The UAE has long been acknowledged as one of the best places in the world to do business, an accolade it does not take lightly. To ensure this reputation is upheld, the country has introduced a variety of economic frameworks in recent years that uphold international tax standards, including the Economic Substance Regulations (ESR). This definitive guide will walk you through everything you need to know about ESR and will specifically explore:
- What does ESR mean?
- ESR compliance requirements
- Implications of non-compliance
- Steps to ensure ESR compliance
- About Creative Zone
What does ESR mean?
The Economic Substance Regulations (ESR) were introduced in the UAE to prevent multinational companies from superficially shifting profits to jurisdictions with low or no taxes to avoid tax in their own region. Originally issued in April 2019, the regulations were formally repealed by in August 2020 but continued to outline essential requirements that businesses must meet.
Specifically, these regulations required the UAE to maintain an adequate “economic presence” tailored to the nature of their activities. Since January 2019, these economic substance requirements have applied to all onshore companies and those operating in free zones.
Simply put, ESR is a regulatory requirement for businesses to demonstrate real economic activities within the country, ensuring they are contributing to the local economy rather than just benefiting from tax advantages. Businesses operating under ESR are required to report specific financial and operational data to show they genuinely operate in the UAE and are not solely using it as a tax haven.
The introduction of these requirements aligns the UAE with global practices. Other popular business jurisdictions, such as the Cayman Islands and Bermuda, have enacted similar legislation. This reflects the UAE’s commitment to addressing concerns about shifting profits to low or no-tax jurisdictions without corresponding local economic activities.
ESR compliance requirements
To comply with ESR, businesses involved in one or more “Relevant Activities” must meet specific Economic Substance Tests (ES Tests) to prove adequate economic presence in the UAE. The following activities are subject to ESR:
- Banking
- Insurance
- Investment Fund Management
- Lease-Finance
- Headquarters
- Shipping
- Holding Company (subject to a reduced ES Test)
- Intellectual Property (subject to enhanced ES Tests)
- Distribution and Service Center
Businesses not involved in any of the above activities do not need to demonstrate economic presence in the UAE, but they do need to file a Notification and provide evidence to support their exempt status.
Any UAE entity earning income from a Relevant Activity will need to perform Core Income Generating Activities (CIGAs). They will need to demonstrate that:
- The business is “directed and managed from the UAE” through holding and minuting board meetings in the UAE, appointing a UAE-based manager and director, and other means.
- The business has an adequate number of qualified employees, premises (an office)and annual operating expenditure in the UAE, relative to the activity undertaken.
Different economic substance requirements apply depending on the Relevant Activity. If you are unsure about what you need to do to meet compliance procedures, our expert team of advisors will be happy to advise on the specific requirements for your company. We understand that navigating these regulations can be complex, and our goal is to simplify the process for you.
Implications of non-compliance
There are serious consequences for businesses that do not comply with ESR in the UAE. Failing to meet ESR requirements or missing notification and reporting deadlines can lead to several repercussions, including:
- Financial penalties
Companies that fail to comply with ESR are subject to financial penalties, which vary depending on the severity and frequency of non-compliance. Initial penalties typically range from AED 10,000 to AED 50,000, with more significant amounts imposed for repeated violations. - License revocation
Non-compliant businesses risk having their licenses revoked, severely disrupting operations. Companies may face a lengthy re-application process if they wish to resume activities too. - Reputation damage
ESR non-compliance can harm a company’s reputation, especially if clients and partners expect adherence to international standards. In a globally connected business landscape, compliance is a signal of legitimacy and operational integrity. - Reporting to foreign tax authorities
In the most serious cases of non-compliance, the UAE may report the company to tax authorities in other jurisdictions. This reporting could trigger further investigations and audits in the company’s home country, leading to more complex legal issues.
Steps to ensure ESR compliance
In order to ensure your business remains ESR compliance in the UAE, you will need to follow these steps:
Determine if your business engages in relevant activities: First, you will need to work out whether your business falls under the categories defined as relevant activities by ESR, which include banking, insurance, fund management, and intellectual property activities. If your business is engaged in any of these activities, you’ll need to follow the required compliance steps.
Evaluate your current operational standards: Conduct an internal assessment of your business’s physical presence, employee qualifications and financial operations within the UAE. This evaluation will help determine if your existing operations meet ESR standards or if changes are necessary.
Set up an effective compliance programme
Develop a compliance programme that ensures your company conducts CIGAs, maintains a sufficient physical presence and meets employee requirements. Appointing a compliance officer or hiring external advisors can provide expertise in setting up an effective programme. This dedicated focus on compliance will help you avoid pitfalls and streamline your operations.
Keep comprehensive records
Accurate and detailed records are crucial for demonstrating compliance with ESR. Maintain records of board meetings, financial statements and reports on CIGAs performed in the UAE. These documents will support your claims if authorities decide to conduct an audit. It’s not just about compliance; good record-keeping also enhances overall business management.
Submit timely notifications and reports
Adhere to the UAE’s notification and reporting deadlines for ESR. Filing an ESR Notification and Economic Substance Report annually is mandatory. Missing deadlines can result in penalties, so ensure these documents are submitted promptly.
Conduct regular compliance reviews
ESR requirements may change over time as global tax standards evolve. Regularly review and update your compliance practices to ensure ongoing adherence to UAE regulations. You might want to consider conducting an annual ESR compliance audit to identify and address potential areas for improvement. This proactive approach can save you time and resources in the long run while safeguarding your business’s reputation and integrity.
About Creative Zone
Creative Zone offers extensive support for businesses navigating regulatory requirements in the UAE, including ESR compliance. Founded in 2010, we have helped more than 75,000 businesses in the UAE and beyond. We offer a wide range of services, from license renewals and visa applications to HR solutions and lease agreements.
Our expert team assists clients in assessing compliance needs, setting up effective compliance programmes and meeting reporting deadlines. If you need guidance on maintaining ESR compliance or require a tailored compliance solution, our expert team of advisors will gladly help.
Contact Creative Zone to find out more about how we can help ensure your business is ESR compliant today.
