This webinar covers latest updates relating to Economic Substance Regulations – UAE, various notification deadlines, step by step explanation in filling the forms and penalties for non compliance.

This webinar was conducted on 20 June 2020 hence do not cover any new updates subsequent to this date.

Webinar 20 June 2020

Hi, Welcome to our webinar today. My name is Bhawna Chopra. I am a tax partner with premier brains accounting and auditing. So in today’s webinar, we will be taking you through the very much hot topic these days, which is the economic substance regulations. So, we will be giving you background and then more of practical insights as to how to fill the economic substance regulations form. So, there will be another speaker today. So, Rishi Chawla he’s a partner with premier brains as well and he will be taking you some of the form filling guidelines and other practical aspects.

So, in today’s agenda, we will be covering first background about ESR. So why these regulations were introduced in UAE. And then we will take you through the notification deadline and the forms. And then we will be covering in detail some of the relevant activities defined in the ESR regulations. And then what it means by meeting the economic substance test, what are the penalties if the compliance is not done, and then we will be taking the q&a at the end of the webinar. So, we please suggest everyone to submit their questions via the q&a portal, which you can see on your screen. So, please submit it through the q&a portal and then we will be taking towards the end of the session.

So, let’s start with you know the background of the economic substance regulations. So why these regulations were introduced in UAE.

So, basically, in May 2018, UAE joined the OECD framework OECD is basically the organization of Economic Cooperation and Development. So, there are more than 130 countries which have joined the inclusive framework and within the members of this inclusive framework have committed to meet the minimum standards of a project called beps. So beps means base erosion and profit shifting. So in the next slide, I’ll explain more in detail what beps means. So basically, there was an assessment done by the European Union, where in earlier UAE was blacklisted as non cooperative jurisdiction. So in response to that, you we introduced the economic substance regulations, and then subsequently in October 2019 UAE was removed from the blacklist. So this base erosion and profit shifting scheme which was introduced by the OECD, it had basically 15 action points. And one of the action points was Action Point Number five, which was to curb the harmful tax practices, basically certain corporate structures by multinational corporations, wherein they were relocating their activities and shifting the profits from higher tax jurisdictions or to a low or no tax jurisdictions. So in response to that OECD made these action points and action five is for harmful tax practices. And in relation to the action five UAE introduced these economic substance regulations. So the main idea of this is to demonstrate the actual economic activity in UAE.

So the main concern was about that too much profit and too little substance in no or low tax jurisdiction. And the objective is basically to curb harmful tax competition. So what beps is that, you know, you’re shifting the profits, base erosion and profit shifting. So base is basically your tax base, which gets eroded when you shift the profits to a no tax jurisdiction.

And these kinds of hurdles resulted in the launch of the beps project by the OECD and these action points were designed to tackle this problem of shifting the profits. So there was a survey done by OECD in 2019, where it was estimated that the loss of revenue because of these tax planning structures done by some of the corporations, the higher tax jurisdictions were losing between four to 10% global income tax because of this, this is an important step done to curb these harmful tax practices and that is the reason UAE introduced the economic substance regulations.

So just to see the landscape of the economic or substance regulations in UAE, when was it introduced and what has been done so far? And what is the deadlines we are looking at currently. So there was cabinet Resolution Number 31, which was introduced effective 30th April 2019, which laid the foundation of the economic substance regulations in the UAE. Then further on Fourth September 2019, there were further guidances issued. And then cabinet Resolution Number 58 was also issued, determining what are the regulatory authorities for ESR. Then 11 September was the implementation guidance by ministerial decision number 215. Then on January 2020, Ministry of Finance which is the competent authority for the economic substance regulations, issued, frequently asked questions on their website giving more insight onto these regulations. And then, recently, like, couple of months back on 15th April 2020, a relevant Activity Guide was published by the Ministry of Finance on their website wherein they explained in detail the scope of these regulations, what kind of activities are being covered, what is the definition of those activities, so, after 15th April, then the deadlines have been given for submitting the economic substance notifications. And there have been different deadlines by different authorities, different freezone authorities and other regulatory authorities, but mostly it is 30th June and there are some other deadlines also. So we will be covering those specific deadlines in detail in the next slides.

