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The economic substance regulation in the United Arab Emirates is one of the requirements of compliance for the entities which have been registered in the United Arab Emirates. It was brought into effect by resolution no. 31/2019 on 30 April 2019 by the cabinet of United Arab Emirates Ministry. This decision was backed up with a decision 215 for 2019 by the ministry which gave directives in order to implement the provisions of the resolution 31/2019. The primary aim of this resolution is to enhance the internal competencies of the country. It also takes into account the concerns expressed by the European Union on the related matters. It provides the criteria of economic substance requirements which are applicable to a particular category of transactions in United Arab Emirates.
The organisation for economic co-operation and development has 34 countries as its members which are democratic and support free-market economies. The members generally discuss and formulate social and economic policies. Dubai, being a member of OCED, has committed to comply with the framework of the organisation. It also commits to bring the Economic Substance Regulation to effect, by way of responding to the assessment of tax framework of Dubai.
This resolution was passed on 30 April 2019 and is applicable to all the licensee holders who carry out the relevant activities in Dubai. This includes financial free zones or free zones.
The law has decided to specify the kind of activities that are considered relevant according to the resolution and come under the economic substance regulations in the Dubai. It excludes the companies in which the government of any emirate of UAE or government of state or any other state authority has at least 51% indirect or direct ownership in the shareholding of the company.
The resolution has had its effect on the financial years starting from January 1, 2019. All the companies that come under this regulation, need to declare themselves by filing an Economic Substance Declaration and meet the requirements of the Economic Substance Test for any financial period during which they earned an income from the relevant activity.
Failure in complying with the resolution norms would lead to several administrative penalties, potential suspension or non – renewal of its registration.
The activities which are geographically mobile activities for the substance requirements are considered. Below, is the list of the activities which are considered relevant and has the law applicable on them as identified by the FHTP (Forum of harmful tax practices):
- Headquarters Business
- Intellectual Property Business
- Holding Company Business
- Distribution & Service Centre Business
- Banking Business
- Insurance Business
- Investment Fund Management Business
- Lease-Finance Business
- Shipping Business
Requirements for the Economic Substance Regulation Test
Some requirements which should be ensured in order to meet the economic substance regulation test include:
- The entity should be directed and managed in the state in relation to that activity.
- The entity should be performing core income generating activity in the state.
- The entity should have an adequate number of full-time employees working for them and should be incurring adequate amount of operational expenditure and have adequate physical assets in the state.
Powers of regulatory authorities
The powers of the regulatory authorities are as follows:
- Initiation of audit by the authorities can take place within six years from the end of the year of filing the report. So, the entities are required to maintain and document the details for this period.
- The authorities have the right to examine the documents of the business and enter its premises without any prior notice. Ongoing compliance is mandatory in such scenarios.
- The authorities have the right to suspend, revoke and refuse the renewal of licences and these measures can lead to some major disruptions in the functioning of the entities.
The penalties for the entities in cases of non-compliance with the economic substance regulation in Dubai are:
- Fine: first year AED 10,000 – AED 50,000
- The immediate financial year: AED 50,000 – AED 300,000
The introduction of the economic substance regulation in the United Arab Emirates has been brought in accordance to the jurisdiction of other countries which have introduced the economic substance regulation recently. They include Mauritius, Cayman Islands, Guernsey, Bermuda Bahamas and some more. It in a way affirms the commitment of United Arab Emirates to address the concerns of shifting of profits which are deduced from different business activities to no or nominal tax jurisdictions without compromising the local activities of the economy.
The major purpose of introducing these regulations was because it had been included in the inclusive framework of the global Organization for Economic Co-operation and Development (OECD) on the Base Erosion Profit Shifting (BEPS). It was done as a response to the concerns laid down by the European Union.
So, the issuance of this resolution of Economic substance regulation on April 20, 2019 was an important requirement to be fulfilled to remove Dubai from the blacklist of the European Union (EU) on October 10,2019. Another major purpose of this jurisdiction is to make sure that the entities of the United Arab Emirates which perform the relevant activities do not artificially attract the profits which are not in sync with the economic activities taking place in the Dubai.
This decision in the United Arab Emirate’s tax policy is nothing less than a milestone as it is a crucial step to its association with the global Organization for Economic Co-operation and Development (OECD) as well as with the directives of the Base Erosion Profit Shifting (BEPS). This jurisdiction has made the international players and their investors, address various concerns regarding their transparency. Hence, this will also strengthen and benefit the Dubai to meet up to and address such reputation concerns.