The United Arab Emirates (UAE) has recently published its economic substance (ES) legislation through Cabinet Resolution 31 of 2019. The legislation entered into force as from April 30, 2019 and was expected for some time.
The immediate cause for the UAE introducing the ES legislation is that it will be instrumental in removal of the UAE from the EU’s blacklist of non-cooperative tax jurisdictions. The introduction of these rules is also proof of the UAE’s commitment to curbing international tax avoidance, which is consistent with the country’s member status of the Organization for Economic Co-operation and Development (OECD) Base Erosion and Profit Shifting (BEPS) Inclusive Framework.
This article provides an overview of the new rules, which aim to align a corporate’s profits reported in the UAE with the ES it has in the country, such as functions, people, assets and risks.
The UAE was blacklisted by the EU in December 2017 as a non-cooperative tax jurisdiction, along with 16 other countries. The UAE was included in the list because the EU perceived it as a jurisdiction facilitating offshore structures or arrangements aimed at attracting (overseas) profits which do not reflect real economic activity in the jurisdiction (so-called Criterion 2.2).
Following commitments to remedy the EU concerns, the UAE was successfully transferred to the EU gray (or watch) list on January 23, 2018. In particular, those commitments included the introduction of ES legislation required to resolve the UAE’s status as a perceived Criterion 2.2 jurisdiction. The formal introduction of new federal legislation in a country such as the UAE requires adequate time, and because the UAE was not able to do this before the end of 2018, it was put on the blacklist again in March 2019.
The recent introduction of the ES legislation, with effect as from April 30, 2019, should result in the UAE’s removal from the list.
The Economic Substance Legislation
Similar to legislation recently introduced by jurisdictions such as the British Virgin Islands (BVI), Cayman Islands and the Bahamas, the UAE ES legislation largely follows the set of rules as stipulated in the Scoping Paper published by the EU Code of Conduct Group on Business Taxation in 2018. The ES legislation will require UAE corporates performing geographically mobile activities (which can be “shifted” to other jurisdictions relatively easily) to have sufficient substance in the UAE, which requirement is enforced through a newly introduced annual reporting regime.
Economic Substance Requirements
In essence, the new legislation prescribes mandatory levels of substance for UAE corporates, including companies, branches and representative offices (including those based in any of the UAE Free Zones) performing the following activities (Relevant Activities):
- fund administration;
- finance and leasing;
- holding company business;
- intellectual property holding;
- distribution centers.
Corporates performing activities not included in the above list are not subject to the new ES requirements. However, all corporates in the UAE will, from now on, need to notify the regulatory authorities whether or not they perform any Relevant Activities.
For corporates that do perform Relevant Activities in the UAE, the new legislation’s ES requirements prescribe that the corporate must meet the following tests:
- conduct core income-generating activities within the UAE;
- have its director(s) and management in the UAE;
- have an adequate number of qualified staff to perform its activities physically present in the UAE;
- incur an adequate level of operational expenses in the UAE; and
- have adequate physical assets in the UAE.
The Relevant Activity can be outsourced to third parties as long as there is adequate supervision of those outsourced activities, and provided they are performed within the UAE.
In order to satisfy the requirement that direction and management of the corporate takes place in the UAE, corporates must ensure that:
- the board of directors have quorate meetings in the UAE on frequent occasions;
- the meetings are minuted and signed by all attendees;
- the directors have the necessary knowledge and experience to carry out the functions of the board; and
- the records of all meetings of the board and records of the company are kept within the UAE.
For legal entities such as branches, representative offices, and other companies which do not have a board and whose management is carried out by a single manager/director, that manager/director must be physically present in the UAE when making the main decisions concerning administration and operation of that entity.
Holding companies are subject to less extensive requirements and will satisfy the ES requirements if they fulfill the requirements for the submission of data and information to the regulatory authority, and if they have sufficient staff and premises to carry out the work of a holding company.
Companies which carry out intellectual property (IP) Related Activities are subject to additional obligations, as IP is typically considered an increased risk area within BEPS.
The legislation envisages that further guidance will be issued to assist corporates in meeting the ES requirements, and in particular to help interpret terms such as “adequate,” which is used throughout the legislation.
Reporting and Fines
Corporates that fall within the remit of the new legislation will need to prepare and submit to the regulatory authority (such as the relevant UAE Free Zone or the Department of Economic Development) a report no later than 12 months after the end of the corporate’s financial year. This reporting requirement will apply annually and the report must be prepared in accordance with the form to be issued by the regulatory authority.
With the rules having come into effect as at April 30, 2019, first reporting for existing corporates should be done in 2020.
The report will contain mandatory information which includes:
- the value and type of income related to the Relevant Activity;
- the location of the activity and the manufacturer, property or equipment used to conduct the Relevant Activity;
- the number of employees, their qualifications and the number of people responsible for conducting the Relevant Activity; and
- a disclosure stating that the corporate has met the ES requirements.
There will be fines of between 10,000 dirham ($2,723) and 50,000 dirham for failure to provide the relevant information and for not meeting the ES requirements (in the first year). For consecutive non-compliance with the ES requirements the fines will be between 50,000–300,000 dirham. Non-compliance may eventually result in commercial license suspension, withdrawal or non-renewal.
The statute of limitations for the imposition of fines is six years. The legislation also provides for the possibility for corporates to file an appeal against a fine.
Exchange of Information
The regulatory authority will inform the UAE Ministry of Finance (MoF) accordingly in cases where corporates are not in compliance with the new ES requirements. Subsequently, in cases where international agreements or (tax) treaties allow this, the MoF will inform the foreign competent authorities where the parent company, ultimate parent company or ultimate beneficial owner is established, of the relevant non-compliance with the ES requirements.
Impact for Corporates
For many UAE-headquartered corporates and overseas multinationals that undertake genuine business activities within the UAE, the new legislation will have a limited impact, save for imposing additional reporting requirements for which they should await supplementary guidance with regard to the form, content and timing of reporting.
Corporates who have operations (and conduct Relevant Activities) within the UAE but which are managed from outside the UAE should closely review their governance structures to ensure that management is conducted in accordance with the requirements of the legislation. Similar caution applies to those corporates with Relevant Activities in the UAE but which have never developed an appropriate level of in-country substance in relation to those activities.
How the UAE Benefits
First of all, the new ES legislation is another step in the right direction to the UAE becoming a fully compliant international player within the global tax community. This is also in line with the UAE’s membership of the OECD BEPS Inclusive Framework.
Secondly, similar ES legislation has also been introduced in countries such as the BVI, Cayman Islands and the Bahamas. The relative sizes of those jurisdictions may impede corporates established there and performing Relevant Activities to build up the required ES under those new rules.
In contrast, the UAE has both the size and infrastructure as well as the people and technology to host a large number of international businesses which are willing to align their ES with their profits, which are still largely untaxed in the UAE. The fact that the UAE now has more than 90 double tax treaties in place with other jurisdictions will further facilitate that trend.
Removal from EU Blacklist
The ES legislation will undoubtedly already have been submitted to the EU for their review and the UAE’s subsequent removal from the EU blacklist. As Dominica was removed from the blacklist in June 2019, after Aruba, the BVI and Barbados in May 2019, the UAE’s removal could follow very quickly, assuming that the EU indeed accepts its new legislation (at the time of writing, July 9, 2019, the UAE is still included on the EU’s blacklist).
Ton van Doremalen is a Partner with DLA Piper Middle East.
The author may be contacted at: email@example.com