AURIFER
Does the newly issued UAE economic substance guidance answer all questions?

Does the newly issued UAE economic substance guidance answer all questions?

20190915 by Thomas Vanhee, Nils Vanhassel
Earlier this year, the United Arab Emirates ("UAE") issued Cabinet Decision No. 31 concerning economic substance requirements ("Economic Substance Regulations” or “ESR"). UAE onshore and free zone entities (“Licensees") that carry out one or more Relevant Activities as defined under the ESR, are required to meet the Economic Substance Test in respect of the Relevant Activities carried out in the UAE. However, many businesses were left wondering how to meet certain criteria set out by the ESR.

Does the newly issued UAE economic substance guidance answer all questions?

Does the newly issued UAE economic substance guidance answer all questions?
20190915 by Thomas Vanhee, Nils Vanhassel

Earlier this year, the United Arab Emirates ("UAE") issued Cabinet Decision No. 31 concerning economic substance requirements ("Economic Substance Regulations” or “ESR"). UAE onshore and free zone entities (“Licensees") that carry out one or more Relevant Activities as defined under the ESR, are required to meet the Economic Substance Test in respect of the Relevant Activities carried out in the UAE. However, many businesses were left wondering how to meet certain criteria set out by the ESR.

On 11 September 2019, the Ministry of Finance published Ministerial Decision No. 215 for the year 2019 on the issuance of directives for the implementation of the provisions of the Cabinet Decision No. 31 concerning economic substance requirements ("The Ministerial Decision"). The Ministerial Decision contains guidance on how the Economic Substance Test may be met by Licensees in order to comply with the ESR. The guidance is intended to serve as a guide to entities carrying out one or more Relevant Activities captured by the ESR. In addition, the Ministerial Decision sets out various guidelines on how Regulatory Authorities shall comply with the various functions imposed on them by the ESR and which powers are granted to them to ensure effective execution of the ESR provisions.

Licensees

Every Licensee that carries on a Relevant Activity and derives an income therefrom in the UAE, including a Free Zone or a Financial Free Zone, must meet the Economic Substance Test (article 3.1. and 4.1 of The Ministerial Decision). It seems that licensees carrying on a relevant activity, without deriving any income from that activity, are not in scope of the ESR. The practical implications of this requirement seem rather limited, as most of the Relevant Activities as defined in the ESR (perhaps with the exception of holding activities) are usually carried out for consideration.

The ESR stipulate that its provisions do not apply to entities that are directly or indirectly owned by the Federal Government, or the Government of any Emirate of the UAE or the governmental authority or body of any of them (article 3 (2) of the ESR). The Ministerial Decision now clarifies that the government's shareholding interest must be at least 51% for the entity to fall outside the scope of the Economic Substance Regulations (article 3.2. and 4.2 of The Ministerial Decision).

Relevant activities

With respect to the Relevant Activities, carried out by Licensees, the Ministerial Decision reiterates that:

  • Licensees that carry out more that one Relevant Activity are required to satisfy the Economic Substance Test for each Relevant Activity (article 6 (1) of the ESR); 
  • There are reduced substance requirements for holding companies that do not carry out any other Relevant Activity (in short, Holding Companies are not required to carry out any Core Income Generating Activities in the UAE); and
  • Higher reporting requirements and standards apply for Licensees that derive income from a High Risk IP Business. Such Licensee shall be presumed by the Regulatory Authority to not meet the Economic Substance Test (see below). This assumption must be rebutted by the Licensee (article 5.3 of The Ministerial Decision). Furthermore, the Regulatory Authority is required to submit all information obtained in relation to such Licensee to the the Ministry of Finance, irrespective whether the Regulatory Authority has made a determination as to whether such Licensee has met the Economic Substance Test or not (see below).

The Economic Substance Test

Reporting requirements

Under the ESR, Licensees are required to submit an information notification to the Regulatory Authority, indicating (i) whether or not it is carrying on a Relevant Activity, (ii) whether or not all or any part of the Licensee’s gross income in relation to the Relevant Activity is subject to tax in a jurisdiction outside of the UAE, and (iii) the date of the end of its Financial Year. The Ministerial Decision stipulates that the notification must be made with effect from 1 January 2020.

