type of expenses and UAE based assets (including premises) in respect of the Relevant Activity, and ensure access to assets (including premises) can be demonstrated (through agreements and financial records);
- identify the number of UAE based full-time employees or other personnel (and their qualifications) responsible for carrying on the Licensee’s Relevant Activity; and
- ensure control and supervision over any outsourcing arrangements can be demonstrated, e.g. through contractual agreements.
Additional actions may be required to ensure a Licensee can demonstrate sufficient economic substance in the UAE for a relevant financial period, and the considerations above may differ where a Licensee has either a Holding Company or a “High Risk” Intellectual Property Business (as defined in the Regulations).
How we can help?
If you are concerned that the Regulations may apply to you and are unsure of the next steps you should be taking, we would be happy to assist you. Please see the contacts below.