OUE Substance
So, to avoid ending up on the EU blacklist for non-compliance with the BEPS plan requirements, the UAE was forced to adopt the Economic Substance Regulation. The regulation was adopted on 30 April 2019 as No. 31. Its announcement in June caused tension, if not panic, both in the professional community and among stakeholders whose business models are closely tied to this jurisdiction. After all, until recently the UAE was considered almost the most attractive jurisdiction in terms of substance compliance.
Let us look at the main aspects of the Economic Substance requirements. First of all, let us determine who they apply to. The new Regulation applies to all onshore companies in the UAE and to free zone resident entities in the UAE that earn income from one of the Relevant Activities, namely:
— banking;
— investment fund management;
— insurance;
— finance and leasing;
— service and distribution activities;
— headquarters services for a group of companies;
— holding company business;
— intellectual property ownership;
— shipping.
The BEPS minimum standard requires a company to comply with the Economic Substance requirements. Let us examine these requirements in detail, because even minor non-compliance leads to significant fines and sanctions, which we describe below. To confirm compliance with the Economic Substance requirements, a company has to pass tests. So we need to understand what these tests are and what they consist of.
- Conducting core income-generating activities in the UAE. The test is passed if the company's business activity matches the list of Relevant Activities, is carried out in the UAE, and its core income-generating activities correspond to those listed in the table below:
| Relevant activity | Core income-generating activities |
| Banking | · Raising funds. · Managing credit, currency and interest rate risks. · Hedging positions. · Providing loans, credit and other · financial services. · Capital management. · Preparing reports for investors or for any authorised government bodies responsible for supervising and controlling this type of activity. |
| Insurance | · Providing insurance services. · Insuring or reinsuring against risks and providing insurance services to clients. · Predicting and calculating risk. |
| Investment fund management | · Taking decisions on holding and selling investments. · Calculating risks and reserves. · Taking decisions on currency or interest rate fluctuations and hedging positions. · Preparing reports for investors or for any authorised government bodies responsible for supervising and controlling this type of activity |
| Finance and leasing | · Agreeing funding terms. · Identifying and acquiring assets to be leased. · Setting the terms and duration of any financing or leasing. · Monitoring and revising any agreements. · Managing risks. |
| Headquarters services for a group of companies | Providing the following activities within one group: · Taking relevant management decisions; · Incurring expenditure on behalf of group entities; · Coordinating group activities. |
| Shipping | · Managing crew (including hiring, paying and overseeing crew members). · Hauling and maintaining ships. · Overseeing and tracking deliveries. · Determining what goods to order and when to deliver them. · Organising and overseeing voyages. |
| Service and distribution activities (for a group of companies) | · Transporting and storing component parts, materials and goods ready for sale. · Managing inventory. · Taking orders. · Providing consulting or other administrative services. |
| Holding company | Companies whose main purpose is acquiring and holding shares in other companies and which do not carry on commercial activities. |
| Intellectual property | Owning, using and earning income from intellectual property such as copyrights, patents, technical know-how, as well as non-trade intangible assets (including trademarks), branding, marketing and distribution. |
- Demonstrating management and control.
The test is passed if:
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Most board meetings of the company are held in the UAE, in a sufficient number given the level of decision-making.
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Directors attend board meetings in person to form a quorum.
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Meetings are minuted in writing, and the directors present sign the minutes.
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The minutes kept at meetings record the company's strategic decisions.
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The directors have the knowledge/experience necessary to perform their
duties.
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All company documents and minutes that must be kept are to be stored in the UAE jurisdiction.
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In the case of branches or representative offices of foreign companies, or other commercial companies that have no board of directors and are run by a sole manager, that manager must be physically present in the UAE when key decisions on the organisation and management of such entities are taken.
- Adequate expenditure on employees and physical assets.
The test is passed if:
- An adequate number of employees are physically present in the UAE.
- There is adequate expenditure in the jurisdiction.
- Office premises of a proportionate size are used.
Pure holding companies deserve a separate mention.
Holding companies whose main source of income is purely equity participation, earning profit exclusively from dividends and capital gains, can pass the economic substance test under the following conditions:
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Compliance with the requirements for filing documents, records and information with the relevant regulatory authority under the legislation in force applicable to the company in the UAE.
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A proportionate number of employees and office premises to manage the holding company.
But there is a catch: these provisions do not apply to holding companies that earn income not from dividends and capital gains but from another source.
On compliance with the new Regulation.
The Regulation requires companies to notify the regulatory authority annually of the following:
- Whether they carry on or have ceased a Relevant Activity.
If the company does carry on a Relevant Activity;
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Whether all or part of the company's gross income from the Relevant Activity is subject to tax in a jurisdiction outside the UAE.
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The end date of the company's financial period.
A company that carries on a Relevant Activity and must pass the Economic Substance test must prepare and file a report with the regulatory authority no later than 12 months after the end of each of its financial years. The regulatory authority then forwards the report to the Ministry of Finance.
The financial year means the company's annual reporting period under its constitutional documents.
Fines and sanctions.
And now for the unpleasant part – the penalties that follow failure to comply with or breach of the rules and requirements of Regulation No. 31, namely when:
– the company has failed the economic substance test;
– the company does not provide information;
– the company provides incorrect information.
On the first determination of non-compliance with the economic substance requirements, a fine of AED 10,000 to AED 50,000 may be imposed
On a repeated determination, a fine of AED 50,000 to AED 300,000 may be imposed.
The regulatory authority reserves the right to apply any other administrative measures, including striking the company off the register, revoking or not renewing its licence.
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Whether they carry on or have ceased a Relevant Activity.
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Whether all or part of the company's gross income from the Relevant Activity is subject to tax in a jurisdiction outside the UAE.
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The end date of the company's financial period.
All of the above means that the UAE is very serious in its determination to remain on the “white” list of jurisdictions for international business. Even at the cost of losing its former attractiveness.
But has everything really become that bad? We believe not. It has become somewhat more complicated. However, if you see the restrictions of Regulation No. 31 as a solvable problem, the advantages of the UAE as a jurisdiction for international business remain the same.
So let us look at the options foreign businesses have in the UAE given the new legislative requirements. For example, a company may cease its activity or change it so that it no longer falls under the provisions on Relevant Activities. Or it may continue to operate in the UAE within the Relevant Activity it carries on.