What are the Relevant Activities Under Economic Substance Regulations in the UAE?
As the date for filing the annual Economic Substance Regulations (ESR) notification to the regulatory authority is nearing, the companies in the UAE are faced with the challenge of assessing whether they are undertaking the relevant activity or not. As per the Cabinet of Ministers Resolution No.31 of 2019, the companies carrying out the relevant economic activities are required to demonstrate the economic substance in the UAE. Since ESR compliance is mandatory, the companies need to clear the air over the relevant activities and their associated Core Income Generating Activities (CIGA), for which professional assistance of ESR service providers in Dubai, UAE is recommended.
List of Relevant Activities Under the UAE Economic Substance Regulations
The UAE businesses are required to notify the regulatory authority that whether they are undertaking a relevant activity in the UAE. There are a total of 9 economic activities as per the ESR. To determine whether they are carrying out the Relevant Activity, the companies should not only consider the activities stated in their trade license but the activities they perform in a financial year. The following are the Relevant Activities as per the ESR:
1. Banking Business
The UAE ESR Guidelines define the Banking Business as the businesses that accept cash deposits, which can be withdrawn on demand. Such businesses use deposits for providing loans, advances, overdrafts, guarantees, or making investments. The Core Income Generating Activities (CIGA) under banking business include
- Raising funds, managing risk including credit, currency and interest risk
- Taking hedging positions
- Providing loans, credit or other financial services
- Managing capital and preparing reports to investors or government authority
It is also important to note that the UAE financial institutions that are engaged in currency exchanges and remittance of money or financial intermediaries that are engaged in the sale and purchase of domestic and foreign stocks and bonds, currencies and commodities are not considered as banking business as per the ESR in the UAE.
2. Insurance Business
As per the ESR, an insurance business accepts risks by undertaking insurance contracts both in life and non-life categories. This includes contracts of reinsurance and captive insurance arrangements. The CIGA under insurance business include
- Predicting and calculating risk
- ‘Insuring or re-insuring against risk and providing Insurance Business services to customers
- Underwriting insurance and reinsurance
Insurance brokers, agents, and other UAE entities providing insurance-related services that do not involve the insured risk are not considered as conducting insurance business activity as per the ESR guidelines.
3. Investment Fund Management Business
The entities that provide discretionary investment management services such as investment, disinvestment, and risk are termed as investment fund management businesses under the ESR. If the UAE business is only engaged in providing fund administration, custodian, investment advisory, then it doesn’t come under the definition of the investment fund management businesses as per the ESR
The activities under the investment fund management business include
- Taking decisions on the holding and selling of investments
- Calculating risk and reserves
- Taking decisions on currency or interest fluctuations and hedging positions
- Preparing reports to investors or any government authority
4. Lease-Finance Business
The UAE companies that provide credit or financing is defined as lease-finance business as per the ESR. Such businesses provide the loan, enter into finance lease in relation to assets other than land. They also provide credit in the form of hire purchase agreements or other types of financial arrangements. Banks, insurance, and investment fund companies that also provide in lease financing services are not included under Lease-Finance Business to prevent duplicate reporting while demonstrating economic substance in the UAE.
The CIGA include
- Agreeing to funding terms
- Identifying and acquiring assets to be leased
- Setting the terms and tenure of any financing/leasing
- Monitoring and revising any agreements
- Managing risks
5. Headquarters Business
A UAE company is considered as undertaking a headquarters business if it provides services to foreign group entities by being responsible for the success of the group and the groups’ overall performance. To meet these criteria the services must include the provision for senior management and the company should assume the control of the material risk associated with the activities of the foreign group. It should also provide advice related to the control of the material risks. Businesses engaged in banking, insurance, investment fund management, and lease-finance also provide headquarters services but they are not included under this activity and are not required to demonstrate economic substance in the UAE separately.
The following activities are associated with the headquarters business:
- Taking relevant management decisions
- Incurring operating expenditures on behalf of group companies
- Coordinating group activities
6. Shipping Business
A company that operates multiple ships for international traffic for the transportation of either passengers or cargo or both are required to demonstrate the economic substance in the UAE in relation to the shipping business. However, the ships that are used for leisure, and fishing don’t come under the definition of ships as per the ESR. The vessels that are too small also are excluded from the ESR definition of the shipping business.
