The most recent tax changes in the United Arab Emirates (UAE) have been introduced mainly in order to accommodate requests made by the Organization for Economic Co-operation and Development, under the Base Erosion and Profit Shifting (BEPS) project that is aimed at combating tax avoidance.
Two new resolutions were issued on April 30, 2019; the UAE has introduced country-by-country reporting (CbCR) and economic substance requirements. CbCR is designed to enable tax jurisdictions to share tax relevant information about companies. A key driver for the economic substance requirements is to ensure that companies’ core income generating activities are actually performed in their respective jurisdictions.
The key impacts on affected companies are the additional annual reporting requirements and the organizational changes that may be required to achieve the required specific economic substance levels. Non-compliant companies could risk fines and penalties, suspension, withdrawal or non-renewal of licenses, and the disclosure of their position to other foreign authorities.
Companies Within Scope of New Regulations
UAE-based companies are required to submit a country-by-country report (Report) to the Ministry of Finance if the company is:
- part of a multinational corporation group (MCG) consisting of a group of companies that are tax resident in more than one country (either through another group company or via a permanent establishment) and has consolidated revenues of 3.15 billion UAE dirham ($857 million) or more; and is
- an ultimate parent entity (UPE) of this MCG; or
- a subsidiary of an MCG with a foreign UPE unless the UPE or an assigned alternate parent will submit the report for the relevant year in another country with which the UAE has an effective exchange relationship.
In case the UPE submits the Report in another country with which the UAE has an effective exchange relationship, the UAE company is only required to submit a notification to the Ministry of Finance indicating in which country the Report will be filed on behalf of the MCG and subsequently exchanged with the UAE.
Economic substance requirements apply to companies that carry out the following “Relevant Activities” in the UAE, whether onshore or within the free zones (including financial free zones):
- insurance services;
- investment fund management;
- finance leasing;
- headquarter activities related to (i) conducting management decisions, (ii) incurring operational expenditures on behalf of group entities, and (iii) coordinating group activities;
- intellectual property services;
- holding company activities; and
- distribution and service center activities provided to non-UAE related persons including (i) transporting and storing spare parts, materials or ready-for-sale goods, (ii) managing inventories, (iii) taking orders, and (iv) providing consulting or other administrative services.
Country-by-Country Reporting Requirements
The Report needs to be prepared based on the templates determined by the OECD in BEPS Action 13 (i.e., Table 1, Table 2 and Table 3) and must contain information on revenue, profit (losses), income before tax, and tax paid for each country where the MCG engages in its activities.
Each entity of the MCG must be identified, clarifying its tax residence, nature of its activities and main business activity.
The Report needs to be submitted to the Ministry of Finance within 12 months after the end of the fiscal year of the MCG. The first filing deadline for the submission of the Reports is December 31, 2020 if the company’s financial year follows the calendar year. The notifications need to be submitted by UAE subsidiaries that do not need to file the Reports ultimately at the last day of the fiscal year of the MCG. As such, the first deadline for submitting a notification would be December 31, 2019 where the company’s financial year follows the calendar year.
Economic Substance Requirements
Companies established in the UAE that carry out Relevant Activities must maintain economic substance in the UAE, in particular:
- carry out the core income generating activity (CIGA) in the UAE;
- be directed and managed in the UAE; and
- have an adequate level of qualified full-time staff, operational expenditure and physical assets present in the UAE to conduct the CIGA.
The economic substance requirement may also be met if there is an adequate level of expenditure incurred on outsourcing these to third party service providers in the UAE.
Additional Reporting Requirements
Companies are required to prepare and submit a compliance report to the regulatory authority (which has yet to be determined) which should include the following information:
- type of CIGA conducted;
- amount and type of income arising from the CIGA;
- amount and type of operating expenses and assets to conduct the CIGA;
- location of place of business and, if applicable, plant, property or equipment;
- number of full-time employees with qualifications and staff responsible for carrying out the CIGA; and
- a declaration of compliance with the economic substance test.
The regulatory authority will submit the report to the Ministry of Finance. The first compliance report needs to be submitted not later than 12 months after the end of the current financial year.
Exchange of Information
Exchange of Reports takes place globally among countries that signed up for the CbC Multilateral Competent Authority Agreement and that in addition have activated the bilateral exchange relationship with the specific country with which the Reports will need to be exchanged. The UAE has signed up for this instrument, but has not yet activated any bilateral exchange relationships with other countries.
It is expected that the UAE will activate various bilateral exchange relationships before the first deadline for filing Reports in the UAE. We recommend that affected companies monitor the status of the activation of bilateral exchange relationships, which can be found here.
If the UAE does not activate the exchange relationships with other countries before the end of 2020, a local filing requirement will arise for UAE subsidiaries of foreign MCGs.
In addition, under the economic substance legislation, the information reported by the company to the regulatory authority will be provided to the Ministry of Finance if the company has not met the economic substance requirements. Also, if the Relevant Activity of the company is regarded as “high-risk intellectual property services,” the regulatory authority will need to provide the reported information to the Ministry of Finance irrespective of whether the economic substance test is met. The Ministry of Finance may exchange this information with foreign governments.
Administrative Penalties and Other Possible Consequences of Non-compliance
Under the economic substance legislation, an administrative fine of not less than 10,000 UAE dirham and not more than 50,000 UAE dirham shall be imposed when the economic substance requirements are not met, or for failure to provide information or providing inaccurate information. A penalty of not less than 50,000 UAE dirham and not more than 300,000 UAE dirham shall be imposed in the subsequent year for recurring non-compliance. In addition, the regulatory authority may decide to suspend, withdraw or not renew the commercial license of the company.
Separately, it is unlikely that the company will be able to obtain a Tax Residency Certificate if the economic substance requirements are not met. A Tax Residency Certificate is required to receive protection under the double tax treaties signed by the UAE with other countries.
An administrative fine of 100,000 UAE dirham shall be imposed for failure to keep records for a period of less than five years from the date on which the Report is submitted, and failure to provide information to the Ministry of Finance.
Failure to report is penalized with a penalty of 1 million UAE dirham and 10,000 UAE dirham for each day of failure, up to a maximum of 250,000 UAE dirham. Incorrect or incomplete reporting is penalized with a fine of not less than 50,000 UAE dirham and not more than 500,000 UAE dirham. The company may appeal against the fine.
- Companies should evaluate if the documentation and reporting requirements apply to them. If so, they should collect relevant data as soon as possible to ensure the reports are submitted within the deadline and meet the requirements.
- Companies should consider the data and information required to fulfill the new requirements, and avoid any ambiguities, once provided to or filed with the various tax authorities.
- It is important that companies ensure that the information reported is consistent with all other information reported to the authorities.
- Companies should consider what information is relevant to disclose in the Report, in order to avoid any inadvertent or incorrect inferences by the tax authorities in the countries in which the MCG is located. More specifically, the Reports that tax authorities receive will be analyzed using automation software to select specific attention points and outliers in terms of countries within one MCG, but also within the whole base or a subset of all Reports received covering all MCGs within a country.
- It is important that companies take a proactive approach to avoid administrative penalties, forfeiture of their operating license or inability to claim applicable reliefs under the double tax treaties.
Reggie Mezu is Senior Tax Counsel, and Bastiaan Moossdorff is Senior Tax Adviser with Baker McKenzie (based in Dubai); Lisanne Bögels is Associate with Baker McKenzie (based in Amsterdam).
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.