The Economic Substance Regulations (ESR) were introduced in the United Arab Emirates (UAE) in 2019 to ensure compliance with global standards for preventing base erosion and profit shifting (BEPS). As a major international financial center, the UAE aims to demonstrate that its legal entities have real economic activities and substance within the country. This article will discuss the key aspects of complying with the ESR for companies licensed in the Dubai Multi Commodities Centre (DMCC) free zone.
Relevant Activities under the Economic Substance Regulations In DMCC
The relevant activities under the Economic Substance Regulations (ESR) in DMCC Free Zone include:
- Banking Business
- Insurance Business
- Investment Fund Management Business
- Lease-Finance Business
- Headquarter Business
- Shipping Business
- Holding Company
- Intellectual Property Business
- Distribution & Service Centre Business
These activities are outlined in the guidelines for ESR in the UAE and are subject to the Economic Substance Test, requiring companies to have substantial activities in the UAE and comply with specific reporting requirements
Compliance with Economic Substance Regulations in DMCC
To comply with the ESR in DMCC, companies need to take the following steps:
- Self-Assessment: Companies must self-assess if they have adequate economic substance for any relevant activities carried out. This involves directing and managing core income generating activities from the UAE and having adequate local staff, expenses and physical assets.
- Filing ESR Notification: All DMCC companies must file an ESR notification with the DMCC Authority by the deadline, declaring if they conduct a relevant activity in the UAE. The notification requires details such as financial year-end and any foreign tax paid.
- Submission of ESR Report: If a relevant activity is conducted, an ESR report must be filed within 12 months of the financial year-end. The ESR report must include details of local management, employees, premises, bank accounts, level of operating expenditures and revenue, assets, and any transfer pricing arrangements. It is important to maintain proper documentation to substantiate the details provided.
- Meeting the Economic Substance Test: The regulatory authority may conduct an assessment to ensure the company meets criteria for adequate economic substance as per the guidelines. To meet this test, companies must ensure adequate local management decisions are made, a sufficient number of qualified employees are employed full-time in the UAE, sufficient operating expenditures are incurred in the UAE, and adequate physical assets are owned or leased and located in the UAE.
- Deadline Adherence: It is crucial for companies to adhere to the deadlines for notification and reporting, as hefty penalties may be incurred for non-compliance.
Impact of ESR on DMCC Entities
The ESR has significant implications for DMCC entities, in several ways:
Increased Compliance Burden: Complying with the ESR notification, self-assessment, documentation and reporting requirements has increased the compliance burden for many DMCC companies. It requires allocating more resources to understand applicability, gather information, and prepare and submit the necessary filings on time.
Closer Scrutiny of Operations: DMCC entities now face closer scrutiny from the authorities to ensure their relevant activities, income, management, employees, expenditures and assets meet the economic substance criteria. They must be able to substantiate the details provided in the ESR report.
Higher Operating Costs: To meet the substance requirements, DMCC companies may need to increase local staff, rent larger office premises, purchase assets and incur higher expenditures. This can increase the overall operating costs of running a business through the DMCC.
Group Tax Structure Impacts: Non-compliance may result in a DMCC entity being considered a shell company for tax purposes. This can affect the entire group’s tax structure and result in penalties, back taxes or even license cancellation.
Reputational Risks: Any non-compliance or penalties imposed are also a reputational risk factor. DMCC companies aim to demonstrate legitimate operations with real economic activity to all stakeholders.
While the ESR aim to promote transparency, companies need to carefully manage applicability, compliance requirements and substance criteria to avoid undue compliance burdens and risks to their operations and group structure.
Assistance for DMCC Companies
Given the complexity of complying with the ESR, professional assistance is recommended. Audit and consulting firms can help DMCC companies with:
- Assessing applicability and conducting the self-review
- Preparing and filing the ESR notification
- Maintaining proper documentation for the economic substance test
- Developing and filing the annual ESR report
- Acting as the local substance representative
- Advising on any penalties or resolving issues with the authorities
By working with experienced advisors, DMCC companies can ensure full compliance with the ESR and avoid associated penalties. Overall, the ESR aim to demonstrate that legitimate business activities have real economic substance within the UAE. With proper compliance measures in place, companies can continue to conduct their operations smoothly.
Conclusion
In conclusion, the ESR are an important regulation for all companies operating in the UAE including those licensed by DMCC. Key requirements involve filing notifications and reports, conducting self-assessments, and meeting substance criteria. While compliance requires diligence, it helps legitimize business operations. Professional assistance can aid smooth compliance. Overall, the ESR support the UAE’s stance against tax avoidance practices.