In addition, a Licensee that is carrying on a Relevant Activity and is required to satisfy the Economic Substance Test, must prepare and submit a report to the Regulatory Authority, no later than twelve (12) months after the last day of the end of the financial year of the Licensee. The Ministerial Decision clarifies that this requirement applies in respect of financial years commencing on or after 1 January 2019.

Each Regulatory Authority shall set out the form of reports to be filed and mechanisms for submitting such forms to the Regulatory Authority.

Meeting the Economic Substance Test

In general, the Economic Substance requirements will be met:

  • If Core Income Generating Activities (“CIGA”) are conducted in the UAE;
  • If the activities are directed and managed in the UAE;
  • If there is an adequate level of qualified full-time employees in the UAE, 
  • If there is an adequate amount of operating expenditure in the UAE,
  • If there are adequate physical assets in the UAE.

The Ministerial Decision clarifies that the list of CIGA not exhaustive. This means that other activities outside the ones listed in the ESR, which could be considered as (one of) the most important activities of a Licensee, may qualify as CIGA and should therefore be carried out in the UAE. This may also be an indication that a Licensee is not required to carry out all CIGA listed in article 5 of the ESR in relation to a Relevant Activity.

A Licensee’s activity is directed and managed if there are an adequate number of board meetings held and attended in the UAE in relation to that activity. The term adequate is dependent on the level of Relevant Activity carried out by the Licensee. Meetings must be recorded in written minutes which are kept in the UAE and signed by attendees. Quorum for such meetings must be met and attendees must be physically present in the UAE. Directors must have the necessary knowledge and expertise in relation to the Relevant Activity, which entails that their activity is not merely limited to giving effect to decisions being taken outside the UAE. In the event that a Licensee is managed by an individual (e.g. single managing director), the Ministerial Decision states that these requirements will apply to such individual.

The meaning of the term “adequate” in terms of the level of qualified full-time employees, the amount of operating expenditure and physical assets will be dependent on the nature and level of Relevant Activity being carried out by the Licensee in question. A licensee must maintain sufficient records to demonstrate the adequacy in relation to these requirements. Employees must be suitably qualified to carry out the Relevant Activity. Premises may be owned or leased by the Licensee, however, the Licensee must be able to submit the necessary documentation evidencing the right to use the premises.

With respect to outsourcing, the Ministerial Decision clarifies that timesheets can be used to demonstrate the level of employees which are being outsourced in relation to a certain Relevant Activity. Furthermore, outsourcing may not be used with the objective of circumventing the Economic Substance Test.

Retention of information and Records

The ESR do not prescribe a set period for the retention of information and records by Licensees. Taking into account the six-year limitation period for the Regulatory Authority to determine whether a Licensee has met the Economic Substance Test, it is advisable that a Licensee retains any relevant information evidencing compliance with the ESR for a period of six years. 

Any records required to be kept and submitted to the Regulatory Authority must be provided in English. In the event that such records are kept in a language other than English, the Licensee shall provide an English translation thereof.

Regulatory Authority functions

The Ministerial Decision provides further detail on how Regulatory Authorities shall comply with the various functions imposed on them by the ESR and which powers are granted to them to ensure effective execution of the ESR provisions.

The Regulatory Authority shall obtain all documentation, records and information from any Licensee which they are required to submit to the Regulatory Authority within the timeframe stipulated in the ESR. The Regulatory Authority shall follow-up promptly with any Licensee in the event of any delay of failure in the submission of required documentation, records and information or in case the latter would prove to be incorrect or incomplete. 

In this respect, the Regulatory Authority may:

  • Serve a notice on a Licensee requiring further documentation or information; and/or
  • Enter a Licensee’s premises in order to obtain necessary documentation or information; and/or 
  • Impose on a Licensee an administrative penalty not exceeding AED 50,000.

The Ministerial Decision further provides guidance to Regulatory Authorities on how to determine whether a Licensee has met the Economic Substance Test (e.g. timesheets may be used as a means to verify adequate” employee criterion). In general, the Ministerial Decision states that the Regulatory Authority should adopt a strict yet pragmatic approach to determine whether a Licensee meets the Economic Substance Test.