So, who is subject to ESR in UAE? So everybody has to comply with the law or there are any specific businesses who are who have to comply with the law. So if we look at the definition of the law, it says that any person any business who has a commercial license or any form of permit, or even a certificate of incorporation has to assess whether they are falling within the ambit of the law or not. So, basically every licensee that means anyone who has a commercial license permit or any other form of incorporation as a document in UAE, they need to assess whether they are carrying on a relevant activity and earning that income from that activity or not. And then meet the economic substance test. So, we will be covering these definitions, what is relevant activity what is economic substance test. So, for now, just keep in mind that any business which has a commercial license or any permit needs to make at least an assessment as to whether they are falling under any of the relevant activity or not. So, there is no materiality threshold these questions have been asked by many people if there any revenue threshold but there is no such thresholds defined in the law. Only exemption is for the companies in which UAE Government is directly or indirectly holding 51% of the ownership, this is the only exemption in the ESR law otherwise, all the businesses need to make an assessment of the relevant activity.

So, what is a relevant activity? So, there are nine activities defined in the law, which are covered as relevant activities. So, any business which is falling into any of these nine activities need to comply with the ESR law. So, I will be going briefly into some of the businesses and then some businesses we will be taking into detail towards the later part of the session. So, basically starting with banking business, so banking business is relatively a straightforward business. So, these are regulated entities which are licensed as commercial banks, usually by the central bank or if they are in a free zone by the DIFC or the ADGM regulated free zones.

In this any UAE business which is engaged in exchanging foreign currency or remitting money or exchange houses, they are not covered under the banking business or any financial intermediaries. They will not be considered as banking business.

So, going into insurance business, insurance business is a business where someone is accepting the risk for carrying out the insurance contract. So, the most important element is to see whether the business is accepting the risk or not. So, insurance business is regulated by the insurance authority or if you’re coming under the free zone, then the regulator authority with the respective free zone. But it has been clarified in the relevant Activity Guide of the Ministry of Finance that insurance brokers, agents or anyone who’s providing insurance related services does not come into the definition of the insurance business if they are not assuming any part of the insurance. So again, the important part is who is assuming the risk and such business will be falling under the insurance business. But it doesn’t mean that if you are out of the insurance business, you shouldn’t check for the other relevant activities. So if you’re out of the insurance business, you should check whether you would fall into the other relevant activities or not.

So going to the investment fund management business. So the main criteria here is those businesses, which are making investment divestment and risk related decisions on behalf of investment funds. So, again, the main point here is the business has to be making those risk related decisions themselves. So, then they will fall into the investment fund management business.

So, if someone is providing only investment advisory kind of services, then they will not be considered as an investment fund management business.

So, moving on to a lease finance business, so, lease finance, business covers businesses, which are offering credit or financing for any kind of consideration. So, where there is no consideration involved the businesses will not be considered as lease finance business. So, it needs to be seen whether you are entering into any finance leases kind of transactions, then you would also get covered under lease finance business.

So next, this headquarter holding company intellectual property and distribution service center we will be covering later and giving more details on these businesses. So I’ll just skip those and then cover shipping business for now and headquarter holding an IP and distribution service center, I’ll be taking in the later in more detail.

So shipping business basically covers the businesses who are operating ships in international traffic for either cargo or passengers. So in the relevant Activity Guide, they’ve explained that the ships do not include, like fishing vessels, or small vessels where the tonnage is less than 10 tonnes or leisure vessels like those cruise and private yachts. Those would not form part of the definition of the ships and the important part here in shipping business is that you should be operating the ship to be qualified as a shipping business. So they gave an example that bareboat charter would not fall into the shipping business because the entity which is chartering the ship is not operating the ship. But again, like in this case, you may fall into lease finance business. And then you should look at the terms of the charter and see whether you qualify as a lease finance business or not.

So, headquarter as I mentioned, headquarter holding IP and distribution service center, I’ll be taking much more detail later.

So how do you determine whether you are falling under the relevant activity or not? Do you just go by what is stated on your license? Or what exactly do you need to do to determine that

The ministry clearly clarified that a substance over form approach needs to be followed. What it means is that you need to see what is the exact nature of the transactions you carried on in the reporting period. And then decide whether you would be falling under the relevant activity or not. Don’t just go by what is your licenses saying, go into the actual nature of the transactions. In fact, look at the accounts of the past year and then assess whether you would be falling under any of the relevant activity or not.

So, now I will be passing over to Rishi so he will be taking you through the notification deadlines and other

formats of the notification form.

