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What is the Economic Substance Test in Dubai?
The Economic substance test regulation which came into effect on 30th April 2019 is a compliance requirement for specific entities (as listed out) which are registered in Dubai.
The Cabinet of Ministers issued resolution no. 31/2019 regarding Economic Substance Regulations to follow the economic substance immediately.
Why is this regulation necessary?
The reason for this economic substance regulation is the requirement by Dubai to follow the rules laid down by the European Union in order to curb the practice of tax evasion. This regulation is in accordance with the norms set by Organisation for Economic Co-operation
and Development (OECD) to avoid harmful practices of invading of taxes.
Applicability of these regulations:
This regulation is applicable to all the businesses carrying on the following relevant activities (as listed). The regulation is also applicable to Free zone companies and also the companies in financial free zones.
The relevant activities are as follows:
- Banking Activities
- Distribution and Service Centres
- Fund Management Activities
- Headquarters Business
- Holding Company
- Insurance activity
- Intellectual Property (IP)
- Lease financing
Exemptions from the applicability of Economic Substance Regulation Test:
There is an exemption granted to any Company in which the Dubai Government holds directly or indirectly, 51 % of the stake.
In this context, the Dubai Government refers to
- UAE Federal Government
- Governments of any Emirate of the Dubai
How will the Relevant Entities meet the Economic Substance Test Criteria?
There has been a particular set of pre-determined rules to meet the Economic Substance test criteria:
- The relevant entities shall be directed and managed in a specific manner in Dubai.
- The entities will be required to conduct activities in a way that they generate major incomes in Dubai.
- They shall have a prescribed number of full time qualified employees in Dubai.
- A prescribed amount of expenditure is required to be incurred by these entities.
- An adequate amount of physical assets are required to be held in Dubai.
Different sets of rules are prescribed for some specific entities i.e
- Holding Companies which derive their income only by way of investments
- High-Risk Intellectual Property activities.
The entities mentioned above have to report to the relevant regulating authorities annually that it satisfies the Economic Substance Requirements.
From when will the Regulations be applicable?
For entities already in existence: From 20th April 2019, hence the Annual Return will be due in 2020.
For newly incorporated entities: Once they receive their trading licences.
The returns must be submitted within a period of 12 months from the end of the relevant financial year.
Conducting of Board Meetings in Dubai:
To meet the regulations, the Board meetings must be held in the Dubai. The meetings should be held in accordance with the nature of the relevant activities.
The basic criteria relating to the meetings must be met i.e.
- Presence of the adequate quorum and physical presence of Directors
- Minutes of the meetings should be signed in the Dubai.
The physical presence of Directors is required in the Dubai only for the purpose of attending relevant Board Meetings.
The employees undertaking CIGA’S of an entity should be the resident of Dubai.
In the case of Non-Resident Employees.
- The activities should be undertaken by the non-resident while being physically present in the Dubai.
- The costs of the non-resident should be beard by the licensee.
What should be done by the Registered Entities?
With a view to meet the requirements of the test, the Registered Entities should:
- Analyse whether any Relevant Activities have been performed by the Entities, and also one more thing must be considered, i.e. the quantum of profits or income earned by the Entities through the Relevant Activities.
- It is quite essential now to hold the Board Meetings where it marks the physical presence of the Directors; also the Minutes of these Board Meetings be signed in the Dubai only.
- It is now also required to analyse the number of full-time Dubai based employees and also to identify their qualifications.
- Also, sufficient business activities should be conducted in the Dubai.
- Timely reports regarding complying with the Economic Substance Test must be submitted.
- Each licensee shall make sure that they can demonstrate their individual Economic Substance Test compliance as the grouping is not permitted
Similar moves by other Countries:
- Tax treaty signed by India and Singapore: The requirement of this treaty was quite similar. It stated that for any Singapore based company seeking benefit from this treaty, it needs to demonstrate relevant ties with Singapore with the limit of expenditure amount to be incurred there.
Consequences of non-Compliance with the requirements of the regulation:
- Non-Compliance can be of three types:
- Non-complying with the Economic Test
- Not providing adequate information
- Providing incorrect information
- Penalty: There are financial penalties of up to AED 50,000 ($13,600).
Also, the information regarding such non-compliance will be shared with the tax authorities where the parent companies of such entities are situated.