In case a Licensee fails to meet the Economic Substance Test, the Regulatory Authority shall issue a notice, stating the reasons for that determinations, containing details of any administrative penalty, directing any action to be taken to satisfy the Economic substance Test and advising the Licensee of its right to appeal.

The Regulatory Authority will notify the Competent Authority of each Licensee that fails to satisfy the Economic Substance Test in relation to any activity. The Competent Authority shall provide the submitted information to the Foreign Competent Authority in the event that (i) the Licensee fails to meet the requirements under the ESR for a certain Financial Year, or (ii) the Licensee carries out a High Risk IP Business.

Conclusion

The Ministerial Decision provides some clarification with respect to a number of elements touched upon in the ESR (e.g. which companies are outside of scope of the ESR, the deadlines for the submission of the notification and reports to the regulatory authority, guidance on how to meet the Economic Substance Test). For the most part, however, the guidance merely reiterates the provisions of the ESR. We therefore expect that a large number of companies in the UAE will still have many questions in terms of how to comply with the ESR.

As expected, the Ministerial Decision does not contain one-size-fits-all criteria on how to meet the Economic Substance Test (i.e. in the sense that the Ministry of Finance does not prescribe a specific number in terms of what is considered an adequate number of employees, operating expenditure and physical assets). What qualifies as adequate, will instead depend on the nature and level of the Relevant Activity carried out by the Licensee and it will be up to the latter to provide evidence thereof to the Regulatory Authority.

Another thing worth noting is that the Ministry of Finance has given ample freedom to the Regulatory Authorities to ensure the effective implementation of and compliance with the ESR. Given the fact that every Regulatory Authority has been given the opportunity to determine its own forms and mechanisms for submitting the economic substance reports, in combination with the fact there seems to be some leniency in terms of determining whether a business has met the economic substance test (after all, one Regulatory Authority’s interpretation of what is adequate may differ from another), from a practical point, businesses can expect some level of divergence in terms of how the ESR will be implemented between the different Regulatory Authorities in the UAE.

10 things to know about the UAE’s Country by Country Reporting

10 things to know about the UAE’s Country by Country Reporting

20190831 by Thomas Vanhee and Melissa D'Souza
The UAE is a popular destination for foreign entities to set up their businesses in the Middle East region, amongst others because there is no corporate income tax on the federal level.

10 things to know about the UAE’s Country by Country Reporting

10 things to know about the UAE’s Country by Country Reporting
20190831 by Thomas Vanhee and Melissa D'Souza

The UAE is a popular destination for foreign entities to set up their businesses in the Middle East region, amongst others because there is no corporate income tax on the federal level. 

In line with international developments around tax transparency, the UAE decided to align its legislative framework with international tax practices by adopting Country by Country Reporting (“CbCR”). The adoption of BEPS Action 13 (introduction of CbCR legislation) is a strong recommendation from the OECD and is part of the wider OECD BEPS action plan and the Inclusive Framework.

Below we list the top 10 things to know for UAE businesses in relation to the new CbCR.


     1. What is a Country by Country Report?

The CbCR is a high level report through which multinational groups report relevant financial and tax information, for each tax jurisdiction in which they do business.


      2. Who does it apply to?


The reporting is compulsory for multinational groups which are present in at least two tax jurisdictions and which meet the consolidated revenue threshold of AED 3.15 billion (approx. USD 878 million) in one financial year. The subsidiaries of the group need to be linked through common ownership or control.


     3. Which entity files the CbCR?


Multinational groups have to establish which entity must submit this report, the i.e. the ultimate parent entity (“UPE”) or a surrogate parent entity (“SPE”). If the tax jurisdiction of the UPE does not have CbCR legislation or does not (automatically) exchange the reports, the tax jurisdiction of the SPE needs to file the CbCR.

The jurisdiction where the CbCR is filed will automatically exchange the information shared in the CbCR with the other tax jurisdictions in which the group is active.


    4. If the UAE entity does not file the CbCR, does it have any other obligation?


If the UAE entity is part of a multinational group, it needs to notify the UAE Ministry of Finance of the name of the entity submitting the CbCR and the tax residence of this entity before the last day of the financial reporting year (31 December 2019 for the first year). There is no formal process in place yet for notifying MoF of this.