Thank you, Bhawna for conducting earlier part of the session. So, I will be taking over from here. So, I will be talking about the notification deadlines and the various forms which have been issued by the regulatory authorities. So, starting with this screen, so, you can see there are four columns here, the first one is basically the description of various regulatory authorities, then we have the location, the form availability and the deadlines. So, with the description, I mean the various regulatory authority who are going to monitor the filing of the notification then the location is basically divided among various Emirates within the UAE. Most of the Free Zones have the forms listed on their portals For example, DMCC DIFC, Dubai Development Authority, the forms are available on their portal. So if you have to go and fill the form the right place to go is go to the portal and fill it up. However, this is not the case with every free zone like in the case of Jebel Ali free zone. The form has to be emailed to Jebel Ali free zone and the email ID which is mentioned here. Same is the case with the by World Trade Center. So the form might have come to your email through these free zones and then you have to reply back to them at the respective emails, which has been designated for that purpose.

Going to the next slide, so here I’ve got another set of free zones. So you can see a ADGM Kizad are in Abu Dhabi. Then we have three free zones in Sharjah namely Hamriyah free zone, SAIF zone and Sharjah media, city free zone. We have Minister of Economy in mainland.

ADGM Kizad, even SHAMS, the forms have to be emailed. However, in most of cases forms either to be filled on portal or emailed to respective regulatory authorities, the only exception which I’d like like to talk a little bit more on is about Minister of Economy Notification. So Ministry of Economy, the notification form is basically available on the website of minister of economy. So it is not like in other cases where you get an email or it is available on the portal, there is no portal as such for the mainland companies. So the best way to refer to this form is go to the Ministry of Economy website, and access that form. So we have actually filled quite a few forms this morning. So it’s very much there and functioning very well. So we will be talking a little bit about the format of the Ministry of Economic Form later on during our session today. So just want to talk the last bit on this slide is if some of the companies are established in KIZAD must take action today to avoid any kind of penalties for late filing as today is the deadline for it.

So, coming to the slide, this is one of the format which I have taken and for one of the Free Zones just to take you through how the form looks like and what are the various kinds of information which is required to be filled in the form, actually it is not very lengthy or a very long form. It is a very concise form, but what is important in this case is to have a proper understanding of what is to be filled in the form. So, I’ll start from the top like the first one section is licensee details. So, licensee details basically you have to put in the licensee name, the trade license number and the financial year and So, basically this is the year and which is the accounting year followed by your company. So, for example, some companies follow calendar year and some may have a different financial year.

So, year can be a calendar year such as 31 December or other year end such as 31 March so you need to see what is financial year for your company. So, you have to see what is your financial year and use that. So, one thing should be kept in mind is that the notification under the law is required for 2019. So, there are certain examples which have been in the law, Just want to talk a little bit about that is the law requirement is that the accounting year should be starting on or after first of January 2019. So, that’s the law requirement. And then, if you go to the next column, which is the reporting period, so, this is the reporting period for economic substance purposes which needs to be mentioned. So, in this case, as per the information which we have seen so far is the accounting year has to be falling within the 2019 period, but there are certain cases wherein the companies have started within 2019. And the year end is actually going to fall later in 2020, there are some specific conditions around that which are bit complex. So I’ll not get into it right now that we can discuss on one to one basis, but just want to give you some reference point to look at this. So for example, a company which was active full in 2019, can use first January 2019 to 31st of December 2019 as the reporting period, but for a company having financial year from April to March, so they can use first April 2019, to 31 March 2020. So that’s how you have to look at what is your accounting year. Further this year can be found out from the memorandum of association, or the Group Policy and things like that.

So moving to the next column, and so next is relevant activities

Now, this says that did the licensee carry on relevant activity during the reportable periods? So, you have to say yes or no as the case may be, consider the list of relevant activities Bhawna spoke about it in earlier slides, and which is also mentioned here down in this screen. So, if it applies in your case, you have to say yes or no in this point number one. So, coming to point two.

So, you can see there is a list of nine kinds of relevant activities, which are part of ESR and then two B is basically did the licensee earn income from the relevant activity during the period. So, in this one has to tick mark right activity mentioned here and in next column then you have to see whether you have an income during this period or not. So, one thing I like to mention here is that there is a there is a concept of duplicate reporting, which means in certain activities, if there is overlapping, relevant activity for example, if a banking business is also engaged in lease finance activities or service and distribution business, then there is no need to list all the activities here. So, basically once you tick on one particular aspect it is understood that other ancillary activities are covered. So, for this part you have to see the law and the guide which has very clearly explained this point.

