ESR Compliance in the UAE: What Every Business Needs to Know

11 Nov 2024

By Vista Corp

The UAE’s commitment to being a world-class business destination goes beyond just providing favourable conditions—it involves upholding standards that align with global economic frameworks. In recent years, the UAE has adopted various measures to meet international tax transparency standards, and one key initiative is the Economic Substance Regulations (ESR), implemented in April 2019. ESR is designed to prevent companies from misusing the UAE as a tax shelter without meaningful operations, supporting a fair and sustainable business environment. This regulation not only solidifies the UAE’s cooperative stance with global tax authorities but also reinforces its reputation as a trusted and compliant business hub.

Whether you’re setting up a new business or managing an established one, understanding and meeting the UAE’s Economic Substance Regulations is essential. To comply, companies must show real substance within the UAE—this includes ensuring key management decisions are made locally, maintaining a sufficient number of full-time employees, generating most of their income domestically, holding adequate assets, and demonstrating meaningful operating expenses within the country. These criteria are designed to establish a credible presence in the UAE, reinforcing the nation’s commitment to fair and transparent business practices.

What is Economic Substance Regulation (ESR) in UAE?

Economic Substance Regulations (ESR) in the UAE were introduced as part of the OECD’s Base Erosion and Profit Shifting (BEPS) Action Plan, aimed at creating fairer tax practices globally. These regulations prevent multinational companies from shifting profits to low-tax jurisdictions like the UAE without having real, substantial operations there.

Who Needs to Comply with ESR in the UAE?

The Economic Substance Regulations apply specifically to companies conducting certain relevant activities. Businesses involved in these activities must meet ESR’s requirements to demonstrate significant operations within the UAE, aligning with international standards. These relevant activities include:

• Banking – Businesses involved in providing financial services or banking activities.
• Insurance – Companies offering insurance products or managing insurance services.
• Investment Fund Management – Entities managing or administering investment funds.
• Lease-Finance – Companies involved in providing leasing or financing services.
• Headquarters – Businesses functioning as a central or parent organization overseeing other entities.
• Shipping – Entities engaged in transporting goods by sea.
• Holding Company – Companies primarily holding shares or other equity interests.
• Intellectual Property (IP) – Businesses involved in IP-related activities, including licensing and managing intellectual property assets.
• Distribution and Service Centre – Entities involved in distributing products or providing services to foreign group companies.

If your business is engaged in any of these activities, it must comply with ESR by demonstrating substantial economic presence in the UAE. This includes performing Core Income Generating Activities (CIGAs), which are specific to each relevant activity and involve:

• Management and Direction – The business must be directed and managed from within the UAE. This means holding and recording board meetings within the country, appointing a UAE-based manager or director, and ensuring key decisions are made locally.
• Substantial Resources – The business must maintain an adequate number of qualified employees, premises (such as an office), and annual operating expenditure in the UAE, relative to the nature and volume of the activity undertaken.
• Economic Substance Variation by Activity – Different ESR requirements apply depending on the specific activity. Companies must ensure compliance according to the nature of the activity they conduct.

For businesses not involved in these relevant activities, demonstrating economic presence is unnecessary. However, they are still required to file an ESR Notification and provide supporting evidence to confirm their exempt status.

If navigating ESR compliance seems complex, our team of expert advisors can guide you through each step, offering tailored advice to meet your specific business needs. We simplify the process, ensuring your company adheres to all ESR requirements accurately and efficiently.

ESR Reporting and Notification in the UAE

For businesses in the UAE conducting relevant activities, fulfilling Economic Substance Regulation (ESR) reporting and notification requirements is crucial to stay compliant. These companies must annually notify the regulatory authority, providing essential information, including:

• Confirmation of conducting a relevant activity within the UAE.
• Disclosure of any income that may be subject to taxation outside the UAE.
• The end date of the financial year.