    5. When do we submit the CbCR?


The CbCR regulations came into effect as of 1 January 2019, this means that for the financial year ending 31 December 2019, the CbCR must be submitted at the latest by 31 December 2020, and annually thereafter.


    6. What information should we provide?


The CbCR needs to include the amount of revenues, profits (losses) before income tax, income tax paid, income tax payable, declared capital, accrued profits, number of employees, and non-cash or cash-equivalent assets for each country. 


     7. What will the CbCR be used for?


The CbCR allows tax authorities around the world to automatically exchange information on taxable profits in different tax jurisdictions. The information allows the tax authorities to make a first assessment before highlighting risk jurisdictions in which too little tax is being paid.

Given the current absence of Federal Corporate Income Tax, the UAE authorities will not have a particular interest in the CbCR. Other States however will be interested in what the UAE subsidiary of the international group is reporting.


     8. How long do we keep the information?


The relevant records need to be maintained until 5 years after submitting the CbCR. The records can be kept electronically and in English.


     9. Is there a format for submitting the CbCR?


The report should be in the same format as per the OECD guidelines. Click here for Appendix C of OECD’s guide for reference.


    10. Are there any penalties for non-compliance?


See above table

Except for the additional daily penalty, the total fines imposed may not exceed AED 1,000,000 in one financial year.

UAE introduces Country by Country reporting

UAE introduces Country by Country reporting

20190703 by Thomas Vanhee
By way of a Cabinet Resolution, the UAE has introduced Country by Country reporting (“CbC reporting”). Almost simultaneously with the introduction of economic substance regulations, the UAE further implements international tax standards and joins around 80 other countries which have implemented the CbC reporting. The impact of this reporting on international corporations in the UAE cannot be understated.

UAE introduces Country by Country reporting

UAE introduces Country by Country reporting
20190703 by Thomas Vanhee

By way of a Cabinet Resolution, the UAE has introduced Country by Country reporting (“CbC reporting”). Almost simultaneously with the introduction of economic substance regulations, the UAE further implements international tax standards and joins around 80 other countries which have implemented the CbC reporting. The impact of this reporting on international corporations in the UAE cannot be understated.

Background

In the Framework of the Base Erosion and Profit Shifting (“BEPS”) project of the OECD and the G20, countries agreed, amongst others, to implement BEPS action 13 in order to tackle the shortcomings of the international tax system. 

This action prescribes that countries implement legislation requiring multinational enterprises (MNEs) to report annually and for each tax jurisdiction in which they do business certain relevant tax related information and exchange this information with other countries.

UAE implementation

The UAE’s legislation very much mirrors the standards imposed by the OECD which have been adopted in countries which have already implemented CbC reporting. It is applicable to groups which have subsidiaries in at least two tax jurisdictions. The threshold for the consolidated revenues is AED 3.15 billion.

Ultimate Parent Entities in the UAE will therefore have the obligation to file a CbC report to the Ministry of Finance (“MoF”). Certain entities in the UAE may become Alternate Parent Entities as a result of the legislation.

The Federal Tax Authority is not involved in the process, even though according to its Establishment Law it is also competent.

There is currently no requirement to prepare master files and local files. There is additionally no requirement to file a Controlled Transactions Disclosure Form or similar, which KSA has implemented.

Information to be shared by 31 December 2019

The CbC report needs to include the amount of revenues, profits (losses) before income tax, income tax paid, income tax payable, declared capital, accrued profits, number of employees, and non-cash or cash-equivalent assets for each country. In absence of any UAE Generally Accepted Accounting Principles, it will be interesting to see what accounting methods will be used to share the information.

In addition to the above information, the tax residency of the subsidiaries needs to be disclosed, the nature of its activity or main business activities.

The UAE will be using the Model Form prescribed by the OECD. The filing deadlines will be determined later this year. Most likely the notification will have to be done by the end of this year and the CbC report by the end of 2020 for companies with a financial year matching Gregorian calendar years.

Sharing of the information

The collected information will be shared by the UAE Ministry of Finance with other countries with which it has information sharing agreements. These could be bilateral treaties or the Convention on Mutual Assistance in Tax Matters. The bilateral treaties concluded by the UAE generally include a provision allowing the exchange of information.