In case there is an income earned in 2019 during the reportable period from any of these relevant activities, so, you have to say yes or no here there is no need of entering amounts as yet because that will come in at the time of return which is 12 months after the end of the reporting period, but at least yes or no has to be mentioned here. Then the C section, this says that is the income earned from the relevant activities subject to tax outside the UAE. So let me give you one example say income from a relevant activity could be subject to tax outside the UAE if the licensee has a taxable presence or permanent establishment in a foreign country that reports all a part of the income from the relevant activity in its tax return. So basically, if the part of the income is been already reported in other country for example, if there is a branch, Office of a foreign company here, the branch has already been reported somewhere else. So that part you have to look at and see if it applies in your case and accordingly disclose

So coming to the next slide, Section D, the first column is quite straightforward. So if a company has an investment by government by 51% or more, has to say yes or no So, so it’s quite straightforward question. So you can say that. So D two says, was the licensee tax resident outside the UAE during the reportable period, a licensee is regarded tax residents in jurisdiction other than UAE if it’s subject to tax from relevant activity by virtue of tax residents by domicile in that particular state, so when licensee notify notifies this, they will have to provide evidence to support like tax return tax Residency Certificate, tax return etc. So what it means is that if a licensee is taxed outside UAE and they say yes here then there will be additional requirements asked by the Ministry like tax returns submitted outside or the tax residency certificates. So, one has to be careful before saying yes here and to have to ensure that they have enough information at hand before saying yes and submitting the form. And the last part of the section is the designated person. So, designated person is basically the person who is the manager on the license or the owner of the company. So, accordingly you can put the details

So, now, coming to the Minister of Economic format, so, the format is very much similar to what we have discussed in the earlier slides. However, there are a few very small differences which I will talk through.

Overall, the content is similar

So, let’s start with that. So, first is of course, to start with giving the email id then include the licensee name, the commercial trade license number. And then going to the next slide is basically financial year then we discussed that earlier and also here there is a requirement to give the Registered Office Address. So, you can find the registered office address on the trade license of the company and then you have to disclose the legal form. So, you can see what which applies in your case. So if there is a professional license or a civil company, you may like to select other. So you can do that. Next slide is reportable period. We discuss already in the last slide. So that has to be mentioned here.

Relevant activities, did the licensee carry on a relevant activity as defined under Article four during the reportable period? So yes or no? You have to assess whether it applies in your case or not, and accordingly, say yes or no. And coming to the next session.

So, basically here you have to indicate whether you have conducted the relevant activity or not. So one thing you might have noted here is that it only shows five activity instead of the nine activities. Reason being a Minister of Economy is responsible regulatory authority for only these five activities. So rest of the other four activities for example, banking, business, and lease finance business comes under the central bank, then the insurance activities comes under the insurance authority and the investment fund business comes under the security and commodity authority. So that’s the reason so for the other four activities, you have to go to those regulatory authorities to fill form there and licenses for these five categories, this format to be used.

Now here, did the licensee earn income from the relevant activity during the reportable period so we discussed that part so you can see yes or no for these five activities and then the next slide is if income earned from the relevant activities subject to tax outside the UAE. So yes, no or partially there’s so there’s additional column here for partially So, accordingly you have to say and once you say yes to it, you have to be prepared that there could be additional information that needs to be provided to ministry. So, for example, if you have any tax returns been submitted outside etc. So, prepare for that before submitting this form. And last one here is intellectual property business, whether or not you are engaged in a high risk IP business. So, we will cover this part later on the slides. But this is showing here separately and not in the form which we have shown earlier is because in the in that form, if you would have ticked intellectual property business, there is an drop down asking you to confirm whether it’s a high risk or low risk IP business.

Then the additional information is if 51% shares held by government entities, we already discussed that part. So similar to that question like what was the licensee, tax resident outside the UAE doing the reportable period or not, and then do the submission.

So that brings us to the end of the form. Enter the details of the manager or the owner should be mentioned here, and then you submit and so that’s about the format, but the most important point is to assess whether you’re conducting the relevant activity or not. That’s the most important part.

Moving to the next slide. So this is this is another interesting format which we have developed that shows the flow of ESR submission. The purpose of this flowchart is basically to run you through the whole process of ESR submission. So, with the start, you can see it’s very important first of all the company should have a trade license to operate. So, that is the most important point. Once a company’s operating, then the company has to file a notification. So, next one is to file notification latest by deadline. So, here I would like to discuss a little bit. Most of the free zones are asking every company to file the notification. However, like Minister of Economy in the form, they have mentioned that only companies conducting relevant activity should fill the forms and still there is a little bit of ambiguity around it. And what we are recommending to all our clients is that they have to anyways, do a full review whether they are conducting a relevant activity or not. So once they have done that task of doing the review, it is always better to submit the form and ensure that this legal compliance has been taken care of. So, what we have noted is some companies on first read immediately think that it does not apply. So say no that it does not apply to them. But what is more important in this case is there are situations where our activities done maybe one or two cases with related parties, so that might not occur straight away, whether it will fall under the distribution service center for instance, or not, but once a person goes into filling the form, and then they realize what it means so we are recommending everybody to go and fill the form instead of not doing it at all. So but as I said, the free zones are asking everybody to fill it. But Minister of Economy is a little bit more flexible in that regard by allowing not to file it but we expect in the coming days is that it will be made mandatory. So, we recommend everybody to file the notification form and ensure this is done. So, after the notification done is there are three question mark boxes.

