Economic Substance Regulations
The UAE has enacted Economic Substance Regulations (“ESR”) that applies in all UAE jurisdictions, including financial free zones such as the DIFC. In the DIFC, the ESR will be administered by the Registrar of Companies (“Registrar”) for all DIFC entities, including entities that are regulated by the DFSA.
Key points to note about ESR and how to prepare your business for it are set out below:
1. All DIFC entities are required to submit an economic substance notification by 30 June 2020 in the DIFC Client Portal
2. The UAE Ministry of Finance has issued a Relevant Activities Guide which should assist you in determining whether your business conducts a relevant activity and falls within the scope of the ESR.
3. Your business may also be required to file an economic substance return (“ES Return”), within 12 months of your financial year end, to demonstrate that your business meets the ESR requirements. Information relating to the ES Return will be issued in the second half of 2020.
The relevant UAE Economic Substance Legislation can be found at the Ministry of Finance Website.
Further information on the ESR can be found in the presentation (which can be accessed by clicking on the “Download PDF” button below) and on the Ministry of Finance’s Economic Substance Regulations page.
While it is each DIFC entity’s responsibility to evaluate their obligations under the ESR, determine whether it conducts a Relevant Activity and ensure compliance with the regulations, the DIFC will provide support by conducting outreach sessions and general enquiries can be directed to email@example.com or you can call us on +971 (0)4 362 2222. The DIFC will not be able to provide specific advice relating to your entity, confirm whether it conducts a relevant activity, or whether it meets the economic substance test.
Economic Substance FAQs
Q1- What are the Economic Substance Regulations (“ESR”) and why did the UAE government enact them?
ESR have been introduced in countries with low or no corporate taxes, in order to comply with international initiatives to combat harmful tax practices including unlawful avoidance or evasion. ESR requires certain legal entities to demonstrate that they carry out substantial economic activities in these jurisdictions, in accordance with the Economic Substance Test (see Q6 below).
The UAE introduced the Economic Substance Regulations, applicable in free zones as well as on-shore, to honour its commitment as a member of the OECD Inclusive Framework on Base Erosion and Profit Shifting (“BEPS”), and in response to a review of the UAE tax reporting framework by the European Union (EU). The purpose of the Regulations is to ensure that UAE entities undertaking certain activities report actual profits that are commensurate with the economic activity undertaken within the UAE.
Q2- When did the ESR come into force?
The UAE Economic Substance Regulations came into force on 30 April 2019, and subsequent guidance on the regulations was issued on 11 September 2019. Regulatory Authorities responsible for administering the ESR were identified in a Ministerial Resolution issued on 4 September 2019. Amendments were made to the ESR in Cabinet Decree No. 7 of 2020, which was issued on 19 January 2020. The Ministry of Finance is working with the OECD to further refine the scope and applicability of the UAE Economic Substance Regulations. Updates will be posted on this website and on the Ministry’s website.
Q3- Who does the Economic Substance Regulations apply to?
The Regulations primarily apply to legal entities that carry out a ‘Relevant Activity’.
Q4- What are the Relevant Activities?
The Relevant Activities under the Economic Substance Regulations are:
- Banking Businesses
- Insurance Businesses
- Investment Fund Management Businesses
- Lease-Finance Businesses
- Headquarters Businesses
- Shipping Businesses
- Holding Company Businesses
- Intellectual Property Businesses
- Distribution and Service Centre Businesses
Please refer to the UAE Economic Substance Relevant Activities Guide issued by the Ministry of Finance for further information and explanation on each of the above Relevant Activities.
Q5- Are the Economic Substance Regulations applicable to DIFC entities?
- The Regulations apply to DIFC entities and are administered by the Registrar of Companies in the DIFC.
- All UAE entities, whether they are located onshore or in a free-zone (including financial free-zones, such as the DIFC and the ADGM) are subject to the Regulations.
Q6- What is the Economic Substance Test?
The Economic Substance Test requires a DIFC entity to demonstrate that:
- the DIFC entity and the Relevant Activity are being directed and managed in the UAE;
- the relevant Core Income Generating Activities (CIGAs) are being conducted in the UAE; and
- the DIFC entity has adequate employees, premises and expenditure in the UAE.
Q7- What do DIFC entities need to do in the short term?
The ESR apply everywhere in the UAE, including free zones. As such, ALL DIFC entities (including regulated firms and those that qualify for an exemption) are required to file a notification (“Notification”) with the Registrar on the DIFC Client Portal (please refer to Q8 – Q12).
Q8- Which DIFC entities need to file a Notification and by when?
The first deadline for filing Notifications under the Economic Substance Regulations is June 30, 2020. While this deadline is most relevant for firms that have a financial year commencing on or after 1 January 2019 and ending on or before 31 December 2019, the Registrar exercises his powers under the Operating Law 2018, to require all DIFC entities to file a Notification, in order to ensure that the Economic Substance Regulations are properly implemented in the DIFC and to assist firms to comply with their requirements under these Regulations. Therefore, each DIFC entity, that is incorporated or registered under one of the following licensed in DIFC laws, is required to file its Notification with the Registrar via the DIFC Client Portal:
- Private Companies incorporated under the Companies Law 2018;
- Public Companies incorporated under the Companies Law 2018;
- Branches of companies registered under the Companies Law 2018;
- General Partnerships and Recognised Partnerships (branches) registered under the General Partnership Law 2004;
- Limited Partnerships and Recognised Limited Partnerships (branches) registered under the Limited Partnership Law 2005;
- Limited Liability Partnerships registered under the Limited Liability Partnership Law 2005;
- Foundations registered under the Foundations Law 2018; and-
- Incorporated Organisations under the Non Profit Incorporated Organisations Law 2014.
