The companies that conduct the banking business in the UAE are required to meet the Economic Substance Test as per the Economic Substance Regulations (ESR). The banking business that generates income from the State Core Income Generating Activities (CIGAs) it carries out in the UAE to meet the annual ESR test as set out in article 6 of the regulations.
ESR Test as Defined in Article 6 of the Regulations:
All companies with activities and income in a relevant sector in an accounting period will be required to demonstrate the adequate economic substance in the UAE for which the following criteria (Tests) are required to meet, the company will generally require to:
- Be directed and managed in the UAE in relation to the activity – the Regulations contain specific requirements on how a company has to be directed and managed in the UAE
- The company has to establish that CIGAs has been undertaken in the jurisdiction, in relation to the level of the income derived from the relevant activity.
- Have an adequate number of qualified full-time employees in the UAE
- Incur an adequate amount of operating expenditure in the UAE
- Hold adequate physical assets in the UAE
Related: How Will Businesses be tested for ‘Adequate’ Economic Substance in the UAE?
Banking Business
The UAE ESR law defines the banking business as the business of accepting deposits of money which may be withdrawn, or that is payable on demand or after a fixed period, or after notice, by cheque or other modes and the use of such deposits either in whole or in part, in:
- the making or giving of loans, advances, overdrafts, guarantees or similar facilities; or
- the making of investments, for the account and at the risk of the Licensee
A Licensee that is part of a banking group and only provides advisory, arranging, and other services to clients of the banking group would generally not be considered to conduct a Banking Business (although such a Licensee should consider whether it undertakes another Relevant Activity). Further, Money Exchanges do not come within the scope of Banking Business as per ESR rules.
Core Income Generating Activities of Banking Business as per the Economic Substance Regulations (UAE)
To meet the Economic Substance Test in the UAE, the banking businesses should conduct the following CIGAs in the UAE in a financial year:
1. Raising Funds, Managing Risks
The CIGA under raising funds includes accepting deposits from the public, raising capital, issuing bonds or going to money markets. Managing risks include the activities carried out to ensure that the capital base of the Licensee is not eroded and to control the cost of funds. All the major decision-making processes related to these core activities must be performed in the UAE to ensure that the banking businesses are meeting the UAE economic substance test.
2. Taking Hedging Positions
A licensee conducting banking business mitigates risks by taking opposing or offsetting positions, which is referred to as taking hedging positions. As per the ESR regulations, the activities related to this CIGA are expected to be performed in the UAE.
3. Providing Loans, Credit or Other Financial Services
A banking business can meet the economic substance test by generating gross income by lending or investing its customer deposits or other available funds. The customers can be individuals, corporations, or other financial institutions.
4. Managing Capital and Preparing Reports
This CIGA involves compiling reports to investors or any government authority with functions relating to the supervision or regulation of such business. Since the banking sector is a highly regulated sector, its core functions include reporting to regulators and investors. The Licensee, however, must perform and supervise the reporting-related functions in the UAE.
Also read: ESR Compliance: 5 Requirements for the UAE Economic Substance Test
Illustrating Core Income Generating Activities of Banking Business through Examples
Scenario 1
A UK-headquartered named CBZ is offering current accounts, savings accounts, loans, credit cards, and other products and services to individual and corporate customers through a number of branches in the UAE. In this case, the CBZ Bank is conducting the CIGA to meet the Economic Substance Test.
Scenario 2
ABC is a UAE branch of the Investment Banking division of the CIG Banking Group. ABC conducts activities like underwriting new debt and equity securities, facilitating and advising buyers and sellers on mergers and acquisitions, and marketing financial products. In this case, ABC is licensed to accept deposits whose maturities are at least two years. Since ABC’s funding is limited to borrowings from its head office and from other banks, the entity would not be considered as conducting the CIGAs in relation to the banking business activity.
Scenario 3
PQR is the UAE branch of the EFG Banking Group that provides retail and corporate banking services globally. The activities of PQR are limited to providing UAE and regional customers with assistance and advice regarding the EFG Banking Group’s products and services, including assistance in the process of opening accounts with EFG Banking Group entities that are based outside of the UAE.
PQR is not considered to undertake a Banking Business by virtue of being in the same corporate group, and assistance in the opening of bank accounts would not be considered as conducting the CIGA of deposit-taking activities.
Why Choose Jitendra Chartered Accountants?
Carrying out the Core Income Generating Activities is one of the key requirements for a licensee to meet the economic substance test in the UAE. The ESR law has defined specific CIGAs for each of the 9 relevant activities which the Licensees need to undertake to meet the test. The Licensees need to assess whether they are conducting the CIGAs in the UAE to confirm whether they can meet the economic substance test. The assessment has become a necessity as the failure to pass the test may incur hefty penalties and other consequences or actions. To avoid such unforeseen events, the entities must enlist the services of professional ESR consultants like the Jitendra Chartered Accountants (JCA). JCA assists the companies to comply with the UAE ESR by
- Assessing if the entities can pass the ESR Test
- Recommend action plans if the Licensee doesn’t meet the ESR Test
- Help to file and submit annual ESR Return