So, in nutshell if I have to explain that, there is a return that that needs to be filed after 12 months from the end of the reportable period. So, who needs to file this return? So, this new return has to be filed by only companies who are first of all conducting a relevant activity. secondly, they are not owned 51% or more by government authority. And the third one is they must have earned income from the relevant activity during the reportable year. So if these conditions are met, then you have to file the return after 12 months after the end of the reportable period, if there is no income earned from relevant activity or there is no relevant activity or there was relevant activity but no income and during the reportable period, then the notification is enough. And there is no more activity to be done after that.

I hope this is clear. So I’ll move to the next slide.

So now this is a little bit about the implications of filing the notification. So what are the different kinds of issues which companies should keep in mind before filing a notification, so incorrect filing can lead to penalties, so Bhawna will cover a little bit more on the penalties later in the slides. So incorrect filing can lead to penalties and penalties are quite high. And then not filing or late filing can lead to penalties as well. stating a yes and not able to meet economic substance can lead to penalties and or closure. So what it means is that for example, a company on the face of it felt that Okay, fine say yes to it and form is gone.

And the next stage when they’re doing the assessment for whether they are meeting the requirements of the law or not. And they’re not able to justify that. So that become a problem area. So what we recommend is, when you’re filling the form, it’s very, very critical that the company should assess whether they are able to meet the economics substance tests in case they are doing any of the relevant activities. So selecting a wrong period can lead to also incorrect reporting. So it’s very important that your reportable period should be correctly mentioned because that is the requirement of the law.

So I’m trying to cover some of the frequently asked question which is which are discussed quite often so. So first one is the reporting period. So what should be the reporting period? for ESR, so I’ve talked about it a little bit that the reporting period has to be 2019. But now, what is happening is different free zones are explaining different reporting period. So, when we say different reporting period is that, like minister of economics says that if your return period, if your reportable period ends in from first January 2019 to 31, December 2019, within 31, December 2019, then you have to file a notification by 30th of June and not in other cases. So, if the if the notification period, the reportable period extend beyond 31st of December, so, there will be a new deadline expected so, this is as per the latest information. However, in other free zones, they are allowing and asking everybody to submit a notification even if the notification period extend beyond 30th of June. So, basically in this you are forecasting the relevant activities which is very difficult for companies to do so. But what they’re also saying is to file the notification, and later will allow additional formats to do a re-notification for any changes. So this this is something for the reporting period, the best way to get the right answer is to look at who is your regulatory authorities so it’s very easy to just ask that question and get the answer to avoid any confusion on any of this point, you can always talk to us as we are studying it quite closely. Then the branch notification now this is another point for whether if a company has many branches within UAE So do they file one notification for the head office and for the branches separate notifications. So what we come to understand is that if, if a head office and the branches is within one regulatory authority, for example, the mainland licenses are companies formed by the Ministry of Economy So, so the mainland license and the branches gets clubbed into one. So there’s only one notification required to be mentioned. So even in case of branch, you might have noted that the trade license number of the head office is always mentioned in the branch trade license so there is a connection, so there is no need to file separate notification. But you have to assess all the branches and the head office together before giving this notification. However, this case can be a little different when the mainland license is the head office, for example, and the branch in the free zone. So the free zone has a different setup than a mainland there are different regulatory bodies. So in that case, what we understand it, there is a separate notification to be filed at both places. So that has to be looked at quite closely.

Now does it apply to all I covered that point also earlier, it applies to all companies in UAE. But if the law says that you have to file when, when you are conducting a relevant activity, so what it means is that every company has to assess whether or not they’re doing a relevant activity. So in our opinion, it is always better to go and file the notification, rather than just leaving it like that. Because once you start filling the form, there are additional information or additional set of question that comes to mind that can help you to assess better so we recommend highly to file and even some of the free zones are asking every company to file so all companies should look at that way to file the notification.

So, the next question is licensed activity does it needs to be as per the licensed activities or not. So, the simple answer to this question is law talks about substance over form approach. So, if in substance there is a transaction done, company need to file the notification even if the licensed activity is not a relevant activity

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