DIFC entities that are in the process of liquidation (under dissolution) are required to comply with the Economic Substance Notification requirement in respect of Reportable Periods ending on or before the completion of the liquidation process.
Q9– Who is currently exempt from filing a Notification?
Only DIFC entities that have been dissolved, struck-off or liquidated prior to the deadline for submission of the Notification, are not required to file a Notification.
All other entities are required to file Economic Substance Notification, including those that are currently in the process of dissolution / liquidation.
Q10- Can a single Notification be filed for multiple DIFC entities?
No, each DIFC entity must file a Notification on a stand-alone basis, irrespective of whether the entity is part of a consolidated group, for accounting purposes.
Q11- What is the Reportable Period referred to in the Notification?
The Reportable Period is the financial period commencing after 1 January 2019 to which the Notification relates. DIFC entities are required to include the "start" and "end" date of the relevant financial period. Please refer to the examples below:
- Start date: 1 January 2019
- End date: 31 December 2019
A DIFC entity incorporated on 1 July 2019 with a 31 March 2020 financial year end, would have the following Reportable Period:
- Start date: 1 July 2019
- End date: 31 March 2020
A DIFC entity incorporated on 1 June 2018 with a long financial year ending on 31 December 2019, would have the following Reportable Period:
- Start date: 1 January 2020
- End date: 31 December 2020
In this example, the firm’s first reportable period will be 1 January 2020 to 31 December 2020 and an initial Notification will be due on 30 June 2020 for this reportable period, and a subsequent Notification would be due in 2021, after the end of the entity’s financial year.
Q12- What happens if a DIFC entity does not submit a Notification?
Non-compliance with the obligation to file an Economic Substance Notification before the deadline may be subject to a fine of up to US$25,000 from the Registrar under Article 31(2) of the Operating Law, DIFC Law No. 7 of 2018 for a failure to comply with a requirement of the Registrar as well as penalties under the UAE Economic Substance Regulations ranging from AED 10,000 to AED 50,000 (refer to Q16).
Q13- What are the key compliance requirements of an entity carrying out Relevant Activities under the Regulations?
An entity carrying out Relevant Activities must:
- demonstrate economic substance in the DIFC in accordance with the economic substance test (see Q6); and
- file an ES Return containing all requisite information on an annual basis, within 12 months of the end of a relevant financial period. Information relating to the ES Return will be issued in the second half of 2020.
Q14- What if false or incorrect information is filed in the Notification?
Intentionally or knowingly providing incorrect or false information in the Economic Substance Notification is subject to a fine of up to US$50,000 from the Registrar for breach of Article 66(2) of the Operating Law for concealing information or providing false or misleading information, as well as penalties ranging from AED 10,000 to AED 50,000 under the UAE Economic Substance Regulations. In addition, knowingly providing incorrect or false information or incorrectly claiming an exemption from the Economic Substance Regulations can result in the DIFC entity being deemed to have failed the economic substance test for the relevant accounting period.
Q15- Who is currently exempt from filing an ES Return demonstrating economic substance?
- DIFC entities that are directly or indirectly owned 51% or more by the UAE government (Federal or Emirate level)
- DIFC entities that carry out a Relevant Activity but do not earn income from it
Q16- What are the penalties under the Regulations?
- Failure to file a Notification – penalty of AED10, 000 - AED50, 000
- Failure to provide accurate or complete information - penalty of AED10, 000 - AED50, 000
- Failure to demonstrate sufficient economic substance in the UAE for the relevant Financial Year.
1. Penalty for first year:
(a) AED10, 000 - AED50, 000; and
(b) information exchange with foreign competent authority of:
(i) Parent company;
(ii) Ultimate parent company; and
(iii) Ultimate beneficial owner
2. Penalty for second consecutive year of failure:
(a) information exchange (see 1(b) above);
(b) penalty of AED100, 000 - AED300, 000; and commercial license could be: suspended, withdrawn or not renewed
With respect to the filing of the first Notifications under the Regulations by 30 June 2020, only DIFC entities that conduct a relevant activity and have a reportable period that ends on or before 31 December 2019 are subject to the fine for failure to file a Notification. For DIFC entities with a financial year that ends after 31 December 2019 (e.g. a financial year ending 31 March 2020 or 30 June 2020), there is no statutory requirement under the UAE Economic Substance Regulations to file a Notification by 30 June 2020, and accordingly no administrative penalties will apply under these Regulations for such entities, if a Notification is not submitted by the 30 June 2020 deadline. While the Registrar will not issue fines for firms with a financial year ending after 31 December 2019 that fail to file a Notification by 30 June 2020, the Registrar strongly encourages all entities to file a Notification to ensure that all DIFC firms comply with the Economic Substance Regulations. The Registrar recognises that firms with a financial year that ends after 31 December 2019 may not have completed their financial year and therefore these firms will be able to file a further Notification, after the end of their financial year. Accordingly, the Registrar will communicate the deadline for filing a further Notification for reportable periods ending after 31 December 2019, during the second half of this year.
Q17- Where can I find out more information about Economic Substance?
At the Ministry of Finance’s Economic Substance Regulations page, which includes additional FAQs and other useful background information.