In addition to the notification, businesses are also required to submit an annual report to the Regulatory Authority. This report demonstrates that the company meets the UAE’s economic substance test and must include:

• A detailed summary of the relevant activity conducted.
• Information on income generated, expenses incurred, and assets held within the UAE.
• Confirmation of adequate economic presence within the country, meeting ESR requirements for employees, premises, and operating expenditures.

Timely submission of this annual report is essential, with companies required to file it within 12 months from the end of each financial year. Ensuring accurate reporting not only keeps companies compliant but also helps maintain their standing with the UAE’s regulatory authorities, safeguarding their business operations in the region.

Penalties for Non-compliance with Economic Substance Regulations

Failure to comply with the UAE’s Economic Substance Regulations (ESR) carries significant penalties, as outlined in Cabinet Resolution No. 57 of 2020. These penalties are structured to ensure businesses meet reporting and operational requirements, promoting transparency and alignment with international tax standards.

• Failure to Submit Notification: Companies that fail to file the required ESR notification within six months from the end of their financial year may incur a penalty of AED 20,000, as specified under Article 13. Extensions may be granted by the competent authority, but failing to meet the initial deadline can lead to substantial fines.
• Failure to Meet the Economic Substance Test: If a company fails to submit the ESR report or does not meet ESR requirements within 12 months from the financial year-end, they face a penalty of AED 50,000. Repeat non-compliance in the following year may lead to a penalty of AED 400,000. In cases of continuous violations, the National Assessing Authority can further suspend, withdraw, or refuse to renew the company’s trade license.
• Providing Inaccurate Information: Companies that knowingly submit inaccurate ESR information or fail to correct inaccuracies when discovered are subject to a penalty of AED 50,000, as specified under Article 15.

Time Frames for Imposing Penalties

Penalties for ESR violations can be applied up to six years after the date of the violation, unless fraud has delayed enforcement. However, fines for providing inaccurate information are imposed within 12 months from when the authority learns of the inaccuracy, unless fraud is involved.

Information Exchange with Foreign Authorities

For companies penalized under Articles 14 and 15, the UAE’s National Assessing Authority will share information with the foreign competent authority of the parent company, ultimate parent company, and beneficial owners. This data exchange helps to uphold tax compliance on an international scale, ensuring businesses in the UAE contribute meaningfully to the country’s economic landscape.

Steps to Ensure ESR Compliance in the UAE

Maintaining compliance with the UAE’s Economic Substance Regulations (ESR) involves a proactive approach to ensure that your business meets all regulatory standards. Here are key steps to guide you through the compliance process:

• Assess Your Business Activities: Start by determining if your business activities fall under ESR requirements and assess whether your current operations meet the necessary substance standards.
• Implement Necessary Changes: If your business doesn’t meet the required standards, make adjustments, such as leasing office space, hiring local staff, or increasing your operational spending within the UAE.
• Maintain Accurate Documentation: Keep thorough records of your operations, including invoices, contracts and leases, to support your compliance with ESR reporting requirements.
• File Annual Reports: Ensure timely submission of your annual economic substance report, providing accurate information about your business activities and economic presence.
• Seek Professional Advice: Navigating ESR can be complex. Consulting with the Vista team, including experienced tax advisors and compliance specialists, can provide you with the guidance needed to stay compliant and avoid potential issues.

Following these steps will help your business stay aligned with the UAE’s ESR requirements, minimizing risk and promoting smooth operations.

Conclusion

Compliance with the UAE’s Economic Substance Regulations (ESR) is crucial for businesses involved in specified activities, ensuring transparency, avoiding penalties and contributing to the UAE’s strong reputation as a responsible global business hub. By meeting ESR guidelines, companies demonstrate genuine economic presence, aligning with both UAE standards and international expectations.

If your business needs support with ESR compliance, the Vista team is here to assist. Our experts offer tailored guidance to help you navigate regulatory requirements so you can focus on growing your business with confidence. Reach out to Vista Accounting and Taxation for comprehensive ESR support and keep your business aligned with UAE standards and positioned for long-term success.