Skip to content

Importance of Economic Substance(ESR)in the UAE

The issue of corporate economic substance is high on the agenda of tax authorities globally, following recent developments to improve fairness and cooperation in international tax.

As a member of the OECD inclusive framework, UAE is committed to ensuring that the UAE’s legal and commercial framework is in line with global standards. As apart of this commitment, Economic Substance Regulations (“ESR”) were introduced to the UAE in April 2019.

These regulations are applicable to all natural or legal person licensed to carry out a ‘Relevant Activity’ in the UAE. This includes licensees in Free Zones, Financial Free Zones and Offshore Free Zones. The regulations apply to financial year commencing from 1 January 2019.

Whilst each jurisdiction will have its own approach, here we highlight some of the key points tax authorities are expected to consider when determining whether a company has sufficient economic substance.

These regulations are applicable to all natural or legal person licensed to carry out a ‘Relevant Activity’ in the UAE. This includes licensees in Free Zones, Financial Free Zones and Offshore Free Zones. The regulations apply to financial year commencing from 1 January 2019.

Tax residence

Determining where a company is tax resident is important as this will typically be the jurisdiction that has primary taxing rights over the company’s income. A company will generally be tax resident in the jurisdiction in which it is incorporated, but circumstances can arise where another jurisdiction also claims primary taxing rights.

In the UAE, for example, case law has determined that a company that is not incorporated in the UAE is tax resident in the UAE if it is ‘centrally managed and controlled’ in the UAE The test applies to identify where the highest level of management and control over a company’s affairs is exercised (ie where the key strategic business decisions are made), as opposed to decisions over normal day to day operational matters.

Where more than one jurisdiction claims primary taxing rights and a double tax treaty applies, the treaty will typically require consideration of where such strategic decisions take place in determining the territory of residence recognised under the treaty. This will generally be where board meetings take place, but the location of such meetings is not necessarily conclusive and the facts of each case need to be considered on their own merits. 

It is therefore important to ensure that management’s actions do not cause the company to unintentionally become tax resident in another jurisdiction. Being resident in more than one jurisdiction can give rise to unexpected tax liabilities and compliance costs, either through dual residence itself, or the need to claim relief from double taxation where available.

What factors will the tax authorities consider?

A number of factors will be taken into account by tax authorities when considering where control over a company is exercised, such as:

  • the location of board meetings;
  • how directors attend board meetings (eg in person or remotely via electronic communications);
  • where the directors are tax resident; and
  • whether the board meeting simply ‘rubber-stamps’ significant decisions made outside of the meeting.

As a minimum, therefore, board minutes should evidence key strategic decisions being made in the meeting held at the appropriate location. If the board of directors does not, in practice, make the key decisions, tax authorities will look to understand who does, and where.

Why it matters

Tax residence and corporate economic substance are ultimately matters of fact. However, it is important for companies to take necessary steps to ensure they do not inadvertently become tax resident in another jurisdiction.

With global corporate tax rates generally falling, there is likely to be pressure on jurisdictions to prevent the loss of tax receipts. This could therefore bring the topic of corporate residence even more to the fore as countries seek to protect their tax base.

Are you ready with ESR Return Filing in the UAE ?

If you are concerned about whether your business operations meet the ESR tests and compliance obligations, our team of specialists can help. Alya Auditors offers a range of services to help you in this journey.

We’re a leading firm of chartered accountants & VAT/Tax advisers supporting entrepreneurs, high net worth individuals, family offices and growing businesses in UAE.

Recent Posts

error: Content is protected !!