Following a review conducted by the European Union on countries with low or nominal corporate tax, the committee prescribed the 'Economic Substance Regulations' and requested that the low tax jurisdictions review their own regulations and make efforts to ensure their compliance with best practices. The purpose of the regulations is to impede potentially harmful tax practices by requiring entities within low tax jurisdictions to demonstrate they carry out a substantial amount of economic activity in the country in which they are incorporated.
As a result, on 30 April 2019, the UAE Cabinet issued Cabinet of
Ministers Resolution No 31 of 2019, which concerns economic
substance regulations in the UAE, requiring all qualifying UAE
entities that conduct 'relevant activities' to demonstrate
their economic substance in the UAE on an annual basis.
Over the course of 2019, the Ministry of Finance published a series of guidelines, flow charts and information to assist UAE entities in assessing whether they would be considered subject to the new Economic Substance Regulations and if so, to advise of the applicable deadlines which they must adhere to.
Who is subject to the Economic Substance Regulations?
According to the relevant laws and regulations, the definition of an entity which falls within the scope of these guidelines is broad and is considered as any entity with a UAE trade license that carries out a 'relevant activity'. The relevant activities are listed as follows:
- Banking Businesses
- Insurance Businesses
- Investment Fund Management Businesses
- Lease-Finance Businesses
- Headquarter Businesses
- Shipping Businesses
- Holding Company Businesses
- Intellectual Property Businesses
- Distribution and Service Centre Businesses
It is important to note that the regulations apply irrespective of whether the entity is in a free zone or is considered as a mainland entity. Entities which are excluded from the regulations are any that are directly or indirectly owned by the government.
What are the requirements?
In order to fulfil the economic substance requirements, a relevant UAE entity that conducts a 'relevant activity' must comply with the following:
- Conduct the 'core income-generating activity' within the UAE;
- direct and manage the entity from the UAE;
- employ full-time staff in the UAE (or outsource to a UAE-based provider);
- incur operating expenditure in the UAE;
- retain adequate physical assets in the UAE.
Compliance with reporting requirements
Any Relevant Entity is required to notify their regulatory authority (i.e. the authority which issued their Trade License) and submit their annual report in line with the prescribed deadlines.
The annual reports must contain information concerning the relevant activity, the income, any assets or expenses and a declaration that the requirements of the Economic Substance Test have been met.
As each regulatory authority is empowered to decide whether an entity is in compliance with the Economic Substance Test, each authority may interpret the application of the test differently.
The aforementioned requirements are the general requirements that are applicable to relevant entities. However, where an entity is considered to conduct "high risk Intellectual Property activities' they will be subject to more stringent requirements.
What does this mean for Intellectual Property?
A UAE entity is considered to conduct the relevant activity of Intellectual Property (IP) if it holds, exploits or receives income from any IP Assets.
The above does not apply to an entity that simply maintains its intellectual property portfolio as a supplementary part of their business activity. The majority of entities within the UAE will hold IP assets in the form of trademarks, patents, copyrights and trade secrets in order to protect their brand for the goods or services that they offer. However, simply owning IP assets does not equate to conducting the business activity of Intellectual Property for the purposes of the Economic Substance Regulations, unless an entity is using its IP assets to procure and benefit from a separate income.
In the event that an entity is using their Intellectual Property assets to procure a separate income by way of a licensing or franchise agreement and where they are in receipt of royalties, the entity will be required to declare 'Intellectual Property' as a relevant business activity to their regulatory authority and submit their reports demonstrating compliance with the Economic Substance requirements.
According to the applicable regulations, the core income-generating activity required will depend on the IP asset that is being exploited and how the asset is operating to procure income.
High Risk Intellectual Property Licensee
In accordance with the Economic Substance Test conditions, where an entity established in the UAE is a Licensee of Intellectual Property and is conducting the business activity of Intellectual Property within the UAE, it will need to consider whether it falls within the remit of a 'High Risk' Licensee and will be required to declare this accordingly.
A Licensee is considered a High Risk IP Licensee if it receives income from an Intellectual Property asset and meets all of the following three requirements:
1. The Licensee did not create the IP asset which it holds for
the purpose of its business; and
2. The Licensee acquired the IP asset from either:
- A group company; or
- In consideration for funding research and development by another person situated in foreign jurisdiction; and
3. The Licensee licenses or has sold the IP Asset to one or more group companies, or otherwise earns separately identifiable income (e.g. royalties, licence fees) from a foreign group company in respect of the use or exploitation of the IP asset.
As per the regulations, 'income derived from IP assets poses a greater risk of profit shifting as opposed to income derived from non-IP related activity'. Therefore, any Licensee which meets the above criteria of a High Risk IP Licensee will be presumed as automatically failing the Economic Substance Regulation Test. As a result, the UAE will automatically exchange information with the any concerned Foreign Competent Authorities to which the Parent Company, Ultimate Parent Company and/or Ultimate Beneficial Owner of the High Risk IP Licensee are residents of.
The presumption can then be rebutted by the concerned Licensee in the event that they are able to fulfil the enhanced economic substance requirements. This includes producing evidence of the following:
- that decision making is taking place with the UAE.
- that it has or had a high degree of control in developing the IP asset
- that it has a business plan demonstrating the reasons for holding IP assets in the UAE
- that it has adequate full-time employees permanently residing in the UAE
In the event that a High Risk IP Licensee is unable to meet the enhanced Economic Substance requirements, the Licensee will receive notice of the application an administrative penalty in addition to any actions it must undertake to satisfy the Economic Substance Test. The administrative penalty should not exceed fifty thousand Dirhams in the first instance. However, if the Licensee fails to meet the conditions of the test in the next financial year, the penalty will increase to up to three hundred thousand Dirhams.
The proper implementation of Economic Substance law in UAE will proof the country's commitment to IP owners that incorporate their IP holding companies in UAE to be internationally accepted without busines difficulties. For instance, the issue resulted from a review of the UAE tax framework by the EU resulted in the UAE being included on the EU list of non-cooperative jurisdictions for tax purposes (EU Blacklist) should be resolved in the future. IP owners are invited to meet their regulatory commitment, make submission to authorities and disclose their assets/licenses in according to acceptable formalities. Holding companies, such as those at JAFZA or any other free zones, are being notified by their companies' registrars and urged companies to complete and file the forms. This demonstrate a serious step is being taken to implement and enforce this law to clear UAE from the EU list and enrich the level of transparency in doing business in UAE as being the leading economic hub at the region.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.