What is the UAE’s Definition of Economic Substance?
What is the definition of economic substance according to the authorities in the United Arab Emirates? In exchange for the country’s removal from the European Union’s Blacklist of Uncooperative Jurisdictions in October 2019, the country introduced economic substance legislation. It tightened the first regulations to meet the strict requirements requested from EU authorities. A crucial part of grasping the impact to understand the economic substance definition in the context of the UAE. Here’s what you need to know.
The UAE economic substance definition
The definition of economic substance comes from the Organisation for Economic Cooperation and Development (OECD)’s Forum on Harmful Tax Practices (FHTP). This organism is the one that establishes the international standard that “...requires companies to have substantial activities in a jurisdiction.” The idea is that entities actually carry out business activities in their country of jurisdiction rather than registering in a country merely for tax reasons.
How does this apply to the UAE context? On 30 April 2019, the UAE enacted its economic substance regulations (known as the Economic Substance Regulation, or ESR) in an effort to ensure that Emirati-based entities that operate in a set of sectors do not serve”...to artificially attract profits that are not commensurate with the economic activity undertaken in the UAE.” The economic activities that are subject to this economic substance testing are those firms involved in banking, investment fund management, lease-finance, insurance, holding companies, shipping, headquarter, distribution and service centres, intellectual property and shipping. In summary, these business activities are known as core income-generating activities or CIGA.
If your company performs an activity that falls under any of the categories we listed above, it will be subject to Economic Substance testing that meets three pieces of criteria. While our previous article highlighting the introduction of this legislation mentions these parameters, your firm will have to meet three tests to satisfy the economic substance requirements. What are they? They are:
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Your company should be directed and managed inside the UAE for the stated economic activity.
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Your entity must perform its CIGA activities within the UAE.
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Your entity should have an appropriate number of qualified employees, annual operating expenditures and facilities for its operations.
If you have an offshore company operating in any of the 45 Free Zones, does the economic substance testing apply to you? In this case, if your Free Zone company is in any of the sectors mentioned above, you must submit to Economic Substance testing. The entities that are exempt from this regulation are those where the Emirati government either has direct or indirect ownership of at a majority stake, or at least 51%, of the company’s capital.
What is the minimum amount of economic substance?
In the official guidance from the Emirati government, they note that since every company has differing characteristics, they did not set out regulations that they deem adequate. They have also reassured firms that they will take into account that there may be fluctuations throughout a financial period and in their year over year figures. Despite this, you must know that if you have multiple licensees in the same group, each separate group must pass the Economic Substance Test on its own.
Are you looking for guidance on how to comply with Economic Substance regulations?
With a storied track record of company formation in the United Arab Emirates, our corporate services team at Europe Emirates Group is ready to ensure your proper compliance with the Economic Substance Regulation. We will guide you through appropriate financial reporting to avoid any fines and to adequately structure your company. If you are ready to get started, reach out to us and begin your process.
Written by
Adrian Oton, CEO Europe Emirates Group