The following CIGA are included under the shipping business:
- Managing crew
- Overhauling and maintaining ships
- Overseeing and tracking shipping
- Deciding what goods to order and when to deliver them
7. Holding Company Business
A holding company business, as per the ESR definition, holds shares or equitable interests in other companies and doesn’t carry out any other commercial activity. The holding company business that fulfils the narrow definition of the activity and doesn’t carry out any other commercial activity only needs to demonstrate reduced economic substance. However, if the entity carries out other commercial activities and owns investments or assets, it needs to demonstrate increased economic substance requirements in the UAE. The core income-generating activities of the holding company business are related to holding shares in other companies.
8. Intellectual Property Business
Any UAE business that holds, exploits, or receives gross income from its intellectual property assets is regarded as an intellectual property business under the ESR. The intellectual property assets are in the form of patents, copyrights, trademarks, and brands from which the company earns separately identifiable income. The income can be earned in the form of royalty, license fees, franchise fees, capital gains, and any income from the sale of the intellectual property asset.
Businesses that don’t earn separately identifiable income from intellectual property assets are excluded from this definition. This is because most of the businesses own intellectual property assets in some form but instead of a separately identifiable income, such assets provide the owners with the protection of brand identity.
While submitting the annual ESR Notification and undergoing the economic substance test, an IP business needs to assess whether it is deemed as a High-Risk IP Business. A high-risk IP business is by default considered to have failed in the UAE economic substance test. In such a case, the regulatory authority will exchange information with the competent foreign authority such as where the Parent Company, Ultimate Parent Company and the Ultimate Beneficial Owner of the High-Risk IP Licensee are resident.
A UAE entity is considered a High-Risk IP Business if
- It did not create the IP Asset it holds for the business activity (it means IP asset is created by others)
- The company acquired the IP Asset from either a group company or from a person in a foreign jurisdiction in consideration for funding research and development
- The UAE company sold the IP Asset to one or more group companies or otherwise earns separately identifiable gross income eg. Royalties, license fees etc) from a foreign group company in respect of the use or exploitation of IP asset
However, the UAE company still needs to meet the economic substance test even if it has been identified as a High-Risk IP Business. Failing to meet the economic substance test would attract hefty fines. The company can meet the economic substance test by providing supporting documents that prove it historically had sufficient control over the IP assets.
9. Distribution and Service Centre Business
Two separate activities are clubbed together under the “Distribution and Service Centre” Business as per the UAE ESR guidelines: “Distribution business and service business”.
The UAE companies that undertake distribution businesses buy raw materials or finished goods from a foreign group company (foreign sister concern) and distribute them. A service centre business, on the other hand, provides services like consultation, administration and other related services to a foreign group company(foreign sister concern). However, such services should be related to the foreign group company’s business outside the UAE.
The CIGA under distribution business include:
- Transporting and storing goods, components, and materials or goods ready for sale
- Managing inventories
- Taking Orders
Meanwhile, the CIGA under service centre business is providing consultation or administration services.
How the ESR Compliance Services of Jitendra Chartered Accountants Assist the Companies?
All the UAE companies, except those entities in which the government holds a significant share, are required to comply with the Economic Substance Regulations (ESR) introduced by the UAE government. The companies need to demonstrate adequate economic substance in the relevant activities they carry out within the UAE. However, the businesses will be under pressure in determining whether they are carrying out the relevant activities. Also, they will be confused about how to demonstrate adequate economic substance in the UAE. It is in this situation that the ESR services of Jitendra Chartered Accountants (JCA) come to the aid of the UAE-based companies. The JCA assist the companies in
- Determining if the entities are subject to the Economic Substance Regulations
- File the annual Economic Substance Notification with the regulatory authorities
- Prepare and submit the Economic Substance Report to the authority annually
- Provide Recommendations on the Economic Substance test if the company is not satisfying the same