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UAE Explains Updated Economic Substance Rules

Monday, October 5, 2020

The United Arab Emirates Ministry of Finance has highlighted changes made to the territory's rules on economic substance.

The UAE adopted new economic substance regulations in 2019 in Cabinet Resolution No. 31 of 2019. These regulations provide that a company engaged in one of a number of specified sectors must have sufficient economic substance in the territory to access the territory's tax regime. The changes were in response to pressure from the EU on a number of territories, following recommendations from its EU Code of Conduct Group, and apply for financial years starting on or after January 1, 2019.

The key activities identified by the European Commission Code of Conduct Group are: banking, insurance, fund management, financing and leasing, shipping, intellectual property, collective investment vehicles, and holding companies that generate income from any of these key activities.

In August 2020, the UAE published Cabinet Resolution No. (57) of 2020, which replaced and repealed Cabinet Resolution No. 31 of 2019, overhauling the territory's economic substance regime.

In a statement released on September 23, 2020, the Ministry of Finance explained the main changes. MoF Undersecretary Younis Haji Al Khoori said: "This resolution resulted from constructive consultations undertaken by the UAE with its partners in the European Union and the OECD. This reaffirms the UAE's commitment to adhere to tax policies, apply international taxation standards, and address tax evasion."

The UAE Ministry of Finance stated:

"Under [Cabinet Resolution No. (57) of 2020], the UAE Federal Tax Authority (FTA) has been appointed as the National Assessing Authority for the purposes of the UAE Economic Substance Regulations. In this capacity, the FTA will be primarily responsible for assessing whether the Emirati establishments and companies have met the requirements of the Economic Substance Test. The regulatory authorities will continue to be responsible for the collection and verification of information regarding their Licensees and shall assist the FTA in carrying out its role as the National Assessing Authority."

"According to the resolution, the definition of a Licensee has been amended to be limited to juridical persons and unincorporated partnerships that are registered (whether by way of commercial/trade license or other form of permit) to carry out a Relevant Activity. Natural persons, sole proprietorships, and other business forms that are not juridical entities are no longer within the scope of the UAE economic substance regulations."

"The UAE Economic Substance Regulations provides a list of entities that are exempt from the requirements to file an ESR Report and meet the Economic Substance Test. The 'Exempted Licensees' include the UAE companies that are tax resident outside of the UAE and Investment Funds and their underlying SPVs / investment holding entities. Wholly UAE resident-owned businesses that are not part of a multinational group and that only carry out business activities in the UAE, as well as UAE branches of a foreign company – if the Relevant Income of the branch is subject to tax in the foreign jurisdiction - are also included. UAE companies that are majority (51 percent or more) owned by the UAE government are no longer exempt from the UAE Economic Substance Regulations."

"The definition of a 'Distribution and Service Centre Business' was also amended, and currently includes businesses that purchase raw materials or finished products from a foreign group company and distributes them to related or unrelated parties in the UAE or elsewhere, irrespective of whether such raw materials or finished products are imported into the UAE; and/or businesses that provide services to a foreign group company, without the previous requirement that the provision of services is in connection with the foreign group company's business outside the UAE."

Finally, the MOF statement clarified the definition of a "High Risk Intellectual Property Licensee" for the purposes of the regulations, as "an Intellectual Property Business that meets all the following conditions: the business did not create the Intellectual Property Asset; the business acquired the Intellectual Property Asset from either a connected person or in consideration for funding research and development by another person situated in a foreign jurisdiction; the business licenses sold the Intellectual Property Asset to a Connected Person, or earns separately identifiable income from a Foreign Connected Person in respect of the use or exploitation of the Intellectual Property Asset."