Internationally the intention is to move towards an automatic exchange of the CbC reports. The first automatic exchanges have taken place in June 2018.

Penalties for non compliance

If businesses fail to file to comply with their obligations under the CbC reporting, they run a penalty exposure of up to AED 2,250,000.

Conclusion

The UAE is the third GCC country to implement CbCr reporting after Qatar and KSA had done so previously. The context of the UAE is slightly different, given the current absence of Federal Corporate Income Tax. Both Qatar and KSA have a form of corporate income tax.

How useful the CbC reporting is for MoF currently in absence of any Federal Corporate Tax remains to be seen. However, the introduction of the reporting will allow the UAE to be removed from domestic, European and other blacklists.

The Federal Tax Authority may be interested in the file for VAT purposes and ask tax payers to reconcile the amounts in the CbC report, as it can do today already with audited financial statements.

The importance of the introduction of CbC reporting cannot be understated. The UAE’s important neighbour, Saudi Arabia, will be very keen to examine the information in the CbC reports filed by UAE companies to verify whether it is receiving the right end of the tax portion.

Just how spectacular are the new UAE Economic Substance Regulations for the UAE?

Just how spectacular are the new UAE Economic Substance Regulations for the UAE?

20190701 by Thomas Vanhee, Nils Vanhassel and Qurat Ul Ain
On 30 April 2019, the United Arab Emirates ("UAE") issued Cabinet Decision No. 31 concerning economic substance requirements ("Economic Substance Regulations"). UAE onshore and free zone entities that carry on specific activities mentioned in the regulations will need to examine whether they meet the economic substance requirements. Failing to meet those will trigger penalties. But why is this at first glance inane looking piece of legislation so important for the UAE?

Just how spectacular are the new UAE Economic Substance Regulations for the UAE?

Just how spectacular are the new UAE Economic Substance Regulations for the UAE?
20190701 by Thomas Vanhee, Nils Vanhassel and Qurat Ul Ain

At a glance

On 30 April 2019, the United Arab Emirates ("UAE") issued Cabinet Decision No. 31 concerning economic substance requirements ("Economic Substance Regulations"). UAE onshore and free zone entities that carry on specific activities mentioned in the regulations will need to examine whether they meet the economic substance requirements. Failing to meet those will trigger penalties. But why is this at first glance inane looking piece of legislation so important for the UAE?

Background

The introduction of a legal framework regulating the economic substance criterion in the UAE is a direct consequence of the Organisation for Economic Co-operation and Development's ("OECD") ongoing efforts to combat harmful tax practices under Action 5 of the Base Erosion and Profit Shifting ("BEPS") project. 

It also follows the increased focus by the European Union (EU) Code of Conduct Group ("COCG") on companies established in jurisdictions with a low or no income tax regime, resulting in the publication of the first EU list of non-cooperative jurisdictions, which currently includes the UAE (“EU Blacklist”). In response to the EU COCG initiatives, the governments of the Bahamas, Bermuda, British Virgin Islands (BVI), Cayman Islands, Guernsey, Isle of Man, Jersey, Mauritius and Seychelles introduced economic substance rules with effect from 1 January 2019.

There has also been growing interest and scrutiny from the public opinion as to whether entities established in such jurisdictions should be required to have sufficient economic substance before being able to benefit from beneficial tax regimes. 

The purpose of the Economic Substance Regulations is to curb international tax planning of certain business activities, which are typically characterised by the fact that they do not require extensive fixed infrastructure in terms of human and technical capital, in a way which allows profits to be shifted to no or nominal tax jurisdictions, as opposed to taxing profits where the company has actually created economic value. 

One of the reasons why the UAE has attracted so many businesses is because there is currently no income tax regime at a federal level. The economic substance legislation is specifically targeted at businesses that do not have genuine commercial operations and management in the UAE.

The main reason why the UAE has decided to introduce economic substance legislation lies in the country's aim to further align its legislative framework with international tax practice and the standards set out in the OECD BEPS action plan.

What is economic substance?

