How ESR Regulations Affect Businesses in UAE


The UAE has introduced Economic Substance Regulations (ESR) to comply with the global standards of tax transparency and fair competition. The ESR requires certain businesses in the UAE to demonstrate that they have a substantial economic presence in the country, relative to the activities they undertake. This blog post will explain the main features of the ESR, the types of businesses that are affected by it, and the steps they need to take to comply with it.

What is ESR and why was it introduced?

ESR stands for Economic Substance Regulations, which is a set of rules that aim to prevent harmful tax practices and ensure that the UAE does not facilitate offshore structures or arrangements that attract profits without real economic activity. The ESR was introduced by the UAE Cabinet of Ministers Resolution No. 57 of 2020, effective from 1 January 20191. The ESR is part of the UAE’s commitment as a member of the OECD Inclusive Framework and in response to an assessment of the UAE’s tax framework by the European Union Code of Conduct Group on Business Taxation2.

Which businesses are subject to ESR?

The ESR applies to UAE onshore and free zone companies and certain other business forms that carry out any of the following “Relevant Activities” in the UAE2:

  • Banking Business
  • Insurance Business
  • Investment Fund Management Business
  • Lease-Finance Business
  • Headquarters Business
  • Shipping Business
  • Holding Company Business
  • Intellectual Property Business
  • Distribution and Service Centre Business

These businesses are required to meet the Economic Substance Test, which means that they have to:

  • Conduct the core income-generating activities in the UAE
  • Have an adequate level of qualified employees, premises, and expenditure in the UAE
  • Have direction and management in the UAE

What are the reporting obligations under ESR?

The businesses that are subject to ESR have to submit an annual Notification form to their Regulatory Authority, which is the Ministry of Economy or the relevant Free Zone Authority2. The Notification form has to be submitted within six months from the end of the financial year of the business3. The Notification form should include information such as:

  • The name and address of the business
  • The type of Relevant Activity carried out by the business
  • The amount and type of income from the Relevant Activity
  • The financial year of the business
  • Whether the business meets the Economic Substance Test or is exempt from it

The businesses that are subject to ESR also have to submit an Economic Substance Report to their Regulatory Authority within 12 months from the end of their financial year3. The Economic Substance Report should include information such as:

  • The core income-generating activities performed by the business
  • The number and qualifications of the employees involved in the Relevant Activity
  • The details of the premises and assets used for the Relevant Activity
  • The amount and type of expenditure incurred for the Relevant Activity
  • The details of the direction and management of the business
  • The financial statements of the business

What are the consequences of non-compliance with ESR?

The businesses that fail to comply with the ESR may face penalties, spontaneous exchange of information with the Foreign Competent Authority (as defined in Article 1 of the Regulations), as well as other administrative sanctions such as the suspension, revocation, or non-renewal of the business’s trade license or permit2. The penalties for non-compliance may range from AED 10,000 to AED 300,000, depending on the type and severity of the violation4.

How can businesses prepare for ESR?

The businesses that are subject to ESR should take the following steps to prepare for ESR:

  • Assess whether they carry out any Relevant Activity and whether they meet the Economic Substance Test or are exempt from it
  • Maintain accurate and sufficient records and documents to demonstrate their economic substance in the UAE
  • Submit the Notification form and the Economic Substance Report to their Regulatory Authority within the prescribed deadlines
  • Seek professional advice if they have any doubts or questions about the ESR

Conclusion

The ESR is a significant development in the UAE’s tax landscape and affects a wide range of businesses in the country. The ESR aims to enhance the UAE’s reputation as a transparent and cooperative jurisdiction and to prevent the erosion of the tax base of other countries. The businesses that are subject to ESR should be aware of their obligations and responsibilities under the ESR and take the necessary steps to comply with them. By doing so, they can avoid the potential penalties and sanctions and benefit from the opportunities and advantages of doing business in the UAE.

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