Economic Substance: Confirming Economic Presence in the UAE

Published on

Economic Substance in the UAE

As part of the UAE's commitment to the Organisation for Economic Co-operation and Development (OECD), the country has implemented Economic Substance regulations. Offshore companies and those registered in free zones, among others, are required to adhere to these rules.

What is Economic Substance?

Profit shifting to avoid taxation is a global issue. To address this, the OECD unveiled a strategy in 2013 to counter tax evasion. Requirements for foreign companies were tightened, and automatic exchange of tax information was introduced.

The OECD made significant progress, with many countries worldwide implementing restrictions on tax agreements. The key outcome was the introduction of Economic Substance, necessitating the presence of a physical office, employees, and tangible assets in the country of registration.

Economic Substance requires a company's physical presence in the country where it is registered. Substance is demonstrated through the real conduct of business activities in the country, ensuring the company exists not only nominally but also physically. For local businesses (those created by locals or Gulf citizens), the requirements are more lenient.

Requirements for Economic Presence vary among countries, typically necessitating a real office, active communication methods (phone, email, website), and often, employment of local residents. Without proof of presence, opening a business account and enjoying double taxation avoidance agreement benefits is usually not possible.

Economic Substance Requirement in the UAE

The Economic Substance requirement was introduced in the UAE in 2019 following statements from the European Union (EU). In 2017, the EU listed the UAE as a country contributing to income shifting to more lenient jurisdictions, facilitating illegal tax evasion. This move led to the easing of restrictions by EU banking structures.

·         The mandatory presence requirement in the UAE applies to organizations engaged in specific activities. Entities falling under the Economic Substance Regulation (ESR) include companies involved in

  • leasing,
  • wholesale trading,
  • service provision,
  • managing investment funds,
  • insurance and banking,
  • and holding businesses. The list is not exhaustive.

Affected companies must annually submit declarations to the relevant authorities in the Free Zone or the emirate of registration, regardless of whether income was earned during the reporting period.

Economic Substance does not apply to businesses:

  • Registered in Free Zones engaged in activities specified in their registration documents.
  • Owned by the government, governmental entities, or where the government owns 51% or more.

How to Establish Economic Presence in the UAE

  • Lease a physical office: To confirm the existence of a genuine company presence in the UAE, a lease agreement or property ownership documents for commercial real estate are required.
  • Officially employ staff: The number of employees is calculated based on the size of the business.
  • Set up communication channels: Obtain a landline phone number, establish an active website with current contact details, and provide an address for receiving correspondence.
  • Confirm the presence of a decision-making center: Meeting protocols, for example, can be used to prove that the company genuinely operates in the UAE.
  • Report an adequate level of expenses.

Why Confirm Economic Presence in the UAE

Certain companies must confirm Economic Substance in the UAE by law. Failure to comply with this requirement results in financial sanctions. Meeting Economic Substance requirements carries additional benefits, such as avoiding double taxation, obtaining licenses for certain complex activities on a simplified basis, and benefiting from tax incentives. Honest businesses genuinely present in the UAE can expect complete confidentiality and shareholder anonymity. Another advantage is the ability to freely sign agency agreements and loan contracts.

How to Report Economic Presence

Companies falling under ESR requirements must annually submit notifications and reports to regulatory authorities. Testing for economic presence or submitting a report is not mandatory if the business did not generate income during the reporting period. However, a notification must still be submitted.

The main bodies overseeing compliance with Economic Substance norms are the Federal Tax Authority, the Ministry of Finance, the Central Bank of the UAE, and the administrations of free economic zones.

Sanctions for Non-Compliance

  • Failure to comply with ESR requirements leads to tax audits and increased financial costs for conducting business. Most violations incur administrative penalties:
  • Missing the deadline for submitting Economic Presence notification: A fine of AED 20,000.
  • Inaccuracies or incomplete information about the company's activities: A fine of AED 50,000.
  • Late submission or absence of the report: A fine of AED 50,000.

Foreign entrepreneurs planning to develop business in the UAE should seek the support of specialists familiar with local legislation. The Level Consulting experts provide comprehensive services for the registration and support of companies in the UAE, including assistance in obtaining tax residency in the United Arab Emirates and confirming economic presence.

Order a consultation

Learn about the benefits and details of starting or relocating a business in the UAE