Economic substance is a concept introduced to ensure that companies operating in a low or no corporate tax jurisdiction have a substantial purpose other than tax reduction and have an economic outcome that is aligned with value creation. In other words, economic substance requirements are used to analyze whether a company’s presence has a purpose besides the mere reduction of a tax liability. 

Which entities are in scope?

The Economic Substance Regulations apply to UAE onshore and free zone entities that carry out one or more of the following activities:

  • Banking
  • Insurance
  • Fund management
  • Lease-finance
  • Headquarters
  • Shipping
  • Holding company
  • Intellectual property (IP)
  • Distribution and service centre

Entities that are directly or indirectly owned by the UAE government fall outside the scope of the Economic Substance Regulations.

Economic Substance Test

Entities are required to meet the Economic Substance Test when they conduct any of the above activities.

For each Activity, the regulations have defined the so-called Core Income Generating Activities (“CIGA”). This is a list of activities that must be conducted in order to meet the Economic Substance Test. For example, for intellectual property the CIGA would consist of research and development.

In general, the Economic Substance requirements will be met:

  • If CIGA are conducted in the UAE;
  • If the activities are directed and managed in the UAE;
  • If there is an adequate level of qualified full-time employees in the UAE, 
  • If there is an adequate amount of operating expenditure in the UAE,
  • If there are adequate physical assets in the UAE.

In case the CIGA are carried out by another entity, these need to be controlled and monitored.

In accordance with EU recommendations, the regulations provide for less stringent requirements for Holding Company Businesses (“Holding Companies”).

Outsourcing

The CIGA may be outsourced, if there is adequate supervision and the outsourced activity is conducted in the UAE. Economic substance requirements will not be met if multiple Licensees outsource the same activity to the same service provider. There is no possibility for double counting the same service provider.

Reporting and compliance 

Licensees will need to prepare and submit an annual report to their Regulatory Authority (Free Zone Authority or DED), within a period of twelve months after the end of each financial year. The Regulatory Authority will then submit the report to the Ministry of Finance (“Competent Authority”).

Since the Economic Substance Regulations came into effect per 30 April 2019, for existing entities, the first report will have to be submitted in 2020. 

Administrative penalties and sanctions

- Failure to meet the economic substance test

AED 10,000 to AED 50,000 (First Financial Period)

AED 50,000 to AED 300,000 (Consecutive Financial Periods)

- Failure to provide information

AED 10,000 to AED 50,000

In case of continuous non-compliance, Regulatory Authorities may suspend, revoke or deny renewal of an entity’s license.

Exchange of information

If a Licensee fails to meet the Economic Substance Test for a financial year, the Regulatory Authority will inform the Minister of Finance for the financial year in question. 

The Minister of Finance will then inform the foreign competent authority where the parent company, ultimate parent company or ultimate beneficial owner is established of the non compliance. This may lead in these countries to denying treaty benefits. This requires that the UAE has entered into a Treaty or similar arrangement with that country.

Takeaway - much ado about?

UAE entities involved in banking, insurance, fund management, investment holding, financing and leasing, distribution and service center, headquarter companies and intellectual property (IP) activities should asses whether their current presence and activity level meets the newly introduced Economic Substance requirements. 

Where required, they make the necessary adjustments to ensure that their business is compliant with the UAE regulations which entered into force on 30 April 2019, in order to avoid  administrative penalties, and potentially deregistration.

Moving away from the dusty provisions of the law, what consequences does the Economic Substance law now really trigger?

Operational companies should be little worried. They will not be impacted. The very small companies should be slightly worried. The businesses that were attracted by 50 year tax holidays and other promises and failed to develop any substantial activity in the UAE should be more worried.

How much the UAE will be effectively policing this legislation remains to be seen. Merely taking the example of Switzerland, that country had signed up to multiple exchange of information obligations but dragged its feet for the longest time. 

For now though, the UAE has an argument towards the EU and, more importantly, individual countries, to get the UAE off their blacklists. This is important, since some UAE headquarters are currently being denied double tax treaty benefits in a number of countries, because of its failure to comply with international norms.

The legislation may potentially become obsolete though, if the UAE introduces Corporate Income Tax at a rate considered high enough to no longer be considered as a low tax jurisdiction.


Read our previous article on the introduction of Economic Substance Requirements in the UAE here