The companies in the UAE that fall within the scope of the Economic Substance Regulations (ESR) are required to demonstrate economic presence in line with the level and type of substantial economic activities they carry out. To maintain economic presence the company needs to meet the Economic Substance Test by earning income from Core Income Generating Activities (CIGAs), being directed and managed in the UAE, and having adequate employees, premises and incur expenditure.
However, the big question that hangs in the air now is what will happen if a Licensee fails to meet the Economic Substance Test. The Economic Substance Test is considered as a litmus test for the companies to demonstrate that their business intentions are genuine and they are not conducting any harmful tax practices. Therefore, failing the economic substance test attracts actions and penalties from the relevant regulatory authority.
What are the Key Requirements to Meet the Economic Substance Test?
The mainland and free zone regulatory authorities determine whether or not a company is meeting the Economic Substance based on the following key criteria:
1. The Entity must undertake Core Income Generating Activities in the UAE
The companies need to conduct CIGAs in relation to the relevant activities they conduct in the UAE. The relevant activities as per the ESR are Banking business, Insurance Business, Investment Fund Management Business, Shipping Business, Lease-Finance Business, Distribution, and Service Centre Business, Headquarters Business, Intellectual Property Business, and Holding Company Business. Each Relevant Activity has a set of CIGAs associated with it and the companies need to demonstrate economic substance in the CIGAs.
2. The Company must be Directed and Managed in the UAE
In the second test, the companies are assessed to determine if they have held and attended an adequate number of board meetings in the UAE. The companies need to maintain a written minute of the meeting and all the attendees should sign it. A quorum of the meet must be met with all the attendees physically present in the UAE. Finally, the directors need to have the relevant knowledge and expertise to discharge their duties.
3. The Company must Maintain Adequate Staff
In a bid to meet the Economic Substance Test the companies should maintain adequate full-time employees who are qualified enough to manage the CIGAs. The employees must be physically present in the UAE while the activities were carried out.
4. Incur Adequate Operating Expenditure
The companies should have incurred adequate expenditure while carrying out the CIGAs in the UAE. If it is outsourcing the activities the expenditure incurred by the third party should be adequate to meet the test.
5. Has Adequate Physical assets in the UAE
The Licensees need to maintain adequate physical assets in the UAE to carry out the relevant activities. The assets could be the premises that the Licensee used to conduct the activity in the UAE.
6. If CIGA Outsourced, Licensee Should be Able to Monitor &Control
The ESR has provision to meet the economic substance test if the Licensee is outsourcing the CIGAs to another entity. In such a case, the Licensee should be able to monitor and control the entity to which the CIGAs have been outsourced.
What are the Consequences of not Meeting the Economic Substance Test?
If a Company fails to demonstrate adequate economic presence in the key test requirements, it will be considered as failed in the Economic Substance Test. In that case, the regulatory authority will issue a notice stating the following:
(a) The Company has doesn’t meet the Economic Substance Test in the given Financial Year
(b) The reason why the Authority determined that the company didn’t meet the test
(c) Amount of penalty imposed on the company for not meeting the test
(d) Date by which the penalty is due
(e) The actions companies need to take to meet the test
Administrative Penalties for not Meeting the Economic Substance Test
If a company fails to meet the Economic Substance Test then the regulatory authority will impose a fine between AED 10,000 and AED 50,000. A penalty in the range of AED 50,000- 300,000 will be imposed on the companies that do not meet the test in the subsequent year. The Regulatory Authority will issue a notice stating the exact amount of the notice and the penalty needs to be paid within 30 days of the issuance of the notice.
Exchange of Information for Failing to Meet the Economic Substance Test
After determining that a company has failed to meet the Economic Substance Test, the Regulatory Authority will inform the Competent Authority that the entity has failed to meet the test. The Competent Authority in accordance with relevant International Agreements and treaties will exchange the information about the company with the Foreign Competent Authority of the country or territory in which the parent company of the Ultimate Beneficial Owner resides.
Can a Company Challenge the Penalty for not Meeting the Economic Substance Test?
A company that fails to meet the Economic Substance Test has the right to appeal against the penalty. The appeal can be moved in on either of the following grounds:
(1) Make an appeal that the liability to the penalty doesn’t arise
(2) An appeal against the amount of penalty
Why Choose Jitendra Chartered Accountants?
The Economic Substance Regulations (ESR) were introduced by the UAE to ensure that the economy is in line with the global standards and to curb harmful tax practices. To comply with the ESR, the companies will be tested to ensure they are maintaining adequate economic substance in relation to the relevant activities they carry out in the UAE. Failing to meet the Economic Substance Test will attract penalties and actions such as the exchange of information with the competent authority.
To avoid such penalties the companies need the professional assistance of an audit firm like Jitendra Chartered Accountants (JCA). JCA has highly qualified Chartered Accountants and business setup consultants who assist the companies in meeting the Economic Substance Test. JCA provides services such as
- Assessing whether a company can meet the Economic Substance Test
- Give strategic recommendations if a company fails to meet the test
- Help the companies file and submit Economic Substance Return